Long Run Cost Minimisation in Economics

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Define the law of diminishing marginal returns.

The law of diminishing marginal returns states that as a firm increases one input while keeping all others constant, the marginal product of that input will eventually decrease.

What does an isoquant represent?

An isoquant represents the efficient combinations of labor and capital that can produce a single level of output.

Explain the concept of returns to scale.

Returns to scale refer to the effect on output when all inputs are increased proportionately.

What is the main decision firms face in terms of cost minimization?

Firms need to decide on the optimal combination of inputs to minimize the cost of production. Signup and view all the answers

Differentiate between short run and long run costs in terms of cost minimization.

In the short run, firms have limited flexibility to adjust inputs, while in the long run, all costs are variable and firms can optimize input combinations. Signup and view all the answers

Why is it important for firms to understand the law of diminishing marginal returns?

Firms need to be aware of this law to avoid over-investing in a single input and experiencing diminishing returns. Signup and view all the answers

Explain the concept of Long Run Cost Minimisation Isocost lines.

Isocost lines represent combinations of labour and capital that have the same cost, analogous to a budget line in consumer theory. Signup and view all the answers

What is the formula for Total Cost (TC) in terms of Labour (L) and Capital (K)?

Total Cost (TC) = wL + rK Signup and view all the answers

Describe the slope of an Isocost line and its significance.

The slope of an Isocost line is -(w/r), representing the rate at which the firm can trade off labour for capital while keeping costs constant. Signup and view all the answers

What does the X-axis intercept of an Isocost line represent?

The X-axis intercept (K=0) of an Isocost line represents the total cost divided by the price of capital (TC/r). Signup and view all the answers

Explain the concept of Perfect Complement Isoquant curves.

Perfect Complement Isoquant curves represent inputs that are always used in a fixed proportion, similar to perfect complement Indifference Curves (ICs) in consumer theory. Signup and view all the answers

What is the Expansion Path and how does it connect optimal input combinations?

The Expansion Path connects optimal input combinations in the short run and long run, showing how inputs are adjusted to maximize output. Signup and view all the answers

Explain the concept of Elasticity of Factor Substitution.

Elasticity of Substitution gives a firm’s input-substitution opportunities-how easy/difficult is it for a firm to substitute inputs such that the output remains the same. Signup and view all the answers

How does a decrease in the price of labor affect the Isocost line?

It makes the Isocost line flatter, moving from C2 to C1. Signup and view all the answers

Define Price Elasticity of Demand for Inputs and its relationship with Elasticity of Substitution.

PED for Labour= percentage change in the cost minimising quantity of labour with respect to a 1 per cent change in the price of labor. Signup and view all the answers

What is the significance of the curvature of Isoquant in relation to the Elasticity of demand of a factor?

Low Elasticity of demand of labor implies little substitution of Labour for Capital. Signup and view all the answers

Explain the relationship between MRTS and the shape of Isoquants.

As we move downwards on Isoquants, the MRTS changes substantially; Isoquants are nearly L shaped. Signup and view all the answers

Describe the impact of the elasticity of substitution on the firm's input-substitution opportunities.

Elasticity of Substitution indicates how easy or difficult it is for a firm to substitute inputs while maintaining the same output level. Signup and view all the answers