What is an isoquant in production theory?
Function representing all possible combinations of factor inputs that can produce a given level of output.
Input1 und Input2 = Axen
What is the Marginal Rate of Technical Substitution (MRTS)?
- Rate at which one factor input can be substituted for another at a given output level.
- Formula: MRTS = ∆K/∆L = 𝑀𝑃_𝐿/𝑀𝑃_𝐾 = (∆Q/∆L)/ (∆Q/∆K)
K = Capital
L = Labour
What is the isocost line?
- Shows combinations of factor inputs that can be purchased with a given budget.
- Formula: TC = PLL + PKK
ΔK/ΔL = −(P_L/P_K)
Tells us the rate at which a firm
can give up a unit of labor to buy
(𝑃_𝐿/𝑃_K) units of capital while
holding the total cost at the same
level
Umstellen nach K = Zahl - ZahlL
Oder Zahl = ZahlK + Zahl*L
Define the Principal-Agent Problem in cost theory.
- Conflict of interest between firm owners (principals) and managers (agents).
- Asymmetric information leads to inefficiency.
Managers maximize a utility function (salary, status, prestige, security, …).
Manager can act in her/his interest at the owner’s expense. -> The principal-agent problem is an example of moral hazard
In order to ensure that managers comply with the objectives of the principal and implement it economically (efficient), the principal has two strategies:
1. ‘Control’ the agent’s work, check management results (not easy to solve the asymmetric information problem).
2. Match agent’s interests with own ones (definition of incentive strategies):
Participation of manager in ownership of company
Others monetary incentive mechanisms
What is X-Inefficiency?
Deviations from cost minimisation due to non-rational management decisions, influenced by selective rationality.
The level of selective rationality of a manager or management depends on internal and
external pressures. External pressures rely on the
market competition level, while internal pressures depend on the duality of management personality.
Explain Behavioural Agency Theory.
- Agents are boundedly rational and loss-averse.
- Combines selective rationality and principal-agent theory.
- Agents are boundedly rational, i.e. subject
to cognitive and storage limitations to
receive, store, and process information - Agent are loss averse
Describe the Substitution Method for optimisation
Substitution Method is a technique for solving two-variable constrained optimisation problems by substituting constraints into the objective function.
- Express the constraint with either x or y as the dependent variable (nach einem der beiden umstellen)
- Substitute the constraint in the objective function
- Maximize the new objective function with respect to the remaining independent variable by setting its first derivative to zero and solving
= optimization problem -> maximization
Es gibt aber auch minimization
Isoquants When Inputs are perfect substitutes and perfect
complements
perfect substitutes:
perfect complements:
Isoquants When Inputs are perfect substitutes and perfect
complements
perfect substitutes: 7
perfect complements: L
Input Substitution When an Input Price Changes
If the price of energy increases (e.g. CO2 tax), the isocost curve becomes steeper due to the change in the slope (output
remains constant (isoquant stays the same but new point on isoquant))
Least-Cost Input Combination and Total Cost Function
TC curve sind alle Punkte wo sich isoquant fct. und isocost fct. tangieren.
Inefficiency (cost–inefficiency)
Inefficiency: Firms fail to minimize cost of production due to the use of more inputs than technologically necessary or choosing a wrong combination of inputs.
Neoclassical economic theory assumes that firms always take optimal input decisions and hence operate on their cost frontier.
Theories That Explain the Level of Cost Inefficiency
X-Inefficiency and selective rationality (Liebenstein, 1966)
Principal-agent problem (Alchian & Demsetz, 1972)
Behavioral agency theory (Pepper & Gore, 2015)
Case Study Nursing home
While private nonprofit homes tend to be slightly more cost-efficient than public ones, the difference is mainly due to structural rather than managerial factors. It also highlights the distinction between public-law and private-law nonprofit nursing homes, where the former are integrated into local government administration, while the latter operate as foundations, sometimes government-owned, under a separate legal framework.
