Economics Questions

Re: The Austrian position on Isoquant-isocost diagrams

Consumariat — Sun, 25 Nov 2012 01:38:58 GMT

Yes, that sounds right.

In case you missed it, I answer you're original question in the previous post.

Thank you for your response. Sorry about the belated reply, I was mulling over your answer for a while but then got distracted by essays and the like.

The entrepreneur's role is not merely to minimize costs, but to maximize the spread between his costs and income

Could you explain a bit more about this please? How does maximising the spread between costs and income differ from inimising costs? They Sound the same to me.

Re: The Austrian position on Isoquant-isocost diagrams

Daniel James Sanchez — Sun, 04 Nov 2012 23:54:05 GMT

Yes, that sounds right.

In case you missed it, I answer you're original question in the previous post.

Re: The Austrian position on Isoquant-isocost diagrams

Consumariat — Sun, 04 Nov 2012 23:30:42 GMT

No, the point of the diagram is to illustrate that for any given output (isoquant), the least-cost combination of inputs is the point of tangency on the isocost curve that is closest to the origin, but still touching the given isoquant.

OK, what I should have said, which I think would have communicated what I meant better, is that if the price of either of the factors changes, then the slope of the isocost will move, and hense the point of tangency will change to a different isoquant. So wouldn't output be affected?

For example:

Say the budget is such that the isocost is N1 on this diagram. Then the cost of labour goes up so that N1 shifts inwards to N2. The possible output that can be achieved is reduced from isoquant i1 to isoquant i2. The point of tangency of N2 and i2 is the cheapest way that this output can be achieved.

Am I understanding it correctly?

Re: The Austrian position on Isoquant-isocost diagrams

Daniel James Sanchez — Sun, 04 Nov 2012 23:25:41 GMT

All that being said, the iscost-isoquant approach is wrong-headed. The problem with the analysis is that it misunderstands the nature of entrepreneurial decisions. It takes output as given, and portrays profit maximization as simply a matter of achieving that output while minimizing costs.

The entrepreneur's role is not merely to minimize costs, but to maximize the spread between his costs and income. And doing that takes much more than high-school level math. It takes successful forecasting of demand for his product. Based on those forecasts, he must choose both his output and input with the aim of maximizing that spread.

Furthermore, the anlaysis can be misleading. It represents factor hire prices as simply given to the entrepreneur. While to a single entrpreneur in a large market, the "prevailing price" may appear as given, it is fundamentally entrepreneurial demand for the factors that determines factor prices.

Re: The Austrian position on Isoquant-isocost diagrams

Consumariat — Sun, 04 Nov 2012 23:21:10 GMT

The isoquant shows the possible combinations of labour and capital for producing a given output.

Yes, you are correct. I thought that's what I said. My wording was bad I guess.

Re: The Austrian position on Isoquant-isocost diagrams

Daniel James Sanchez — Sun, 04 Nov 2012 22:27:28 GMT

Alternatively, it can indicate, at a given cost, the maxiumum amount of output (the greatest isoquant touching the given isocost).

Re: The Austrian position on Isoquant-isocost diagrams

Daniel James Sanchez — Sun, 04 Nov 2012 22:20:01 GMT

"After all, isn't the point of the isocost-isoquant diagram that you can analyse changes in the relative prices of the inputs, and how this impacts on output?"

Consumariat,

No, the point of the diagram is to illustrate that for any given output (isoquant), the least-cost combination of inputs is the point of tangency on the isocost curve that is closest to the origin, but still touching the given isoquant.

Re: The Austrian position on Isoquant-isocost diagrams

Daniel James Sanchez — Sun, 04 Nov 2012 21:51:27 GMT

"the isoquant (the curved line) shows how much output it is possible to produce at that particular combination of labour and capital. "

Did your teacher tell you that? You have it backward. The isoquant shows the possible combinations of labour and capital for producing a given output.

Re: The Austrian position on Isoquant-isocost diagrams

Jon Irenicus — Sun, 04 Nov 2012 21:50:09 GMT

Good point, actually. He seems to be confusing the physical limitations of capital goods with the subjective attributes of consumer goods.

Re: The Austrian position on Isoquant-isocost diagrams

Daniel James Sanchez — Sun, 04 Nov 2012 21:41:05 GMT

"If things aren't homogenous then there are no diminishing returns. If there are no diminishing returns then something is wrong with Menger's use of marginals in his theory of value."

