Session 8
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Session 8 Presentation Transcript

  • 1. Session 08Session 08 Theory of Long-runTheory of Long-run Lecture Outline Factor substitution Return to scale
  • 2. Ridge LinesRidge Lines Ridgelines are locus of points on the isoquants where the marginal products of the inputs are equal to zero Show the feasible areas to produce Lower ridgeline- MPL = 0 Upper ridgeline- MPk = 0
  • 3. Cont’d…Ridge LinesCont’d…Ridge Lines
  • 4. Cont’d… Ridge LinesCont’d… Ridge Lines  R1 - Upper ridgeline is the collection of points where the MP of capital is zero.  R2 - Lower ridgeline is the collection of points where the MP of labor is zero  Negatively sloped portions of the production isoquant are in between ridge lines  Positively sloped portions are irrational and they are beyond the ridge lines
  • 5. Factor SubstitutionFactor Substitution  Starting from an optimal input combination, if the price of an input declines, the firm will substitute the cheaper input for other inputs in production in order to reach a new optimal input combination. Rs.100 Rs.70 K = 1 L E N Capital 0 Labour 10Q ’ K = 3/8 L 7 Rs.100 5 8 10 R3 5 14Q 14 20 B 10 A
  • 6. Returns to ScaleReturns to Scale  This refers to the degree by which output changes as a result of a given change in the quantity of all inputs used in production  Types of Returns to Scale Constant: output increases in the same proportion Increasing: output increases by a greater proportion Decreasing: output increases by a lesser proportion
  • 7. Cont’d…Returns to ScaleCont’d…Returns to Scale K 0 L 6 3 3 6 100 Q 200 Q K 0 L 6 3 3 6 100 Q 300 Q K 0 L 6 3 3 6 100 Q 150 Q Constant Increasing Decreasing
  • 8. End of the SessionEnd of the Session