Microeconomics
Session 8
Sagnik Bagchi, Ph.D.
School of Business Management, NMIMS-Mumbai
Isoquant and Marginal Rate of Technical Substitution
The firm seeks the optimal combination of inputs, rather than simply the optimal level of one
particular input
Isoquants: Isoquants Curve showing all possible combinations of inputs that yield the same
output.
Isoquant Map: Graph combining a number of isoquants, used to describe a production function.
06-07- Microeconomics-MBA [2025-26], SB
2025
Isoquant and Marginal Rate of Technical Substitution
Input Flexibility
Isoquants show the flexibility that firms
have when making production decisions:
They can usually obtain a particular output
by substituting one input for another. It is
important for managers to understand the
nature of this flexibility.
06-07- Microeconomics-MBA [2025-26], SB
2025
Isoquant and Marginal Rate of Technical Substitution
Substituting Input Factors
The degree of substitutability of two inputs is a measure of the ease with which one input can be
used in place of the other in producing a given amount of output.
Marginal Rate of technical substitution (MRTS) Amount by which the quantity of one input can be
reduced when one extra unit of another input is used, so that output remains constant.
Change in Capital Input ∆
𝐿
MRTSL for K = − =− When we substitute more of labour for the capital
Change in Labour Input ∆
𝐾
The numerator shows the amount of capital that is removed from the production process and the
denominator indicates the amount of labour needed to substitute for capital to maintain same
amount of output.
06-07- Microeconomics-MBA [2025-26], SB
2025
Isoquant and Marginal Rate of Technical Substitution
Isoquants are downward sloping and convex. The slope of the isoquant (MRTS) at any point
measures the marginal rate of technical substitution—the ability of the firm to replace capital with
labor while maintaining the same level of output.
Value of MRTS diminishes along the isoquant
06-07- Microeconomics-MBA [2025-26], SB
2025
Diminishing Marginal Rate of Technical Substitution
Diminishing Marginal Rate of Technical Substitution => Law of Diminishing Returns
As more of the variable input is added to a fixed factor,
at some point the additional output starts to diminish.
If this holds true when one of the inputs is fixed, it must
certainly hold when this same input is reduced.
Why increasingly labour input requires less and less sacrifice of capital to maintain
same level of output?
06-07- Microeconomics-MBA [2025-26], SB
2025
Marginal Rate of Technical Substitution= Ratio of Marginal
Products
If K is reduced by 2 units (∆K=2) while labour is held
constant at 2; then marginal product of capital (MPK) is 
To achieve the same level output, L has to be increased
by 1 unit (∆L=1); then marginal product of labour (MPL)
is 
Ratio of Marginal Products = 
06-07- Microeconomics-MBA [2025-26], SB
2025
Marginal Rate of Technical Substitution= Ratio of Marginal
Products

Or

Increase in Output from increasing labour = 
Reduction in Output from decreasing capital = 
Along the isoquant change in output must be the same: 
After re-arranging:  or 
Or,  or 
06-07- Microeconomics-MBA [2025-26], SB
2025
Optimal Combination of Inputs
Optimal combination of imperfect substitutable inputs depend not only on their degree of
substitutability for one another but also on their relative price.
In the case of two inputs,

Iso-Cost Curve: TC=wL+rk
TC: Total budget allotment for inputs labour and capital (Total Cost)
w: per-unit price of labour (wage rate)
r: per-unit price of capital (rent)
06-07- Microeconomics-MBA [2025-26], SB
2025
Returns to Scale
It is the rate at which output increases as inputs are increased
proportionately.
Increasing Returns to Scale: Output more than doubles when all inputs are doubled
Constant Returns to Scale: Output doubles when all inputs are doubled
Decreasing Returns to Scale: Output less than doubles when all inputs are doubled
Percentage change in output
Coef cient of Output Elasticity (E) =
fi
Percentage change in all inputs
1. If E>1, Increasing Returns to Scale (IRTS)
2. If E=1, Constant returns to Scale (CRTS)
3. If E<1, Decreasing Returns to Scale (DRTS)
; increase the amount of each input by λ; 
If h > λ; E>1; IRTS
h = λ; E=1; CRTS
h < λ; E<1; DRTS
06-07- Microeconomics-MBA [2025-26], SB
2025
Returns to Scale
An example to show returns to scale: 

As λ>1, the production function exhibits increasing returns to scale
06-07- Microeconomics-MBA [2025-26], SB
2025