Michelangelo, Menger's theory of value has nothing to do with the law of diminishing returns, which is distinct from the law of diminishing marginal utility.

Re: The Austrian position on Isoquant-isocost diagrams

Consumariat — Sun, 04 Nov 2012 21:00:12 GMT

In real life you'd never know the values of labor or capital beyond a general sense, so trying to get exact numbers is kinda a waste of time. This becomes clearer when you take upper division courses dealing with things like the Solow model.

I'll have to take your word on this as I am obviously very early on in my learning. Will take a look into the Solow model you speak of.

And yes, for the purpose of the model its being assumed its homogenous. This doesn't however mean that iso curves are useless. They are still useful to help you organize your thoughts.

But if in reality homogeneity does not exist (even if, as you say, there is a sliding scale between homogeneity and heterogeneity) then how does thinking in terms of 'abstract' capital organise my thoughts in any meaningful way? As I said in my previous post, the heteregeneity of capital is implied in the substitution of labour for capital.

While we're at it I'd advise you against using a hardline Austrian perspective of rejecting all homogenous nature of capital and labour. Things aren't either homogenous or heterogenous, but rather lay in a spectrum between the two.

That's fair enough, I'm willing to accept that there will be types of capital that share features, and that there is a graduation of qualities. However, even a small degree of heterogeneity seems like a problem because it removes the possibility of a common unit of measurement.

Re: The Austrian position on Isoquant-isocost diagrams

Jon Irenicus — Sun, 04 Nov 2012 20:51:37 GMT

I advise this because the Austrian theory of value breaks apart if there isn't some homogenous nature to things.

Well it doesn't "break apart". The subjective theory of value continues to apply. In this instance MUTV and its corollary of DMU simply doesn't apply, which isn't the same as "breaking down". The same goes for neoclassical value theory, FYI. They're both predicated on the homogeneity of the good being valued from the point of view of the consumer (i.e. in terms of the uses they assign to the good.) Capital goods have derivative value anyway, so it doesn't apply to them from the outset.

Besides, saying two factors of production are homogeneous implies either one can be substituted for the other in the production process. Capital is not homogeneous in this manner or if it is, it is by no means common. This is a question of physical limitations on their substitutability. Consumer goods can be but only if they fulfill the same want. If you mean that on this spectrum there's degrees of substitutability, sure, that is true, and it is on a good-by-good basis that this will depend. Austrians aren't saying capital goods cannot be substituted one for another; they are denying the notion that capital, as a class of good, is homogeneous in the sense I just described. It isn't.

Re: The Austrian position on Isoquant-isocost diagrams

Consumariat — Sun, 04 Nov 2012 20:45:53 GMT

What if you assume the capital in question is some sort of capital good? Like a machine or something, where X_K is the amount of machines.

The thing is that isocost-isoquant analysis is all about how capital-labour substitution impacts upon the cost of production. But in reality, a labour intensive process would most likely use a different type of capital than a capital-intensive one. So for example, you can imagine the process of populating PCBs in a Chinese factory that uses a lot of labour. The capital used would be soldering irons and flux; the same process in the UK on the other hand might use automated Pick and Place machines, and hardly any labour. The heterogeneity of capital is built into the act of substituting capital for labour, or vice versa.

Re: The Austrian position on Isoquant-isocost diagrams

Andris Birkmanis — Sun, 04 Nov 2012 20:36:05 GMT

Like a machine or something, where X_K is the amount of machines.

The problem is, even the simplest of production processes require at least two inputs - the raw material and the tool/machine. The amount of raw material "mixed in" determines the amount of output, and almost never this influence is as simple as output equals input. Many processes require multiple input materials, which can be mixed in different proportions, with different proportions requiring different ratios of labor/capital.

Re: The Austrian position on Isoquant-isocost diagrams

Zlatko — Sun, 04 Nov 2012 20:19:53 GMT

What if you assume the capital in question is some sort of capital good? Like a machine or something, where X_K is the amount of machines. That seems to make some more sense to me, and does not conflict with the internal logic of the model from what I can see.

As for Austrian critiques, I wouldn't really bother myself with critiquing isoquants/isocosts specifically. There are more serious inadequacies with the standard microeconomic framework, such as the fact that there is no mention of time in the model, and thus zero profits, that it doesn't integrate in to a macroeconomic theory at all, leaving factor prices unexplained.