Page 219 - DECO401_MICROECONOMIC_THEORY_ENGLISH

Microeconomic Theory

Notes If the combination of minimum cost of inputs would be retrieved then the producer would certainly
substitute capital in respect to labour. Because when the price of labour increases, all matter remain
same, then capital gets cheaper. Initially, price average was P /P = 50/75, now it is 75/75, it means
L
K
capital is cheaper than labour.
The minimum cost combination would definitely change now. Now how much should invest in labour
and capital so that the expenditure becomes less?
Definitely, this matter depends on the technical substitution rate between labour and capital. This
imaginary position is described by Fig. 10.10.
To produce similar 100 units of pen, 10 units of labour and 18 units of capital are sufficient. However
the cost of both labour and capital is now 75, but capital is more efficient than labour. So now more
capital and less labour will be used. With this new combination, the minimum production cost to
produce 100 pens is—

(18 × 75 + 10 × 75) = 2,100
E is the new point for the new factors of profit maximization in which 18 units of capital, which is
1
comparatively cheaper, and 10 units of labour, which is comparatively costly, and undoubtly here is no
change in capital.

Fig. 10.10
Y

20

Capital 18 E 1 E
10

IQ (100)
0 X
10 15 20 30
Labour

So we can say that as soon as the cost of labour increases, capital gets cheaper. Thus the Principle of
Substitution happens as capital is substituted for labour. When the price of any factor is changed then
the production by old combination of factors gets costlier or inefficient.

10.12 Expansion Path
If the capital of firm rises then it will want to increase his production. The quantity of production
can rise when there is no increment in price of factors as well as cost due to rise of capital. The total
production level is increased by increasing the capital of firm and firm can produce production in
various levels by using various combinations of factors. The firm will use what point in the various
levels of production can be identified by Expansion Path. Expansion Path refers to the locus of all such
points that show least cost combination of factors corresponding to different levels of output. In other
words, Expansion Path indicates that when the firm increases its production level then which optimum
combination of factors is used. Since the expansion of firm depends upon the status of production, so
expansion path is also called Scale Line.

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