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Lecture 13 Unit 3

The document discusses the long run production function and the laws of returns to scale, emphasizing the relationship between input combinations and output. It explains concepts such as isoquant curves and iso-cost lines, which are essential for understanding producer's equilibrium and optimizing production costs. The producer's equilibrium is achieved when the isoquant curve is tangent to the lowest iso-cost line, indicating the most cost-effective combination of resources for a desired output level.

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kollurudeekshitha
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2 views

Lecture 13 Unit 3

The document discusses the long run production function and the laws of returns to scale, emphasizing the relationship between input combinations and output. It explains concepts such as isoquant curves and iso-cost lines, which are essential for understanding producer's equilibrium and optimizing production costs. The producer's equilibrium is achieved when the isoquant curve is tangent to the lowest iso-cost line, indicating the most cost-effective combination of resources for a desired output level.

Uploaded by

kollurudeekshitha
Copyright
© © All Rights Reserved
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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BBA (2024-28)

Principles of Economics
(POE)

Lecture 13
Long run production function (Laws of
Returns to scale)
• In the long run, all factors (including capital) are variable, so our production
function is
Q = F(K,L)
• In the long run, the supply of both the inputs, labor and capital, is assumed to be
elastic (changes frequently).
• In the long run, the functional relationship between changing scale of inputs and
output is explained under laws of returns to scale.

• Producer’s Equilibrium
• The producer’s equilibrium (optimum level of production) is achieved when
maximum output is derived from minimum costs.
• In order to achieve this, producers first have to classify their resources into different
combinations
• The combination that provides the highest amount of produce at the least amount
of costs is the optimum level of production.
Long run production function (Returns
to scale)
• In-order to analyze ‘returns to scale’ and ‘producers equilibrium’ we first need to
understand:
• isoquant curves
• iso-cost lines.
• Isoquant Curves (equal product curve or production indifference curve)
• The term ‘isoquant’ has been derived from a Greek word ‘iso’, which means equal.
• Isoquant curve is the locus of points showing different combinations of capital and
labor, which can be employed to produce same output.

• Properties of the isoquant curve


• Negative (downward ) Slope:This is because when capital (K) is increased, the quantity
of labor (L) is reduced or vice versa, to keep the same level of output.

• Non-intersecting and Non-tangential:Curves that intersect are incorrect and


produce results that are invalid, as a common factor combination on each of
the curves will reveal the same level of output, which is not possible.
Long run production function (Returns
to scale)
• Convex to Origin: Shows the substitution of inputs and diminishing marginal rate of
technical substitution in economic region. The marginal rate of technical
substitution (MRTS) is the rate at which one factor must decrease so that the same level
of productivity can be maintained when another factor is increased
MRTSKL = ∆K/∆L
Along downward sloping isoquant, marginal productivity of labour decreases with the
increase in units of labour and simultaneously marginal productivities of capital
increase with the reduction in the units of capital. Thus, lesser amount of capital is
required to keep the output constant

• Isoquant curves in the upper portions of the chart yield higher outputs. This
is because, at a higher curve, factors of production are more heavily employed.
• An isoquant curve should not touch the X or Y axis on the graph. If it does,
the rate of technical substitution is void, as it will indicate that one factor is
responsible for producing the given level of output without the involvement of
any other input factors.
Long run production function (Returns
to scale)
• Isoquant and Isoquant map
Long run production function (Returns
to scale)
• Iso-cost Lines
• An isoquant shows what a firm is desirous of producing.
• But, the desire to produce a commodity is not enough.
• The producer must have sufficient capacity to buy necessary factor inputs to be
able to reach its desired production level.
• The capacity of the producer is shown by his monetary resources, i.e., his cost
outlay (or how much money he is capable of spend­ing) on capital and labour, the
prices of which are taken as constant.
• An isocost line is a locus of points showing the alternative combinations of factors
that can be purchased with a fixed amount of money.
• Slope of the iso-cost line is the ratio of the prices
of the inputs i.e.

• Shift and rotation


Producer’s Equilibrium
• The basic objective of rational producer is to maximize his profits and produces a
given quantity of output with that combination of factors that is ‘OPTIMUM’.
• The optimum combination of resources is that which minimize the cost of
production for producing a given level of output
• Conditions
1. the given isoquant is tangent to the lowest possible iso-cost line.
2. Slope of isoquant = Slope of iso-cost line

• Isoquants must be convex to the origin.


Producer’s Equilibrium
• Producer’s Equilibrium
• the isoquant curve represents targeted output, i.e. 200 units.
• Iso-cost lines EF, GH and KP show three different combinations in which we can
utilize the total outlay of inputs, i.e. capital and labour.
• The isoquant curve crosses all three iso-cost lines on points R, M and T.
• These points show how much costs we will incur in producing 200 units.
• All three combinations produce the same output of 200 units,
• but the least costly for the producer will be point M, where iso-cost line GH is
tangent to the isoquant curve and the Slope of isoquant = Slope of iso-cost line

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