INDEX

• What do you understand by Marginal Rate of Technical Substitution. • Why the same is negative? • How the concept is significant from the viewpoint of managerial decision?

Marginal Rate of Technical Substitution

 It indicates the rate at which one input must be

substituted for another as one moves down towards right along an Isoquant, while maintaining the total output constant.  For example, the MRTS of input X and for input Y may be defined as the amount of input Y which can be replaced by one unit of input X so as to keep the level of output same.  It is shown by the Absolute value of the slope of the isoquant.

FORMULA
Algebraically,

 Where ,

X = change in labor (L) Y = change in capital (K)

 The marginal rate of technical substitution usually diminishes as the

amount of substitution increases.  For example in the below diagram, as more and more labor is substituted for cloth, the increment of labor necessary to replace cloth increases.

The input substitution relation indicated by the slope of a production isoquant is directly related to the concept of diminishing marginal productivity.

 The MRTS of labor for capital is equivalent to the absolute slope of

the isoquant at that point

 MRTS is equal to 0 where the isoquant becomes horizontal, and

equal to infinity where it becomes vertical.

 The opposite is true when going in the other direction i.e. from right

to left

 In this case it will be called as the MRTS of capital for labor  In the unusual case of two inputs that are perfect substitutes for

each other in production, the isoquant would be linear

 If, on the other hand, there is only one production process available,

factor proportions would be fixed, and these zero-substitutability isoquant would be shown as horizontal or vertical lines.

MRTS IS NEGATIVE ?

 Isoquant are convex to origin.  The slope of the isoquant is decreasing in the

absolute magnitude from left to right  The convexity of the Isoquant curve suggests that MRTS is diminishing.

SIGNIFICANCE
 The MRTS recognizes that consumers' resources are limited and

cannot acquire unlimited quantities of the goods they want.

 This measure of the relative importance that consumers attach to

particular goods is one of many measures that economists use when studying consumer preferences.

 Consumer preferences and purchasing habits are a large

determinant of the overall demand for goods and services in the economy.

 Whether applied to consumer demand or production processes, the

marginal rate of substitution is not constant.

 It will differ not only across individual consumers and firms, but also

differ by the quantities of goods or resources already being consumed

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