The Marginal Rate of Technical Substitution
Marginal Rate of Technical Substitution
Isoquants are typically convex to the origin reflecting the fact that the two factors are substitutable for each other at varying rates. This rate of substitutability is called the “marginal rate of technical substitution” (MRTS) or occasionally the “marginal rate of substitution in production”. It measures the reduction in one input per unit increase in the other input that is just sufficient to maintain a constant level of production. For example, the marginal rate of substitution of labour for capital gives the amount of capital that can be replaced by one unit of labour while keeping output unchanged.
To move from point A to point B in the diagram, the amount of capital is reduced from Ka to Kb while the amount of labour is increased only from La to Lb. To move from point C to point D, the amount of capital is reduced from Kc to Kd while the amount of labour is increased from Lc to Ld. The marginal rate of technical substitution of labour for capital is equivalent to the absolute slope of the isoquant at that point (change in capital divided by change in labour). It is equal to 0 where the isoquant becomes horizontal, and equal to infinity where it becomes vertical.
The opposite is true when going in the other direction (from D to C to B to A). In this case we are looking at the marginal rate of technical substitution capital for labour (which is the reciprocal of the marginal rate of technical substitution labour for capital).
It can also be shown that the marginal rate of substitution labour for capital, is equal to the marginal physical product of labour divided by the marginal physical product of capital.
In the unusual case of two inputs that are perfect substitutes for each other in production, the isoquant would be linear (linear in the sense of a function ). If, on the other hand, there is only one production process available, factor proportions would be fixed, and these zero-substitutability isoquants would be shown as horizontal or vertical lines.
Read more about this topic: Production Theory
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