Microeconomics 2

Chapter 19. Technology

 Technologies

u A technology is a process by which inputs are

converted to an output.
u E.g. labor, a computer, a projector, electricity, and
software are being combined to produce this
lecture.
 Technologies

u Usually, several technologies will produce the

same product -- a blackboard and chalk can be
used instead of a computer and a projector.
u Which technology is “best”?
u How do we compare technologies?
 Input Bundles

u xi denotes the amount used of input i; i.e. the level

of input i.
u An input bundle is a vector of the input levels;
(x1, x2, … , xn).
u E.g. (x1, x2, x3) = (6, 0, 9).
 Production Functions

u y denotes the output level.

u The technology’s production function states the
maximum amount of output possible from an
input bundle.

y = f ( x1 , ! , xn )
 Production Functions
One input, one output
Output Level
y = f(x) is the
production function.
y’
y’ = f(x’) is the maximal output level
obtainable from x’ input units.

x’ x
Input Level
 Technology Sets

u A production plan is an input bundle and an output

level; (x1, … , xn, y).
u A production plan is feasible if

y £ f ( x1 , ! , xn )
u The collection of all feasible production plans is the
technology set.
 Technology Sets

Output Level

y’
y’ = f(x’) is the maximal output level
obtainable from x’ input units.

y” y” = f(x’) is an output level that is

feasible from x’ input units.

x’ x
Input Level
 Technology Sets
The technology set is

T = {( x1 ,!, xn , y) | y £ f ( x1 ,!, xn ) and

x1 ³ 0,", xn ³ 0}.
 Technology Sets

Output Level

y’

The technology
set
y”

x’ x
Input Level
 Technology Sets

Output Level

Technically
y’ efficient plans

The technology
set
Technically
y”
inefficient
plans

x’ x
Input Level
 Technologies with Multiple Inputs

u What does a technology look like when there is

more than one input?
u The two-input case: Input levels are x1 and x2.
Output level is y.
u Suppose the production function is

1/3 1/3
y = f ( x1 , x 2 ) = 2x1 x 2 .
 Technologies with Multiple Inputs
u E.g. the maximal output level possible from the
input bundle (x1, x2) = (1, 8) is

y = 2x1/
1
3 1/ 3
x 2 = 2 ´ 11/ 3
´ 81/ 3
= 2 ´ 1 ´ 2 = 4.

u And the maximal output level possible from

(x1,x2) = (8,8) is

1/ 3 1/ 3 1/ 3 1/ 3
y = 2x1 x 2 = 2 ´ 8 ´ 8 = 2 ´ 2 ´ 2 = 8.
Technologies with Multiple Inputs
Output, y

x2
(8,8)
(8,1)
x1
 Technologies with Multiple Inputs

u The y output unit isoquant is the set of all input

bundles that yield at most the same output level y.
Isoquants with Two Variable Inputs
x2

yº8

yº4
x1
 Isoquants with Two Variable Inputs

u Isoquants can be graphed by adding an output

level axis and displaying each isoquant at the
height of the isoquant’s output level.
Isoquants with Two Variable Inputs
Output, y

yº8

x2 y º 4

x1
 Isoquants with Two Variable Inputs

u More isoquants tell us more about the technology.

Isoquants with Two Variable Inputs
x2

yº8

yº6
yº4
yº2
x1
 Isoquants with Two Variable Inputs

Output, y

yº8

yº6

x2 y º 4
yº2

x1
 Technologies with Multiple Inputs

u The complete collection of isoquants is the

isoquant map.
u The isoquant map is equivalent to the production
function -- each is the other.
u E.g.

y = f ( x1 , x2 ) = 2 x11 / 3 x21 / 3
 Cobb-Douglas Technologies

u A Cobb-Douglas production function is of the

form
a1 a 2 an
y = A x1 x 2 ´!´ xn .
1/3 1/3
u E.g. y = x1 x 2
with 1 1
n = 2, A = 1, a1 = and a 2 = .
3 3
 Cobb-Douglas Technologies
x2
All isoquants are hyperbolic,
asymptoting to, but never
touching any axis.

