Producer Theory Applications Handout 1 Input Substitution Input

Producer Theory - Applications Handout 1

Input Substitution…. Input Prices • Firms can respond to different input prices in different ways • Model can explain land use patterns • Consider parking space – Urban areas – Suburban areas 2

Input Substitution…. Input Prices (a) Concrete (C) TC/Pc 500 parking spot isoquant Equi-marginal Principle: MPL/MPC=PL/PC ISO-Cost: or: TC=PCC+PLL C=TC/PC-(PL/PC)L Suburban: PL/PC = 1/5 C 0 C 1 Suburban isocost L 0 L 1 TC/PL Land (L)

Input Substitution…. Input Prices (b) Concrete (C) TC/Pc Urban isocost 500 parking spot isoquant Equi-marginal Principle: MPL/MPC=PL/PC ISO-Cost: or: TC=PCC+PLL C=TC/PC-(PL/PC)L Suburban: Urban: PL/PC = 1/5 PL/PC = 5/1 C 0 C 1 Suburban isocost L 0 L 1 TC/PL Land (L)

Input Substitution, Marginal Product and Technological Innovation • Suppose a technological innovation in the productivity of energy inputs occurs – Output per unit energy increases – Easier to substitute more energy for less labor – What happens to the isoquant? • One Possibility: For the same level of production the firm can use less Labor and less energy – And lower its cost of production • But what could happen to energy use? – Jevon’s Paradox 5

Part 1: Input Substitution…. Technological Labor (L) Innovation – one possibility TC/PL L 0 Q=100, 000 L’ E’ E 0 Lower cost TC/PE Energy (E)

Part 2: Technological Innovation and Labor (L) increased production! TC/PL L 0 Q=100, 000 L 1 Q=150, 000 Q=100, 000 E 1 TC/PE Energy (E)

Production and Cost – Short vs. Long run • Suppose an increase in demand prompts the firm to increase production from 100, 000 to 150, 000? • Short Run (SR) costs > Long Run (LR) costs • Why? 8

Production and Cost – Short&Long run (a) K SR – K fixed at K 0 TC/PK K 0 A B Q=150, 000 Q=100, 000 L 0 TC/PL L’ Short run costs L 9

Production and Cost – Short&Long run (b) K SR – K fixed at K 0 LR – Adjust to K 1 Notice what happens to TC TC/PK C K 1 K 0 Expansion Path(Long run) A B Q=150, 000 Q=100, 000 L 1 TC/PL Short run costs L Long run costs 10

Total Cost Curves – SR and LR $ SR LR B A 100, 000 C 150, 000 Q 11