Subtitusi Input

dan
Subtitusi Output
 Topics of Discussion
Concepts of isoquants and iso-cost line
Least-cost use of inputs
Long-run expansion of input use
Economics of business expansion and
contraction
Production possibilities frontier
Profit maximizing combination of products
Physical Relationships
 Isoquant
Isoquantmeans
means“equal
“equalquantity”
quantity”

Output
Outputisis
identical
identicalalong
along
an
anisoquant
isoquant

Two
Twoinputs
inputs
 Slope of an Isoquant
The slope of an isoquant is referred to as the
Marginal Rate of Technical Substitution, or
MRTS. The value of the MRTS in our example
is given by:
MRTS = Capital ÷ labor
 Slope of an Isoquant
The slope of an isoquant is referred to as the
Marginal Rate of Technical Substitution, or
MRTS. The value of the MRTS in our example
is given by:
MRTS = Capital ÷ labor
If output remains unchanged along an isoquant,
the loss in output from decreasing labor must be
identical to the gain in output from adding capital.
MRTS
MRTS
here
hereisis
-4÷1=
-4÷1=-4 -4
What
What isis the
the slope
slope over
over
range
range B?
B?
 What
What isis the
the slope
slope over
over
range
range B?
B?

MRTS
MRTS
here
hereisis
-1÷1=
-1÷1=-1 -1
What
What isis the
the slope
slope over
over
range
range C?
C?
 What
What isis the
the slope
slope over
over
range
range C?
C?

MRTS
MRTS
here
hereisis
-.5÷1=
-.5÷1=-.5-.5
Introducing Input Prices
 Plotting the Iso-Cost Line

Firm
Firmcan
canafford
afford10
10units
unitsof
of
Capital
capital
capitalat
ataarental
rentalrate
rateof
of$100
$100
for
foraabudget
budgetof of$1,000
$1,000
10

Labor
100
 Plotting the Iso-Cost Line

Firm
Firmcan
canafford
afford10
10units
unitsof
of
Capital
capital
capitalat
ataarental
rentalrate
rateof
of$100
$100
for
foraabudget
budgetof of$1,000
$1,000
10

Firm
Firmcan
canafford
afford100
100units
unitsof
of
labor
laborat
ataawage
wagerate
rateof
of$10
$10for
for
aabudget
budgetof
of$1,000
$1,000

Labor
100
 Slope of an Iso-cost Line
The slope of an iso-cost in our example is given by:
Slope = - (wage rate ÷ rental rate)
or the negative of the ratio of the price of the two
Inputs.

($10 × use of labor)+($100 × use of capital)=$1,000

Original iso-cost line Change in budget or both costs

Line
LineABABrepresents
represents
the
theoriginal
originaliso-cost
iso-cost
line
linefor
forcapital
capitaland
and
labor…
labor…

Change in wage rate Change in rental rate

 Original iso-cost line Change in budget or both costs

The
Theiso-cost
iso-costline
linewould
wouldshift
shiftout
out
to
toline
lineEF
EFififthe
thefirm’s
firm’savailable
available
budget
budgetdoubled
doubled(or (orcosts
costsfell
fellin
in
half)
half)or
orback
backto toline
lineCD
CDififthe
the
available
availablebudget
budgethalved
halved(or
(orcosts
costs
doubled.
doubled.

Change in wage rate Change in rental rate

Original iso-cost line Change in budget or both costs

Change in wage rate Change in rental rate

IfIfwage
wagerates
ratesdoubled
doubledthe
theline
line
would
wouldshift
shiftout
outtotoAF
AFwhile
while
the
theiso-cost
iso-costline
linewould
wouldshift
shift
in
intotoline
lineAD
ADififwage
wagerates
rates
doubled…
doubled…
 Original iso-cost line Change in budget or both costs

Change in wage rate Change in rental rate

The
Theiso-cost
iso-costline
linewould
would
shift
shiftout
outtotoline
lineBEBEififrental
rental
rate
ratefell
fellin
inhalf
halfwhile
whilethethe
line
linewould
wouldshift
shiftininto
toline
line
BC
BCififthe
therental
rentalrate
ratefor
for
capital
capitaldoubled…
doubled…
Least Cost Combination
of Inputs
 Least Cost Decision Rule
The least cost combination of two inputs (labor and
capital in our example) occurs where the slope of the
iso-cost list is tangent to the isoquant:
MPPLABOR ÷ MPPCAPITAL = -(wage rate ÷ rental rate)

