PRODUCTION AND COSTS IN THE LONGRUN

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PRODUCTION AND COSTS IN THE LONG-RUN
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• What are returns to scale?
• What does production choice mean?
• What is the marginal rate of technical
  substitution?
• What are economies of scale?
• Finding the least cost.

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Returns to Scale (RTS)

• (In the long-run (LR) firms can vary all of its
  inputs)
• Constant returns to scale occur when the
  proportional increase in a firms output is equal
  to the proportional increase in inputs used.
• Increasing (decreasing) returns to scale occur
  when the proportional increase in a firms output
  is greater than (less than) the proportional
  increase in inputs used.

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• What happens to average cost?

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• Graphically, we can plot the long-run average
  cost curve.
• Cost
• ()
• Output

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Production Choice

• Isoquants
• An isoquant shows all the combinations of two
  factors of production that can be used to produce
  a given quantity of output.
• (iso - same, quant - quantity)

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• An isoquant map
• K
• L

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The Marginal Rate of Technical Substitution

• The marginal rate of technical substitution
  (MRTS) of capital for labour is the rate at which
  the input of capital must be increased to
  compensate for a reduction in the input of
  labour.
• MRTS K,L ?K/?L
• K
• L

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• Diminishing MRTS an isoquant is convex to the
  origin to illustrate diminishing marginal
  products.
• K
• L
• The MP ? as the quantity of a factor ?
• MRTS K,L MPL/MPk
• (slope of isoquant)

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Isoquants and Returns to Scale

• K
• L

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Isocost Lines

• An isocost line shows all combinations of two
  factors of production that can be bought for a
  given total cost.
• TC (PK x K) (PL x L)
• Intercept TC/PK
• Slope -PL/PK

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• An isocost line
• K
• L
• K TC - PL L
• PK PK

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Finding the least cost technique

• The optimal choice of inputs is where the isocost
  line is tangent to the isoquant.
• i.e. where the slope of the isocost line equals
  the slope of the isoquant
• PL MRTS K,L MPL
• PK MPK

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The least cost bundle

• K
• L

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• What will happen to the isocost line if the price
  of labour increases?
• K
• L
• slope of isocost line ?
• (LR) amount of labour hired ?
• (LR) amount of capital hired ?