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The below mentioned article provides an overview on the Principle of Marginal Rate of Technical Substitution (MRTS). The principle of marginal rate of technical substitution (MRTS or MRS) is based on the production function where two factors can be substituted in variable proportions in such a way as to produce a constant level of output. Salvatore defines MRTS thus : “The marginal rate of technical substitution is the amount of an output that a firm can give up by increasing the amount of the other input by one unit and still remain on the same isoquant.” The marginal rate of technical substitution between two factors С (capital) and L (labour) MRTS is the rate at which L can be substituted for С in the production of good X without changing the quantity of output. As we move along an isoquant downward to the right, each point on it represents the substitution of labour for capital. MRTS is the loss of certain units of capital which will just be compensated for by additional units of labour at that point. In other words, the marginal rate of technical substitution of labour for capital is the slope or gradient of the isoquant at a point. Accordingly, slope = MRTS, LC = – ∆С/∆ L. This can be understood with the aid of the isoquant schedule, in Table 2  The above table shows that in the second combination to keep to output constant at 100 units, the reduction of 3 units of capital requires the addition of 5 units of labour, MRTSLC = 3:5. In the third combination, the loss of 2 units of capital is compensated for by 5 more units of labour, and so on. In Figure 9 at point B, the marginal rate of technical substitution is AS/SB, at point Q it is BT/TG and at H, it is GR/RH. The isoquant AH reveals that as the units of labour are successively increased into the factor-combination to produce 100 units of good X, the reduction in the units of capital becomes smaller and smaller. It means that the marginal rate of technical substitution is diminishing. This concept of the diminishing marginal rate of technical substitution (DMRTS) is parallel to the principle of diminishing marginal rate of substitution in the indifference curve technique. This tendency of diminishing marginal substitutability of factors is apparent from Table 2 and Figure 9. The MRTSLC continues to decline from 3:5 to 1:5 whereas in the Figure 9 the vertical lines below the triangles on the isoquant become smaller and smaller as we move downward so that GR < ВТ < AS. Thus, the marginal rate of technical substitution diminishes as labour is substituted for capital. It means that the isoquant must be convex to the origin at every point. 10.Explain why the marginal rate of technical substitution is likely to diminish asmore and more labor is substituted for capital. Get answer to your question and much more 12.Can a firm have a production function that exhibits increasing returns to scale,constant returns to scale, and decreasing returns to scale as output increases?Discuss. Get answer to your question and much more The measure with which one input factor is reduced while the next factor is increased without changing the output What is the Marginal Rate of Technical Substitution (MRTS)?The marginal rate of technical substitution (MRTS) is the measure with which one input factor is reduced while the next factor is increased without changing the output. It is an economic illustration that explains the level at which one factor of input must decline. While maintaining the same level of production, another factor of production is increased. It shows how you can replace one input with another input without altering the resulting output. Summary
Understanding Marginal Rate of Technical SubstitutionBy substituting two input factors, the producer will need less amount of money to achieve an equilibrium where the firm realizes maximum profitability with minimum cost. For example, the labor input can be decreased while the capital input increased with the production level remaining constant. The MRTS demonstrates the value by which one resource can be substituted with another input of production without altering the level of output. The formula for MRTS is as follows: Where:
How MRTS WorksThe marginal rate of technical substitution ascertains the amount of cost which a specific input can be replaced for another resource of production while maintaining a constant output. Therefore, the marginal rate of technical substitution explains when a producer is planning to replace one input of production with the next one. The company may choose several combinations of inputs that can be alternatively substituted to produce the same level of output. The pair of inputs determined by the management must be able to achieve the best results. For example, when factor A can produce a maximum quantity of output than factor B with the same cost incurred, the producer may end up choosing factor A instead of B. Principle of Marginal Rate of Technical SubstitutionThe marginal rate of technical substitution focuses on the rate at which the producer combines two inputs of production and substitutes one factor by decreasing it further upon every consecutive substitution. Generally, the marginal rate of technical substitution specifies the rate at which factors of production can be substituted without any change in the unit of output. For example, the MRTS of labor for the unit of capital is the inputs of capital that can be switched with one input of labor with the output level being constant. The principle states that one input of production decreases with every subsequent replacement by another factor of production. This decline, combined with a constant level of output, is known as the principle of diminishing marginal of technical substitution. How Marginal Rate of Technical Substitution DiminishesThe marginal rate of technical substitution diminishes when the producer keeps on substituting one resource of production with another input of production. The following are the main factors as to why the MRTS diminishes over time during production. 1. Scarcity of the factor of productionContinuous substitution of one factor of production with another one causes inadequacy of the input of production being replaced. In this case, the factor being substituted will not be able to deliver maximum contribution for systematic production. Hence, although more inputs of capital were made, the MRTS declined with successive substitutions. 2. Imperfect substitution of factors of productionIt is impossible for two factors of production to substitute each other perfectly since their usage in the production process is different. Besides, if the two factors could substitute perfectly, a decrease or an increase in either of them cannot cause any change in the MRTS. The marginal rate of technical substitution allows the management to determine the factors that can provide the highest cost-efficient combination for producing a specific quantity of output and find a production point where the combined factors are minimized to decrease the cost of production. MRTS GraphAn isoquant is a graphical illustration that explains how much input of labor and capital will produce a constant output. The gradient of the isoquant indicates the MRTS, any point along the slope specifies how much labor will be required to replace a unit of capital at that production point. More ResourcesCFI is the official provider of the Commercial Banking & Credit Analyst (CBCA)® certification program, designed to transform anyone into a world-class financial analyst. In order to help you become a world-class financial analyst and advance your career to your fullest potential, these additional resources will be very helpful:
Why the MRTS is likely to diminish as more and more labor is substituted for capital?An important characteristic of MRTS is that it diminishes as more and more labour is substituted for capital, i.e, if quantity of labour is increased and quantity of capital reduced the amount of capital that is required to be replaced by an additional unit of labour so as to keep output constant will diminish.
Why does marginal rate of technical substitution of Labour for capital diminish as more Labour is used by substituting capital?How Marginal Rate of Technical Substitution Diminishes. The marginal rate of technical substitution diminishes when the producer keeps on substituting one resource of production with another input of production.
Why does marginal productivity of labor decrease as more labor is added?The law of diminishing marginal returns states that when an advantage is gained in a factor of production, the marginal productivity will typically diminish as production increases. This means that the cost advantage usually diminishes for each additional unit of output produced.
Why does the marginal rate of substitution diminish?As we move along the indifference curve, marginal rate of substitution (MRS) tends to diminish. Because when we have less of a commodity, intensity of its desire increases. Accordingly, less and less of it is sacrificed for every additional unit of the other commodity.
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Why the marginal rate of technical substitution is likely to diminish as more and more labor is substituted for capital?
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