ISOQUANT

2.Types Of Costs
1.VARIABLE COSTS:2.FIXED COSTS: These Cost Exist Whether Production Occurs Or Not. In The Long-Run There Are No Fixed Costs. Can Be Both Cash And Non-Cash Expenses. E.G:- Depreciation On Tractors And Buildings, Etc.

These Costs Exist Only If Production Occurs.

E.G:- Fuel For Tractor, Seed, Etc.

Example of Cost Concepts

X
10 16 20

Y
10 30 48

TFC 1000 1000 1000

TVC 1000 1600 2000 2200 2600 3200 4000 5000 6200 7600

TC 2000
2600 3000 3200 3600 4200 5000 6000 7200 8600

AFC 100 33.33 20.83

AVC 100 53.33 41.67

ATC

MC

200
86.67 62.50 49.23 45.45 43.75 46.30 51.72 60.00 73.51 30 22.22

22
26 32 40

65
81 96 108

1000
1000 1000 1000

15.38
12.35 10.42 9.26

33.85
32.10 33.33 37.04

11.76
25 40 66.67

50
62 76

116
120 117

1000
1000 1000

8.62
8.33 8.55

43.10
51.67 64.96

125
300 -466.67

Typical Total Cost Curves

$ TC

TVC

TFC

Output

Average and Marginal Cost Curves

$ MC

ATC

AVC

AFC

Output

PRODUCTION IN THE SHORT RUN

THE SHORT RUN IS A PERIOD JUST SHORT ENOUGH THAT AT LEAST ONE RESOURCE (INPUT-INDUSTRIAL PLANT,MACHINES) CANNOT BE CHANGED -- IS FIXED OR INELASTIC. THUS IN THE SHORT RUN PROUDCTION OF A COMMODITY CAN BE INCREASED BY INCREASING THE USE OF ONLY VARIABLE INPUTS LIKE LABOUR AND RAW MATERIALS.

LONG RUN
THE LONG RUN IS A PERIOD SUFFIECIENTLY LONG THAT ALL FACTORS INCLUDING CAPITAL CAN BE ADJUSTED OR ARE VARIABLE. THIS MEANS THAT THE FIRM CAN CHOOSE ANY COMBINATION ON THE MANUFACTURING TABLE -- NOT JUST THOSE ALONG COLUMN LABELLED 10

RETURNS TO SCALE
DIMINISHING RETURNS REFER TO RESPONSE OF OUTPUT TO AN

INCREASE OF A SINGLE INPUT WHILE OTHER INPUTS ARE HELD CONSTANT.

WE HAVE TO SEE THE EFFECT BY INCREASING ALL INPUTS.

WHAT WOULD HAPPEN IF THE PRODUCTION OF WHEAT IF LAND, LABOUR, FERTILISERS, WATER ETC,. ARE ALL DOUBLED. THIS REFERS TO THE RETURNS TO SCALE OR EFFECT OF SCALE INCREASES OF INPURTS ON THE QUANTITY PRODUCED.

CONSTANT RETURNS TO SCALE

THIS DENOTES A CASE WHERE A CHANGE IN ALL INPUTS LEADS TO A PROPORTIONAL CHANGE IN OUTPUT.
FOR EXAMPLE IF LABOUR, LAND CAPITAL AND OTHER INPUTS DOUBLED, THEN UNDER CONSTANT RETURNS TO SCALE OUTPUT WOULD ALSO DOUBLE.

INCREASING RETURNS TO SCALE

THIS IS ALSO CALLED ECONOMIES OF SCALE. THIS ARISES WHEN AN INCREASE IN ALL INPUTS LEADS TO A MORE-THANPROPORTIONAL INCREASE IN THE LEVEL OF OUTPUT. FOR EXAMPLE AN ENGINEER PLANNING A SMALL SCALE CHEMICAL PLANT WILL GENERALLY FIND THAT BY INCREASING INPUTS OF LABOUR, CAPITAL AND MATERIALS BY 10% WILL INCREASE THE TOTAL OUTPUT BY MORE THAN 10%.

