Slope of isoquant Marginal Rate of technical substitution: change in capital/change in labor= Diminishing marginal rate of technical substitution.

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Presentation transcript:

Slope of isoquant Marginal Rate of technical substitution: change in capital/change in labor= Diminishing marginal rate of technical substitution

Shape of Isoquants

Imperfect substitution between inputs

Return to scale For the decision making in the long-run Constant return to scale: Property of production function whereby when all inputs are increased by a certain percentage, output increase by that same percentage. –f(2L, 2K)=2f(L,K) Increasing return to scale: ---, output increases more than in proportion to an equal increase in all inputs. –f(2L,2K)>2f(L,K) Decreasing return to scale: ---, output increases less than –f(2L,2K)<2f(L,K)

Chapter 7. Costs Costs

Measuring costs Explicit cot: Firm’s direct, out-of-pocket cost (wage, payment for material) Implicit cost: The value of other resources used but not purchased –Example: Opportunity cost; The value of best alternative use of a resource

Research about Opportunity Cost In 1988 the U.S. Fish and Wildlife Service, under provisions of the Endangered Species Act (ESA), declared two fish species in the Klamath Basin as endangered and mandated minimum water levels in Upper Klamath Lake to protect habitat for these species. watch?v=s7LL_wxb2tohttp:// watch?v=s7LL_wxb2to

ESA lake level restrictions reduced both expected average irrigation water supplies and the capacity of the lake to stabilize water supplies during drought cycles. This research measures the opportunity cost to agriculture of maintaining alternative lake levels for the benefit of the endangered species. - In response to the needs to come up with estimates to subsidize farmers’ loss.

Lake Level vs. Opportunity Cost The expected average cost of maintaining ESA lake levels (estimated over 73 water years) is approximately $2 million annually; for severe drought years, annual costs exceed $15 million or about 60% of average farm profits. The steeply increasing marginal cost curve shows an increasingly heavier opportunity cost to agriculture as lake level restrictions increase.

Short-run cost measures Fixed cost: Production expense that does not vary with output (e.g., land, plant, large machines, other capital goods) Variable cost: Production expense that changes with the quantity of output (e.g., labor and materials) Total cost: Sum of variable and fixed costs Marginal cost: Average cost –Average fixed cost (AFC)= F/q –Average variable cost (AVC) = VC/q –Average cost = AFC +AVC

Variation of Short-Run Cost with Output

Short-Run Cost Curves