AAEC 2305AAEC 2305Fundamentals of Ag Fundamentals of Ag

EconomicsEconomics

Chapter 6Chapter 6

Multiple Inputs & OutputsMultiple Inputs & Outputs

ObjectivesObjectives

How a firm determine the cost-minimizing How a firm determine the cost-minimizing combination of inputs to use in the production combination of inputs to use in the production process.process.

What influences the firm’s demand for inputs?What influences the firm’s demand for inputs? How a firm decides how much of several How a firm decides how much of several

products to produce?products to produce? About the facotors that influence whether a About the facotors that influence whether a

firm specializes or diversifies.firm specializes or diversifies. What influences the quantities supplied by What influences the quantities supplied by

firms?firms?

Production with Multiple Production with Multiple Variable InputsVariable Inputs

Isoquant - shows all of the combinations of two Isoquant - shows all of the combinations of two inputs that can be used to produce a given inputs that can be used to produce a given quantity of an output. (the isoquant is quantity of an output. (the isoquant is analogous to the consumer’s indifference analogous to the consumer’s indifference curve)curve)• An efficient firm will be on the isoquant. An An efficient firm will be on the isoquant. An

inefficient firm will use more than inputs than inefficient firm will use more than inputs than necessary and be operate at a point above necessary and be operate at a point above the isoquant.the isoquant.

Level of output does not Level of output does not along an isoquant along an isoquant Isoquant map shows all possible isoquants.Isoquant map shows all possible isoquants.

Production with Multiple Production with Multiple Variable InputsVariable Inputs

Marginal Rate of Technical Substitution Marginal Rate of Technical Substitution measures the slope of the isoquant.measures the slope of the isoquant.

MRTS is the rate at which on variable MRTS is the rate at which on variable input can physically substitute for input can physically substitute for another variable input in the physical another variable input in the physical pdn process.pdn process.

MRTS is calculated by dividing the MRTS is calculated by dividing the in in the replaced input by the the replaced input by the in the in the added inputadded input

Production with Multiple Production with Multiple Variable InputsVariable Inputs

Types of isoquant relationshipsTypes of isoquant relationships• Variable Proportions:Variable Proportions:

– Imperfect substitutes (Diminishing MRS) Imperfect substitutes (Diminishing MRS) - occurs when one unit of an input can - occurs when one unit of an input can be substituted for another, but at a be substituted for another, but at a decreasing rate.decreasing rate.

– Perfect substitutes - occurs when one Perfect substitutes - occurs when one unit of input can be exchanged for unit of input can be exchanged for another input on a consistent basis. another input on a consistent basis. (MRS is constant & isoquant is linear)(MRS is constant & isoquant is linear)

(continued)(continued)

• Fixed proportions Fixed proportions – Perfect complements - occurs when Perfect complements - occurs when

inputs are used in a fixed ratioinputs are used in a fixed ratio

Production with Multiple Production with Multiple Variable InputsVariable Inputs

Isocost line- indicates the Isocost line- indicates the combination of two inputs that can combination of two inputs that can be purchased with a given amount be purchased with a given amount of money. (The isocost line is of money. (The isocost line is analogous to the consumer’s budget analogous to the consumer’s budget line.)line.)• Slope of the isocost line is equal to the Slope of the isocost line is equal to the

negative inverse of the price ratios.negative inverse of the price ratios.

Production with Multiple Production with Multiple Variable InputsVariable Inputs

Firm minimizes costs by operating Firm minimizes costs by operating where the isocost line is tanget to the where the isocost line is tanget to the isoquantisoquant• (just as a consumer maximized utility by producing (just as a consumer maximized utility by producing

where the indifference curve was just tangent to where the indifference curve was just tangent to the budget line)the budget line)

This tangency provides the This tangency provides the Least Cost Least Cost CombinationCombination of inputs to produce a of inputs to produce a given level of output.given level of output.

Refer to in class exampleRefer to in class example

Production with Multiple Production with Multiple Variable InputsVariable Inputs

Expansion Path - a line connecting Expansion Path - a line connecting the least cost combinations of two the least cost combinations of two inputs used by a firm at various inputs used by a firm at various output levels. output levels.