Production with Two Variable Inputs

Most production processes use many variable

inputs: labor, capital, materials, and land
Capital inputs include assets such as physical
plant, machinery, and vehicles
Consider a firm that uses two inputs in the long
run:
Labor (L) and capital (K)
Each of these inputs is homogeneous
Firms production function is Q = F(L,K)
7-1

Production with Two Variable Inputs

When a firm has more than one variable
input it can produce a given amount of
output with many different combinations of
inputs
E.g., by substituting K for L

Productive Inputs Principle: Increasing

the amounts of all inputs strictly increases
the amount of output the firm can produce

7-2

Isoquants
An isoquant identifies all input
combinations that efficiently produce a
given level of output
Note the close parallel to indifference curves
Can think of isoquants as contour lines for the
hill created by the production function

Firms family of isoquants consists of the

isoquants for all of its possible output
levels
7-3

Isoquant Example

7-4

Properties of Isoquants
Isoquants are thin
Do not slope upward
The boundary between input
combinations that produce more and less
than a given amount of output
Isoquants from the same technology do
not cross
Higher-level isoquants lie farther from the
origin
7-5

Substitution Between Inputs

Rate that one input can be substituted for another is an
important factor for managers in choosing best mix of
inputs
Shape of isoquant captures information about input
substitution
Points on an isoquant have same output but different input mix
Rate of substitution for labor with capital is equal to negative the
slope

Marginal Rate of Technical Substitution for input X

with input Y: the rate as which a firm must replace units
of X with units of Y to keep output unchanged starting at
a given input combination
7-6

MRTS and Marginal Product

Recall the relationship between MRS and
marginal utility
Parallel relationship exists between MRTS and
marginal product

MRTS LK

MPL

MPK

The more productive labor is relative to capital,

the more capital we must add to make up for
any reduction in labor; the larger the MRTS
7-7

Declining MRTS
Often assume
declining MRTS
Here MRTS declines
as we move along the
isoquant, increasing
input X and
decreasing input Y

7-8

Isocost curves
Variouscombinationsofinputsthatafirmcan
buywiththesamelevelofexpenditure
PLL+PKK=M
whereMisagivenmoneyoutlay.

Capital

M/PK

Slope = -PK /PL

M/PL

Labor

Maximization of output for given

cost
Capital

300
200
100

Labor

MPL/PL = MPK/PK
Capital

300
200
100

Labor

EXPANSION PATH

Returns to scale
Ifthefirmincreasestheamountofallinputsby
thesameproportion:
Increasingreturnsmeansthatoutput
increasesbyalargerproportion
Decreasingreturnsmeansthatoutput
increasesbyasmallerproportion
Constantreturnsmeansthatoutputincreases
bythesameproportion

Output elasticity
Thepercentagechangeinoutputresultingfrom
1percentincreaseinallinputs.
> 1==>increasingreturns
< 1 ==>decreasingreturns
= 1 ==>constantreturns

Returns to Scale

Types of Returns to Scale

Proportional change in ALL

inputs yields

What happens when all

inputs are doubled?

Constant

Same proportional change in

output

Output doubles

Increasing

Greater than proportional

change in output

Output more than doubles

Decreasing

Less than proportional

change in output

Output less than doubles

7-16

Returns to Scale

7-17