a1 a 2
y = x1 x 2
y" > y'

a1 a 2
x1 x 2 = y"
a1 a 2
x1 x 2 = y'
x1
 Fixed-Proportions Technologies

u A fixed-proportions production function is of the

form
y = min{ a1 x1 , a 2x 2 ,!, an xn }.
u E.g. y = min{ x1 , 2x 2 }
with n = 2, a1 = 1 and a 2 = 2.
 Fixed-Proportions Technologies
x2 y = min{ x1 , 2x 2 }

x1 = 2x2

7 min{x1,2x2} = 14
4 min{x1,2x2} = 8
2 min{x1,2x2} = 4
4 8 14 x1
 Perfect-Substitutes Technologies

u A perfect-substitutes production function is of

the form
y = a1 x1 + a 2x 2 + ! + an xn .
u E.g. y = x1 + 3x 2
with n = 2, a1 = 1 and a 2 = 3.
 Perfect-Substitution Technologies
y = x1 + 3x 2
x2
x1 + 3x2 = 18

x1 + 3x2 = 36

x1 + 3x2 = 48
8
6 All are linear and parallel
3

9 18 24 x1
 Marginal (Physical) Products
y = f ( x1 , ! , xn )
u The marginal product of input i is the rate-of-
change of the output level as the level of input i
changes, holding all other input levels fixed.
u That is,
¶y
MP i =
¶ xi
 Marginal (Physical) Products
1/ 3 2 / 3
E.g. if y = f ( x1 , x 2 ) = x1 x 2

then the marginal product of input 1 is

¶ y 1 - 2/ 3 2/ 3
MP1 = = x1 x 2
¶ x1 3
and the marginal product of input 2 is
¶ y 2 1/ 3 - 1/ 3
MP2 = = x1 x 2 .
¶ x2 3
 Marginal (Physical) Products
Typically, the marginal product of one input depends
upon the amount used of other inputs.
1 - 2/ 3 2/ 3
E.g. if MP1 = x1 x 2 then,
3
1 - 2/ 3 2/ 3 4 - 2/ 3
if x2 = 8, MP1 = x1 8 = x1
3 3
and if x2 = 27 then
1 - 2/ 3 2/ 3
MP1 = x1 27 = 3x1- 2/ 3 .
3
 Marginal (Physical) Products

u The marginal product of input i is diminishing if it

becomes smaller as the level of input i increases.
That is, if

¶ MP i ¶ æ ¶ y ö ¶ 2y
= çç ÷÷ = < 0.
¶ xi ¶ xi è ¶ xi ø ¶ xi
2
 Marginal (Physical) Products
1/ 3 2 / 3 then
E.g. ify = x1 x 2
1 - 2/ 3 2/ 3 and 2 1/ 3 - 1/ 3
MP1 = x1 x 2 MP2 = x1 x 2
3 3
so
¶ MP1 2 - 5 / 3 2/ 3
= - x1 x 2 < 0
¶ x1 9
and
¶ MP2 2 1/ 3 - 4 / 3
= - x1 x 2 < 0.
¶ x2 9
Both marginal products are diminishing.
 Returns-to-Scale

u Marginal products describe the change in output

level as a single input level changes.
u Returns-to-scale describes how the output level
changes as all input levels change in direct
proportion (e.g. all input levels doubled or halved).
 Returns-to-Scale
If, for any input bundle (x1,…,xn),

f (kx1 , kx 2 ,!, kxn ) = kf ( x1 , x 2 ,!, xn )

then the technology described by the production
function f exhibits constant returns-to-scale.
E.g. (k = 2) doubling all input levels doubles the output
level.
 Returns-to-Scale

Output Level

y = f(x)
2y’

Constant
y’ returns-to-scale

x’ 2x’ x
Input Level
 Returns-to-Scale
If, for any input bundle (x1,…,xn),

f (kx1 , kx 2 ,!, kxn ) < kf ( x1 , x 2 ,!, xn )

then the technology exhibits diminishing returns-to-scale.
E.g. (k = 2) doubling all input levels less than doubles the
output level.
 Returns-to-Scale

Output Level

2f(x’) y = f(x)

f(2x’)
Decreasing
f(x’)
returns-to-scale

x’ 2x’ x
Input Level
 Returns-to-Scale
If, for any input bundle (x1,…,xn),

f (kx1 , kx 2 ,!, kxn ) > kf ( x1 , x 2 ,!, xn )

then the technology exhibits increasing returns-to-scale.
E.g. (k = 2) doubling all input levels more than doubles
the output level.
 Returns-to-Scale

Output Level

Increasing y = f(x)
returns-to-scale
f(2x’)

2f(x’)

f(x’)

x’ 2x’ x
Input Level
 Returns-to-Scale

u A single technology can ‘locally’ exhibit different

returns-to-scale.
 Returns-to-Scale

Output Level

y = f(x)
Increasing
returns-to-scale

Decreasing
returns-to-scale

x
Input Level
 Examples of Returns-to-Scale
The perfect-substitutes production function is

y = a1 x1 + a 2x 2 + ! + an xn .

