Core Producer Theory (CPT)

Question 1

What is the difference between an isoquant and an isocost?

Answer 1

-Isoquant - shows all combinations of K&L that produce the same amount of output.
-Isocost - shows all combinations of K&L that cost the same amount.

Question 2

How do we graphically draw an isoquant/isocost diagram?

Answer 2

As the wage changes, we draw a new isocost line (point b) and draw a compensated line that is parallel to this and goes through point c, which is on the same IC as point a. Can analyse the same as consumer theory, with own and cross output and substitution effects.

Question 3

What is the marginal rate of technical substitution (MRTS)?

Answer 3

w/r.

Question 4

What is the equation for profit maximisation and how do we solve this equation?

Answer 4

PIE = P*Q(L,K) - wL - rK
To solve, we differentiate PIE with respect to L and K and set it to 0. Using the initial wage gives us point a and using the new wage gives us point b.

Question 5

What is the equation for cost minimisation and how do we solve this equation?

Answer 5

Lagrangian = wL + rK + LAMPDA(INITIAL Q - Q((L,K)). To solve, differentiate this with respect to L, K and LAMPDA (however, normally we have already done the first 2 and can just do this last one as we already have mini-equations for w and r). We do this to find point c and can compare before and afters (e.g: substitution effect).