Slope
Slope of
of an
an Slope
Slope of
of iso-
iso-
isoquant
isoquant cost
cost line
line
 Least Cost Decision Rule
The least cost combination of labor and capital in out
example also occurs where:

MPPLABOR ÷ wage rate = MPPCAPITAL ÷ rental rate

MPP
MPP per
per dollar
dollar MPP
MPP per
per dollar
dollar
spent
spent on
on labor
labor = spent
spent on
on capital
capital
 Least Cost Decision Rule
This
The decision
least rule holds
cost combination of labor for a larger
and capital in out
number
example alsoof inputs
occurs where:as well…

MPPLABOR ÷ wage rate = MPPCAPITAL ÷ rental rate

MPP
MPP per
per dollar
dollar MPP
MPP per
per dollar
dollar
spent
spent on
on labor
labor = spent
spent on
on capital
capital
 Production Possibilities

The goal is to find that combination of

products that maximizes revenue for
the maximum technical efficiency
on the production
possibilities frontier.
Shows
Shows thethe substitution
substitution
between
between twotwo products
products
given
given the
the most
most efficient
efficient
use
use of
of firm’s
firm’s resources
resources
 Slope of the PPF
The slope of the production possibilities curve
is referred to as the Marginal Rate of
Product Transformation, or MRPT. The value
of the MRPT in our example is given by:

MRPT =  canned fruit ÷ canned vegetables

Drops
Dropsfrom
from
Slope
Slope over
overrange
range
108
108to
to95
95 between
between D D and
and EE
isis –1.30,
–1.30, or:
or:
-1310
-1310

Increases
Increasesfrom
from
30
30to
to40
40
 95,000 40,000
- 108,000 ÷ - 30,000 = - 1.30
-13,000 10,000
Inefficient
Inefficient
use
use of
of firm’s
firm’s
resources
resources
 Level
Level of
of output
output
unattainable
unattainable with
with
with
with firm’s
firm’s existing
existing
resources
resources

Inefficient
Inefficient
use
use of
of firm’s
firm’s
existing
existing
resources
resources
Accounting for
Product Prices
Plotting the Iso-Revenue Line

30,000
30,000cases
casesofofcanned
cannedfruit
fruit
Canned
fruit
required
requiredatatprice
priceof
of$33.33/case
$33.33/case
to
toachieve
achieveAATARGET
TARGETrevenue
revenue
of
of$1
$1million
million
30,000

Canned
40,000 vegetables
Plotting the Iso-Revenue Line

30,000
30,000cases
casesof
ofcanned
cannedfruit
fruit
Canned
fruit
required
requiredat
atprice
priceof
of$33.33/case
$33.33/case
to
toachieve
achieverevenue
revenueofof$1
$1million
million
30,000

40,000
40,000cases
casesof
ofcanned
cannedvegetables
vegetables
required
requiredat
atprice
priceof
of$25.00/case
$25.00/case
to
toachieve
achieverevenue
revenueofof$1
$1million
million

Canned
40,000 vegetables
Original iso-revenue line Changes in income or both prices
Line
LineAB
ABisisthe
theoriginal
original
iso-revenue
iso-revenueline,
line,indicating
indicating
the
thenumber
numberof ofcases
casesneeded
needed
to
toreach
reachaaspecific
specificsales
sales
target.
target.

Change in price of fruit Change in price of vegetables

The
Theiso-revenue
iso-revenue line
linewould
would
Original iso-revenue line Changes in Revenue or both prices
shift
shiftout
outtotoline
lineEFEFififthe
the
revenue
revenuetarget
targetdoubled
doubled(or (or
prices
pricesfell
fellin
inhalf)
half)while
whilethe the
line
linewould
wouldshift
shiftin intotoline
line
CD
CDififrevenue
revenuetargets
targetsfell fellinin
half
halfor
orprices
pricesdoubled.
doubled.
Change in price of fruit Change in price of vegetables
Original iso-revenue line Changes in revenue or both prices

The
The iso-revenue
iso-revenue line
line would
would
Change in price of fruit Change in price of vegetables
shift
shiftout
outtotoline
lineBC BCisisthethe
price
priceof offruit
fruitfell
fellininhalf
half
but
butshift
shiftinintotoline
lineBDBDifif
the
theprice
priceof offruit
fruitdoubled
doubled
 Original iso-revenue line Changes in income or both prices

