3.7.pptx-LAW OF VARIABLE PROPORTION (SHORT RUN PRODUCTION ANALYSIS)-Part 4

LAW OF VARIABLE PROPORTION (SHORT RUN PRODUCTION ANALYSIS)-Part 4

1. Business Economics 107 Unit- 3 Faculty Name: Dr. Shuchi Singhal Designation: Associate Professor School/Dept: Management Email address of Faculty Member: [email protected]

2. Programme Outcomes 2 PO1: Apply knowledge of various functional areas of business PO2: Develop communication and professional presentation skills PO3: Demonstrate critical thinking and Analytical skills for business decision making PO4: Illustrate leadership abilities to make effective and productive teams PO5: Explore the implications and understanding of the process of starting a new venture PO6: Imbibe responsible citizenship towards a sustainable society and ecological environment PO7: Appreciate inclusivity towards diverse cultures and imbibe universal values PO8: Foster Creative thinking to find innovative solutions for various business situations

3. Course Objective and Course Outcomes 3 CO1:Understand the fundamental concepts of Business Economics. CO2:Analyze the relationship between consumer behaviour and demand. CO3:Explore the theory of production through the use of ISO-QUANTS. CO4:Understand the concept and relevance of short-term and long-term cost. CO5:Examine pricing decisions under various market conditions. CO6:Analyse economic challenges posed to businesses

4. Syllabus

5. Unit-III : (Theory of Production) 5 3 .1 MEANING AND CONCEPT OF PRODUCTION 3 .2 FACTORS OF PRODUCTION AND PRODUCTION FUNCTION 3 .3 FIXED AND VARIABLE FACTORS 3.4 LAW OF VARIABLE PROPORTION (SHORT RUN PRODUCTION ANALYSIS )-Part 1 3.5 LAW OF VARIABLE PROPORTION (SHORT RUN PRODUCTION ANALYSIS)-Part 2 3.6 LAW OF VARIABLE PROPORTION (SHORT RUN PRODUCTION ANALYSIS)- Part 3 3.7 LAW OF VARIABLE PROPORTION (SHORT RUN PRODUCTION ANALYSIS)-Part 4 3.8 LAW OF RETURNS TO A SCALE(LONG RUN PRODUCTION ANALYSIS) THROUGH THE USE OF ISOQUANTS- Part 2 3.9 LAW OF RETURNS TO A SCALE(LONG RUN PRODUCTION ANALYSIS) THROUGH THE USE OF ISOQUANTS-Part 3 3.10 LAW OF RETURNS TO A SCALE(LONG RUN PRODUCTION ANALYSIS) THROUGH THE USE OF ISOQUANTS- Part 4 3.11 LAW OF RETURNS TO A SCALE(LONG RUN PRODUCTION ANALYSIS) THROUGH THE USE OF ISOQUANTS- Part 5

6. 3.7 Isoquants Properties of Isoquants 6

7. 3.7 LAW OF RETURNS TO A SCALE(LONG RUN PRODUCTION ANALYSIS) THROUGH THE USE OF ISOQUANTS- Part 1 By: Shuchi Goel 7

8. Suggested Readings 1. Author : A. Koutsoyiannis Title of the Book : Modern Microeconomics Chapter’s Name : Theory of Production 2. Author : Christopher R. Thomas & S. Charles Maurice Title of the Book : Managerial Economics-Foundations of Business Analysis and Strategy Chapter’s Name: Production and Cost in the Long Run 3. Author : Paul A. Samuelson and William D Nordhaus Title of the Book : Economics Chapter’s Name : Production and Business Organisation By: Shuchi Goel 8

9. 3.5 ISOQUANTS (ISO PRODUCT CURVES) An isoquant represents all possible combinations of the two factors of production that can produce the same level of output. Thus, all combinations of the two inputs yielding the same level of output lie on the same isoquant . Various factor combinations ‘A’, ‘B’, ‘C’, ‘D’ and ‘E’ producing the same level of output, say 100 units, are shown in figure 1 in the form of isoquant IQ. These points depict different techniques of production . For example, point ‘A’ represents capital intensive technique, while point ‘E’ represents labour intensive technique. In figure 1 , as the quantity of one factor is reduced, the quantity of other factor will have to be increased, so that the total output remains the same. A number of isoquants depicting different amounts of output are known as isoquant map as shown in figure 1 , where isoquant IQ represents the lowest output level of 100 units, while isoquants IQ 1 , IQ 2 and IQ 3 represent higher output levels of 200 units, 300 units, and 400 units respectively. By: Shuchi Goel 9

