Page 98 - DECO101_MICRO_ECONOMICS_ENGLISH

Unit 7: Production Theory

Notes
Example: If the firm employs more labour, it must employ less capital if it wishes to

continue producing the same level of output. However, only when there exists a technical
substitution between the two inputs (labour and capital) will the isoquant have a negative
slope. In other words, only if it is possible to substitute capital for labour, will the isoquant
be downward sloping.
2. Isoquants curves are convex to the point of origin. This stems from the fact that while labour
and capital may be technical substitutes for each other they are not perfect substitutes.
Within limits, labour and capital can be substituted for each other but the more the capital
is sacrificed for additional units of labour, the more difficult it becomes to substitute

additional labour for capital. Thus the producer is willing to sacrifice fewer and fewer units

of labour for additional units of capital.
3. Isoquants representing different levels of output can never intersect each other. If they did,
it would be a logical contradiction. It will mean that isoquants representing different levels
of output are showing the same amount of output at the point of intersection, which is an
illogical conclusion.

4. Higher Isoquants denote higher level of output: The further away an isoquant lies from the
origin, the higher is the level of output denoted by it.

7.3.3 Marginal Rate of Technical Substitution

Marginal Rate of Technical Substitution (MRTS) is the amount by which the quantity of one input
has to be reduced (− Δx ) when one extra unit of another input is used (Δx = 1), so that output
2 1
remains constant ( y = y ) .
Δ x MP
MRTS(x ,x ) =− 2 = 1
1 2 Δ x 1 MP 2
where MP and MP are the marginal products of input 1 and input 2, respectively.
1 2
Along an isoquant, the MRTS shows the rate at which one input (e.g. capital or labor) may be
substituted for another, while maintaining the same level of output. The MRTS can also be seen
as the slope of an isoquant at the point in question.

Task Take any hypothetical example and calculate MRTS for a fi rm.

7.4 Isocost Lines

If a firm uses only labour and capital, the total cost or expenditure of the firm can be represented

by:
C = wL + rK
where,
C = Total cost
w = Wage rate of labour
L = Quantity of labour used
r = Rental price of capital
K = Quantity of capital used

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