The
Theiso-revenue Changeline
iso-revenue line would
would
in price of fruit Change in price of vegetables
shift
shiftout
outtotoline
lineAD
ADififthe the
price
priceof ofvegetables
vegetablesfell fellininhalf
half
but
butshift
shiftininto
toline
lineACACisisthe the
price
priceof offruit
fruitdoubled.
doubled.
Profit Maximizing
combination of
Product Prices
 Combination of Products
The profit maximizing combination of two products
is found where the slope of the production possibilities
frontier (PPF) is equal to the slope of the iso-revenue
Curve, or where:

Canned fruit Price of vegetables

= –
Canned vegetables Price of fruit

Slope
Slope of
of an
an Slope
Slope of
of iso-
iso-
PPF
PPF curve
curve revenue
revenue line
line
Assume
Assume Line
LineAB
AB represents
represents
revenue
revenue for
for$1
$1 million.
million.
We
We want
want to to find
find the
the
profit
profit maximizing
maximizing
combination
combination to to “can”
“can”
given
given the
the current
current
prices
prices of
of canned
canned fruitfruit
and
and vegetables.
vegetables.
 Canned
Cannedfruit
fruit Price
Priceofofvegetables
vegetables
= –
Canned
Cannedvegetables
vegetables Price
Priceofoffruit
fruit

Shifting
Shiftingline
lineAB
ABoutoutin
in
aaparallel
parallelfashion
fashion
holds
holdsboth
bothprices
prices
constant
constantatattheir
their
current
currentlevel
level
 Doing the Math…
Let’s assume the price of a case of canned fruit is
$33.33 while the price of a case of canned vegetables
is $25.00. If point M represents 125,000 cases of fruit
and 18,000 cases of vegetables, then total revenue at
point M is:

Revenue = (125,000 × $33.33) + (18,000 × $25.00)

= $4,166,250 + $450,000
= $4,616,250
 Doing the Math…
At these same prices, if we instead produce 108,000
cases of fruit and 30,000 cases of vegetables, then
total revenue would fall to:

Revenue = (108,000 × $33.33) + (30,000 × $25.00)

= $3,599,640 + $750,000
= $4,349,640

which is $266,610 less than the $4,616,250 earned at

point M.
Effects of a Change
in the Price of
One Product
IfIfthe
theprice
priceof ofcanned
cannedfruit
fruit
fell
fellininhalf,
half,the
thefirm
firmmust
must
sell
selltwice
twiceas
asmany
manycases
casesof
of
canned
cannedfruit
fruittotoearn
earn$1
$1
million
millionififititfocused
focusedsolely
solely
on
onfruit
fruitproduction.
production.
This
Thisgives
givesus
usaanew
newiso-
iso-
revenue
revenuecurve…
curve…line
lineCB.
CB.
To
Tosee
seethe
theeffects
effectsof
ofthis
this
price
pricechange,
change,wewecan
canshift
shift
the
thenew
newiso-revenue
iso-revenuecurve
curve
out
outto
tothe
thepoint
pointof
of
tangency
tangencywith
withthe
thePPF
PPF
curve….
curve….
Shifting
Shiftingthe
thenew
newiso-
iso-
revenue
revenuecurve
curvein
inaa
parallel
parallelfashion
fashionout
outto toaa
point
pointof
oftangency
tangencywith
with
the
thePPF
PPFcurve,
curve,we
wegetgetaa
new
newcombination
combinationof of
products
productsrequired
requiredto to
maximize
maximizeprofit.
profit.
The
Thefirm
firmwould
wouldshift
shiftfrom
from
point
pointM Mon onthe
thePPF
PPFto to
point
pointNNas asaaresult
resultofofthe
the
decline
declineininthe
theprice
priceofoffruit.
fruit.
That
Thatis,
is,to
tomaximize
maximize
profit,
profit,the
thefirm
firmwould
wouldcut cut
back
backits
itsproduction
productionof of
canned
cannedfruit
fruitandandproduce
produce
more
morecanned
cannedvegetables.
vegetables.
Summary #1
 Concepts of iso-cost line and isoquants
 Marginal rate of technical substitution
(MRTS)
 Least cost combination of inputs for a
specific output level
 Effects of change in input price
 Level of output and combination of
inputs for a specific budget
 Key decision rule …seek point
 where MRTS = ratio of input prices, or
 where MPP per dollar spent on inputs are
equal
Summary #2
 Concepts of iso-revenue line and the
production possibilities frontier
 Marginal rate of product transformation
(MRPT)
 Concept of profit maximizing
combination of products
 Effects of change in product price
 Key decision rule – maximize profits
where MRPT equals the ratio of the
product prices