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Lecture Managerial economics (10/e): Chapter 9 - Christopher R. Thomas, S. Charles Maurice

In this chapter students will be able to: Draw a graph of a typical production isoquant and use the definition of an isoquant to explain why isoquants must be downward sloping, discuss the properties of an isoquant, construct isocost curves for a given level of expenditure on inputs,. | Chapter 9: Production and Cost in the Long Run McGraw-Hill/Irwin Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved. Production Isoquants In the long run, all inputs are variable & isoquants are used to study production decisions An isoquant is a curve showing all possible input combinations capable of producing a given level of output Isoquants are downward sloping; if greater amounts of labor are used, less capital is required to produce a given output A Typical Isoquant Map (Figure 9.1) Production Function 8- Typical Isoquants 9- Marginal Rate of Technical Substitution The MRTS is the slope of an isoquant & measures the rate at which the two inputs can be substituted for one another while maintaining a constant level of output The minus sign is added to make MRTS a positive number since ∆K / ∆L, the slope of the isoquant, is negative The MRTS can also be expressed as the ratio of two marginal products: Marginal Rate of Technical Substitution | Chapter 9: Production and Cost in the Long Run McGraw-Hill/Irwin Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved. Production Isoquants In the long run, all inputs are variable & isoquants are used to study production decisions An isoquant is a curve showing all possible input combinations capable of producing a given level of output Isoquants are downward sloping; if greater amounts of labor are used, less capital is required to produce a given output A Typical Isoquant Map (Figure 9.1) Production Function 8- Typical Isoquants 9- Marginal Rate of Technical Substitution The MRTS is the slope of an isoquant & measures the rate at which the two inputs can be substituted for one another while maintaining a constant level of output The minus sign is added to make MRTS a positive number since ∆K / ∆L, the slope of the isoquant, is negative The MRTS can also be expressed as the ratio of two marginal products: Marginal Rate of Technical Substitution As labor is substituted for capital, MPL declines & MPK rises causing MRTS to diminish 6– Marginal Rate of Technical Substitution Slope of production isoquant Slope of production isoquant reflects relative marginal product of labor and capital Isocost Curves Show various combinations of inputs that may be purchased for given level of expenditure (C) at given input prices (w, r) Slope of an isocost curve is the negative of the input price ratio (-w/r) K-intercept is C/r Represents amount of capital that may be purchased if zero labor is purchased Isocost curve . Isocost Curves (Figures 9.2 & 9.3) Optimal Combination of Inputs Two slopes are equal in equilibrium Implies marginal product per dollar spent on last unit of each input is the same Minimize total cost of producing Q by choosing the input combination on the isoquant for which Q is just tangent to an isocost curve Optimal Input Combination to Minimize Cost for Given Output (Figure 9.4) Optimal Allocation