Expand all input levels proportionately by k.

The output level becomes
a1 (kx1 ) + a 2 (kx 2 ) + ! + an (kxn )
= k( a1x1 + a 2x 2 + ! + anxn )
= ky.
The perfect-substitutes production function exhibits
constant returns-to-scale.
 Examples of Returns-to-Scale
The perfect-complements production function is

y = min{ a1 x1 , a 2x 2 , ! , an xn }.

Expand all input levels proportionately by k.

The output level becomes

min{ a1 (kx1 ), a 2 (kx 2 ), ! , an (kxn )}

= k(min{ a1x1 , a 2x 2 , ! , anxn })
= ky.
The perfect-complements production function exhibits
constant returns-to-scale.
 Examples of Returns-to-Scale
The Cobb-Douglas production function is
y = x1a1 x a
2
2 ! x an .
n
Expand all input levels proportionately
by k. The output level becomes

(kx1 ) a1 (kx 2 ) a 2 !(kxn ) an

= k a1k a 2 !k an x a1 x a 2 !x an
= k a1 + a 2 +!+ an x1a1 x a
2
2 !x an
n

= k a1 +!+ an y.
 Examples of Returns-to-Scale
The Cobb-Douglas production function is
y = x1a1 x a
2
2 ! x an .
n

(kx1 ) a1 (kx 2 ) a 2 !(kxn ) an = k a1 +!+ an y.

The Cobb-Douglas technology’s returns-to-scale is
constant if a1+ … + an = 1
increasing if a1+ … + an > 1
decreasing if a1+ … + an < 1.
 Returns-to-Scale

u Q: Can a technology exhibit increasing returns-

to-scale even if all its marginal products are
diminishing?
 Returns-to-Scale

u Q: Can a technology exhibit increasing returns-

to-scale even if all its marginal products are
diminishing?
u A: Yes.
2/ 3 2/ 3
u E.g. y = x1 x 2 .
 Returns-to-Scale
2/ 3 2/ 3 a1 a 2
y = x1 x 2 = x1 x 2
4
a1 + a 2 = > 1 So, this technology exhibits
3 increasing returns-to-scale.

2 - 1/ 3 2/ 3
But MP1 = x1 x 2 diminishes as x1
3
increases and
2 2/ 3 - 1/ 3 diminishes as x
MP2 = x1 x 2 1
3
increases.
 Returns-to-Scale

u So, a technology can exhibit increasing returns-

to-scale even if all its marginal products are
diminishing. Why?
 Returns-to-Scale

u A marginal product is the rate-of-change of

output as one input level increases, holding all
other input levels fixed.
u Marginal product diminishes because the other
input levels are fixed, so the increasing input’s
units have each less and less of other inputs with
which to work.
 Returns-to-Scale

u When all input levels are increased

proportionately, there need be no diminution of
marginal products since each input will always
have the same number of other inputs with which
to work. Input productivities need not fall and so
returns-to-scale can be constant or increasing.
 Technical Rate-of-Substitution

u At what rate can a firm substitute one input for

another without changing its output level?
 Technical Rate-of-Substitution

x2
The slope is the rate at which input 2 must be
given up as input 1’s level is increased so as
not to change the output level. The slope of an
isoquant is its technical rate-of-substitution.

x'2

yº100

x'1 x1
 Technical Rate-of-Substitution

u How is a technical rate-of-substitution computed?

u The production function is y = f ( x1 , x 2 ).
u A small change (dx1, dx2) in the input bundle
causes a change to the output level of

¶y ¶y
dy = dx1 + dx 2 .
¶ x1 ¶ x2
 Technical Rate-of-Substitution
¶y ¶y
dy = dx1 + dx 2 .
¶ x1 ¶ x2
But dy = 0 since there is to be no change to the output
level, so the changes dx1 and dx2 to the input levels
must satisfy

