Production with Two Variable Inputs
* There is relationship between productivity and production.
* Long run production K& L are variable.
* Isoquants analyze and compare different combinations of K & L and output
Diminishing Marginal Rate of Substitution
- Reading Isoquant Model
1) Assume capital is 3 and labor increases from 0 to 1 to 2 to 3.
- Notice output increases at decreasing rate (55, 20, 15) illustrating diminishing returns from labor in the short run and long-run.
2) Assume that the labor is 3 and capital increases from 0 to 1 to 2 to 3.
- Output increases at the decreasing rate (55, 20, 15) because of diminishing returns from capital.
* Substituting Among Inputs
- Managers want to determine the combination if inputs to use.
- They should deal with the tradeoff between inputs.
- The slope of each isoquant gives tradeoff between 2 inputs while keeping the output constant.
- The marginal rate(MR) of technical substitution can be given by:
Marginal Rate of Technical Substitution
Observations:
1. Increasing labor in one unit increments from 1 to 5 results in a decreasing MRTS from 1 to 1/2.
2. Diminishing MRTS occurs because of diminishing returns and implies isoquants are convex.