10. Figure 1 : Isoquant Map By: Shuchi Goel 10

11. Marginal Rate of Technical Substitution (MRTS): MRTS in the theory of production is similar to the concept of Marginal Rate of Substitution (MRS) in the indifference curve analysis of consumer theory. MRTS indicates the rate at which factors of production can be substituted such that the total output remains unchanged. If capital (K) and labour (L) are the two factors of production, then the MRTS of labour (L) for Capital (K) is defined as the quantity of ‘K’ that can be given up in exchange for an additional unit of ‘L’ so that the level of output remains unchanged. MRTS at a point on the isoquant can be measured by the negative of the slope of the isoquant at that point. Consider a small movement down from point ‘A’ to point ‘B’ in figure 2. A small amount of factor ‘K’, say ∆K, is replaced by an amount of factor ‘L’, say ∆L, without any loss of output. The slope of isoquant IQ at point ‘B’ is equal to ∆K/ ∆L By: Shuchi Goel 11

12. Thus, MRTS = ∆K/ ∆L Slope of isoquant is negative as the amount of two factors of production change in opposite direction. MRTS can also be calculated as: Since total output remains same on any point on isoquant , so loss in output from small reduction in ‘K’ will be equal to gain in output from small increment in ‘L’ : Loss of output = Gain of output i.e. Reduction in ‘K’ * Marginal Product of ‘K’ = Increment in ‘L’ * Marginal Product of ‘L’ Or -∆K * MP K = ∆L * MP L ∆k / ∆L = MP L / MP K Therefore, MRTS L,K = MP L / MP K Thus, MRTS of L for K is the ratio of their Marginal Products. By: Shuchi Goel 12

13. As the quantity of labour (L) increases and that of Capital (K) decreases, the MP of labour falls and that of capital rises. So lesser and lesser units of capital are required to be substituted for each additional unit of labour so as to maintain the same level of output. This is known as diminishing MRTS . Figure 2: Diminishing MRTS By: Shuchi Goel 13

14. Properties of Isoquants : The important properties of isoquants are as: Downward Sloping : Isoquants have negative slope i.e. they are downward sloping. This is because as the quantity of one factor of production is increased, the quantity of the other factor of production must be reduced so as to keep the total output unchanged/constant. Isoquants Don’t Touch or Intersect One Another : Just as two indifference curves cannot cut each other, two isoquants also cannot cut each other. Intersection of isoquants showing different levels of output contradicts logic. It would imply that isoquants representing different levels of output (A and C in figure 3) show the same output at the point of intersection which is wrong. By: Shuchi Goel 14

15. Figure 3: Isoquants Don’t Touch or Intersect One Another By: Shuchi Goel 15

16. Convex to the Origin : This is based upon diminishing MRTS. In most production processes the factors of production have substitutability. Labour can be substituted for capital and vice versa . However the rate at which one factor is substituted for the other in production process i.e marginal rate of technical substitution (MRTS) tends to fall . MRTS between two perfect substitutes will be constant. Increase in one factor of production requires sacrifice of other factor by the same amount. Isoquant in this case is a straight line with negative slope. In case of perfect complements, isoquants are right angled. Here the production will be increased by increasing both the factors in the same proportion, not necessarily the proportion is one to one. By: Shuchi Goel 16

17. Figure 4: Perfect Substitutes By: Shuchi Goel 17

18. Figure 5: Perfect Complements By: Shuchi Goel 18

19. An isoquant lying above and to the right of another isoquant represents a higher level of output: This is because of the fact that on the higher isoquant , we have either more units of one factor of production or more units of both the factors. This has been illustrated in figure 6. Figure 6: Points A and B lie on the isoquant IQ 1 and IQ 2 respectively. At point A we have = OX 1 units of Labor and OY 1 units of capital. At point B we have = OX 2 units of Labor and OY 1 units of capital. Though the amount of capital (OY 1 ) is the same at both the points, point B is having X 1 X 2 units of labor more. Therefore, it will yield a higher output. Hence, it is proved that a higher isoquant shows a higher level of output. By: Shuchi Goel 19

20. Conclusion An isoquant represents all possible combinations of the two factors of production that can produce the same level of output. Thus, all combinations of the two inputs yielding the same level of output lie on the same isoquant. By: Shuchi Goel 20