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

BUSINESS ECONOMICS
107
UNIT- 3
Faculty Name: Dr. Shuchi Singhal
Designation: Associate Professor
School/Dept: Management
Email address of Faculty Member: s.singhal@dme.ac.in

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

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

Unit-III : (Theory of Production)
5
3.1 MEANING AND CONCEPT OF PRODUCTION
3.2FACTORS OF PRODUCTION AND PRODUCTION FUNCTION
3.3 FIXED AND VARIABLE FACTORS
3.4LAW OF VARIABLE PROPORTION (SHORT RUN PRODUCTION ANALYSIS)-Part 1
3.5 LAW OF VARIABLE PROPORTION (SHORT RUN PRODUCTION ANALYSIS)-Part
2
3
4
3.8 LAW OF RETURNS TO A SCALE(LONG RUN PRODUCTION ANALYSIS)
THROUGH THE USE OF ISOQUANTS- Part 2
THROUGH THE USE OF ISOQUANTS-Part 3

3.7
• Isoquants
• Properties of
Isoquants
6

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

By: Shuchi Goel 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 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 IQ1, IQ2 and IQ3 represent higher
output levels of 200 units, 300 units, and 400 units respectively.

By: Shuchi Goel 10
Figure 1: Isoquant Map

By: Shuchi Goel 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 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 * MPK = ∆L * MPL
∆k / ∆L = MPL / MPK
Therefore, MRTSL,K = MPL / MPK
Thus, MRTS of L for K is the ratio of their Marginal Products.

By: Shuchi Goel 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 14
Properties of Isoquants:
The important properties of isoquants are as:
1. 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.
2. 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 15
Figure 3: Isoquants Don’t Touch or Intersect One Another

By: Shuchi Goel 16
3. 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 17
Figure 4: Perfect Substitutes

By: Shuchi Goel 18
Figure 5: Perfect Complements

By: Shuchi Goel 19
4. 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
IQ1 and IQ2 respectively. At point A
we have = OX1 units of Labor
and OY1 units of capital.
At point B we have = OX2 units
of Labor and OY1 units of capital.
Though the amount of capital (OY1)
is the same at both the points, point B is
having X1X2 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 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.

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

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