DECREASING RETURNS TO SCALE

THIS OCCURS WHEN A BALANCED INCREASE OF ALL INPUTS LEADS TO A LESS THAN PORPORTIONAL INCREASE IN TOTAL OUTPUT. IN MANY PROCESS, SCALING UP MAY EVENTUALLY REACH A POINT BEYOND WHIH INEFFICIENCIES SET IN. THESE MIGHT ARISE BECAUSE THE COSTS OF MANAGEMENT OR CONTROL BECOME LARGE.
THIS WAS VERY EVIDENT IN ELECTRICITY GENERATION WHEN PLANTS GREW TOO LARGE, RISK OF PLANT FAILURE INCREASED.

IMPORTANCE OF RETURNS TO SCALE CONCEPT

IF AN INDUSTRY IS CHARACTERIZED BY INCREASING RETURNS TO SCALE, THERE WILL BE A TENDENCY FOR EXPANDING THE SIZE OF THE FIRM AND THUS THE INDUSTRY WILL BE DOMINATED BY LARGE FIRMS. THE OPPOSITE WILL BE TRUE IN INDUSTRIES WHERE DECREASING RETURNS TO SCALE PREVAIL. IN CASE OF INDUSTRIES WITH CONSTANT RETURNS TO SCALE, FIRMS OF ALL SIZES WOULD SURVIVE EQUALLY WELL.

THREE STAGES OF PRODUCTION

No. of workers (N) (1) 1 2 3 4 5 6 7 8 9 10 11 12 Total product TPL (tonnes) (2) 24 72 138 216 300 384 462 528 576 600 594 552 Marginal Product (MPL) (3) 24 48 66 78 84 84 78 66 48 24 -6 -42 Average Product (APL) (4) 24 36 46 54 60 64 66 66 64 60 54 46 II DIMINISHING RETURNS I INCREASING AND CONSTANT RETURNS Stage of production (5)

III -VE RETURNS

BEHAVIOUR OF TPP,MPP AND APP DURING THE THREE STAGES OF PRODUCTION

TOTAL PHYSICAL PRODUCT STAGE I INCREASES AT AN INCREASING RATE STAGE II INCREASES AT A DIMINISHING RATE TILL IT REACHES MAXIMUM STAGE III STARTS DECLINING MARGINAL PHYSICAL PRODUCT AVERAGE PHYSICAL PRODUCT INCREASES & REACHES ITS MAXIMUM STARTS DIMINISHING

INCREASES, REACHES ITS MAXIMUM & THEN DECLINES TILL MR = AP IS DIMINISHING AND BECOMES EQUAL TO ZERO

BECOMES NEGATIVE

CONTINUES TO DECLINE

FROM THE ABOVE TABLE ONLY STAGE II IS RATIONAL WHICH MEANS RELEVANT RANGE FOR A RATIONAL FIRM TO OPERATE.
IN STAGE I IT IS PROFITABLE FOR THE FIRM TO KEEP ON INCREASING THE USE OF LABOUR. IN STAGE III, MP IS NEGATIVE AND HENCE IT IS INADVISABLE TO USE ADDITIONAL LABOUR. i.e ONLY STAGE I AND III ARE IRRATIONAL

ISOQUANT
AN ISOQUANT OR ISO PRODUCT CURVE OR EQUAL PRODUCT CURVE OR A PRODUCTION INDIFFERENCE CURVE SHOW THE VARIOUS COMBINATIONS OF TWO VARIABLE INPUTS RESULTING IN THE SAME LEVEL OF OUTPUT.
IT IS DEFINED AS A CURVE PASSING THROUGH THE PLOTTED POINTS REPRESENTING ALL THE COMBINATIONS OF THE TWO FACTORS OF PRODUCTION WHICH WILL PRODUCE A GIVEN OUTPUT.

 For example from the following table we can see that different pairs of labour and capital result in the same output. Labour (Units) 1
2 3 4 5

Capital (Units) 5
3 2 1 0

Output (Units) 10
10 10 10 10

FOR EACH LEVEL OF OUTPUT THERE WILL BE A DIFFERENT ISOQUANT. WHEN THE WHOLE ARRAY OF ISOQUANTS ARE REPRESENTED ON A GRAPH, IT IS CALLED AN ISOQUANT MAP.