¶y ¶y
0= dx1 + dx 2 .
¶ x1 ¶ x2
 Technical Rate-of-Substitution
¶y ¶y
0= dx1 + dx 2
¶ x1 ¶ x2
rearranges to
¶y ¶y
dx 2 = - dx1
¶ x2 ¶ x1
so dx 2 ¶ y / ¶ x1
=- .
dx1 ¶ y / ¶ x2
 Technical Rate-of-Substitution
dx 2 ¶ y / ¶ x1
=-
dx1 ¶ y / ¶ x2
is the rate at which input 2 must be given up as input 1
increases to keep the output level constant.
It is the slope of the isoquant.
 Technical Rate-of-Substitution
A Cobb-Douglas Example
a b
y = f ( x1 , x 2 ) = x1 x 2
¶y a-1 b ¶y
so = ax1 x 2 and = bx1axb2 - 1 .
¶ x1 ¶ x2
The technical rate-of-substitution is
a-1 b
dx 2 ¶ y / ¶ x1 ax1 x 2 ax 2
=- =- =- .
¶ y / ¶ x2 -1
dx1 bx1axb
2
bx1
 Technical Rate-of-Substitution
A Cobb-Douglas Example
x2
1/ 3 2 / 3 1 2
y = x1 x 2 ; a = and b =
3 3
ax 2 ( 1 / 3) x 2 x2
TRS = - =- =-
bx1 ( 2 / 3 ) x1 2x1

x1
 Technical Rate-of-Substitution
A Cobb-Douglas Example
x2
1/ 3 2 / 3 1 2
y = x1 x 2 ; a = and b =
3 3
ax 2 ( 1 / 3) x 2 x2
TRS = - =- =-
bx1 ( 2 / 3 ) x1 2x1
x2 8
TRS = - =- = -1
8 2x1 2´ 4

4 x1
 Technical Rate-of-Substitution
A Cobb-Douglas Example
x2
1/ 3 2 / 3 1 2
y = x1 x 2 ; a = and b =
3 3
ax 2 ( 1 / 3) x 2 x2
TRS = - =- =-
bx1 ( 2 / 3 ) x1 2x1
x2 6 1
TRS = - =- =-
2x1 2 ´ 12 4
6

12 x1
F(x1x2)=2x1+x21/2
Find TRS.
F(x1x2)=2x1+x21/2
MPx1= 2
MPx2=1/2 x2-1/2

TRS=MPx1/MPx2= - 4x21/2
 Well-Behaved Technologies

u A well-behaved technology is
l monotonic, and
l convex.
 Well-Behaved Technologies - Monotonicity

u Monotonicity: More of any input generates more

output.

y y
monotonic
not
monotonic

x x
Well-Behaved Technologies - Convexity

u Convexity: If the input bundles x’ and x” both

provide y units of output then the mixture
tx’ + (1-t)x” provides at least y units of output, for
any 0 < t < 1.
Well-Behaved Technologies - Convexity

x2

'
x2

x"2
yº100

x'1 x"1 x1
Well-Behaved Technologies - Convexity

x2 Convexity implies that the TRS

increases (becomes less negative)
as x1 increases.
'
x2

x"2

x'1 x"1 x1
 Well-Behaved Technologies

x2 higher output

yº200

yº50 yº100

x1
 The Long-Run and the Short-Runs

u The long-run is the circumstance in which a firm

is unrestricted in its choice of all input levels.
u There are many possible short-runs.
u A short-run is a circumstance in which a firm is
restricted in some way in its choice of at least
one input level.
 The Long-Run and the Short-Runs

u Examples of restrictions that place a firm into a

short-run:
l temporarily being unable to install or remove
machinery
l being required by law to meet affirmative
action quotas
l having to meet domestic content regulations.
 The Long-Run and the Short-Runs

u A useful way to think of the long-run is that the

firm can choose as it pleases in which short-run
circumstance to be.
 The Long-Run and the Short-Runs

u What do short-run restrictions imply for a firm’s

technology?
u Suppose the short-run restriction is fixing the
level of input 2.
u Input 2 is thus a fixed input in the short-run.
Input 1 remains variable.
 The Long-Run and the Short-Runs
1/3 1/3
y = x1 x 2 is the long-run production function
(both x1 and x2 are variable).

The short-run production function when x2 º 1 is

y = x11 / 3 11 / 3 = x11 / 3 .

The short-run production function when x2 º 10 is

1/ 3 1/ 3 1/ 3
y = x1 10 = 2 × 15x1 .