The chapter examines the theory of production or how firms organize production i. Slope of an iso-quant curve is influenced by the technical possibility of substitution between factors of production. Conclusion: Cost minimisation occurs when an isoquant is just tangent to but does not cross an isocost line. But they intersect each other at point A. Then the output must increase. A set of isoquants which represents different levels of output is called ' isoquant map'. Thus only an unwise entrepreneur will produce in the dotted region of the iso-quant 100.
On an isoquant map this would be shown by the isoquants getting further apart. If isoquant has several linear segments separated by kinks, the isoquant is called kinked isoquant or activity analysis isoquant or linear programming isoquant. The essential condition is that the slope of the isocost line must equal the slope of the isoquant. If the price of labour rose the line would swing in. To put it differently, as more units of labour are used, and as certain units of capital are given up, the marginal productivity of labour in relation to capital will decline. In short, both the concepts of returns to scale and returns to a factor change in factor proportions can be explained by using the technique of Isoquants. By returns to scale we are talking about the increase in output given an increase in capital and labour.
Consider the producer has only two production factors, factor A and factor B. A change in factor price makes changes in the slope of isocost lines as shown in the figure. Take into account that, in this case, the production is data storage. It is the corner point of L-shaped isoquant. Will it double, increase by more than double or less than double? Thus at a point of equilibrium marginal physical productivities of the two factors must be equal the ratio of their prices.
The marginal rate of technical substitution between L and K is defined as the quantity of K which can be given up in exchange for an additional unit of L. If it is horizontal the quantity of labour increases, although the quantity of capital remains constant. At low levels of output they will experience economies of scale. Equation 1 states that for an increase in the use of labour, fewer units of capital will be used. They follow the same shape as indifference curves, sloping downwards, as you can see below.
Different factors are needed to produce a good. The line swings out, pivoting around the point on the y axis. We say that such a production function has a diminishing marginal rate of technical substitution. Two Factors of Production: Only two factors are used to produce a commodity. This shape is a consequence of the fact that if a producer uses more of capital or more of labour or more of both than is necessary, the total product will eventually decline. We may note that the isoquants Iq 1 and Iq 2 are parallel but the isoquants Iq 3 and Iq4 are not parallel to each other. This means, that, as we move to the left, we need to add more K for every worker we subtract.
Each isoquant measures the combinations of capital and labour a firm would need to produce a constant output. Prices of the factors of production and 5. For example, the cost would be Rs. The iso-product map looks like the indifference of consumer behaviour analysis. In both cases the factors will have to be employed in optimal combination at which the cost of production will be minimum. Higher the isoquant, higher will be the level of output produced. Here, the price of labour wages have fallen and therefore the firm can afford more of them with a given budget.
The figure below shows that when a firm moves down from point a to point b and it uses one additional unit of labor, the firm gives up 4 units of K and yet remains on the same isoquant at point b. That is, it is adding extra output to total product but at a declining rate. Along an isoquant output is constant, so the decrease in output caused by the decrease in z 1 must be exactly equal to the increase caused by the increase in z 2. Table 1 illustrates, by using hypothetical numbers, seven alternative methods of producing six units of output. They follow the same shape as indifference curves, sloping downwards, as you can see below. Typically, in the long run the firm will experience a varying level of costs. The isoquant is known, alternatively, as an equal product curve or a production indifference curve.
Consider the producer has only two production factors, factor A and factor B. If the output changes proportionally, we say that the production function has constant returns to scale. What is the long run? This leads to the producer substituting factor A for factor B. Now what is the biggest slope? Make sure you can calculate it in the table. This shape is a consequence of the fact that if a producer uses more of capital or more of labour or more of both than is necessary, the total product will eventually decline. Suppose you get a 70 instead in this class what happens to your average. Try to explain in your own words why diminishing returns set in.