IMPORTANT ASSUMPTIONS
THE TWO INPUTS CAN BE SUBSTITUTED FOR EACH OTHER. FOR EXAMPLE IF LABOUR IS REDUCED IN A COMPANY IT WOULD HAVE TO BE COMPENSATED BY ADDITIONAL MACHINERY TO GET THE SAME OUTPUT.

SLOPE OF ISOQUANT
THE SLOPE OF AN ISOQUANT HAS A TECHNICAL NAME CALLED THE MARGINAL RATE OF TECHNICAL SUBSTITUTION (MRTS) OR THE MARGINAL RATE OF SUBSTITUTION IN PRODUCTION. THUS IN TERMS OF CAPITAL SERVICES K AND LABOUR L MRTS = Dk/DL

LINEAR ISOQUANT
IN LINEAR ISOQUANTS THERE SUBSTIUTABILTY OF INPUTS. IS PERFECT

FOR EXAMPLE IN A POWER PLANT EQUIPED TO BURN OIL OR GAS. VARIOUS AMOUNTS OF ELECTRICITY COULD BE PRODUCED BY BURNING GAS, OIL OR A COMBINATION. i.e OIL AND GAS ARE PERFECT SUBSITUTES. HENCE THE ISOQUANT WOULD BE A STRAIGHT LINE.

RIGHT-ANGLE ISOQUANT
IN RIGHT-ANGLE ISOQUANTS THERE IS COMPLETE NON-SUBSTIUTABILTY BETWEEN INPUTS. FOR EXAMPLE TWO WHEELS AND A FRAME ARE REQUIRED TO PRODUCE A BYCYCLE THESE CANNOT BE INTERCHANGED.
THIS IS ALSO KNOWN AS LEONTIEF ISOQUANT OR INPUT-OUTPUT ISOQUANT.

CONVEX ISOQUANT
IN CONVEX ISOQUANTS THERE IS SUBSTIUTABILTY BETWEEN INPUTS BUT IT IS NOT PERFECT.
FOR EXAMPLE (1) A SHIRT CAN BE MADE WITH LARGE AMOUNT OF LABOUR AND A SMALL AMOUNT MACHINERY. (2) THE SAME SHIRT CAN BE WITH LESS LABOURERS, BY INCREASING MACHINERY. (3) THE SAME SHIRT CAN BE MADE WITH STILL LESS LABOURERS BUT WITH A LARGER INCREASE IN MACHINERY.

PROPERTIES OF ISOQUANTS
1. AN ISOQUANT IS DOWNWARD SLOPING TO THE RIGHT. i.e NEGATIVELY INCLINED. THIS IMPLIES THAT FOR THE SAME LEVEL OF OUTPUT, THE QUANTITY OF ONE VARIABLE WILL HAVE TO BE REDUCED IN ORDER TO INCREASE THE QUANTITY OF OTHER VARIABLE.

PROPERTIES OF ISOQUANTS
2. A HIGHER ISOQUANT REPRESENTS LARGER OUTPUT. THAT IS WITH THE SAME QUANTITY OF 0NE INPUT AND LARGER QUANTITY OF THE OTHER INPUT, LARGER OUTPUT WILL BE PRODUCED.

PROPERTIES OF ISOQUANTS
3. NO TWO ISOQUANTS INTERSECT OR TOUCH EACH OTHER. IF THE TWO ISOQUANTS DO TOUCH OR INTERSECT THAT MEANS THAT A SAME AMOUNT OF TWO INPUTS CAN PRODUCE TWO DIFFERENT LEVELS OF OUTPUT WHICH IS ABSURD.

PROPERTIES OF ISOQUANTS
4. ISOQUANT IS CONVEX TO THE ORIGIN. THIS MEANS THAT THE SLOPE DECLINES FROM LEFT TO RIGHT ALONG THE CURVE. THAT IS WHEN WE GO ON INCREASING THE QUANTITY OF ONE INPUT SAY LABOUR BY REDUCING THE QUANTITY OF OTHER INPUT SAY CAPITAL, WE SEE LESS UNITS OF CAPITAL ARE SACRIFICED FOR THE ADDITIONAL UNITS OF LABOUR.