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CA Foundation · Business Economics · Theory of Production and Cost

Along a typical convex isoquant, as a firm substitutes labour for capital while keeping output constant, the marginal rate of technical substitution of labour for capital (MRTS) diminishes. This happens because:

MRTS diminishes because, as labour is substituted for capital, labour's marginal product falls and capital's marginal product rises. MRTS equals MPL divided by MPK, so the ratio declines, and the firm gives up less capital for each extra unit of labour, making the isoquant convex.

  1. ATotal output falls as more labour is added
  2. BThe marginal product of labour rises as more labour is used
  3. CThe price of labour rises as more labour is demanded
  4. DLabour becomes less productive relative to capital as more labour replaces capitalCorrect

Explanation

As more labour replaces capital, the marginal product of labour falls while the marginal product of the remaining capital rises. Since MRTS equals MPL/MPK, it declines, so less capital is given up for each additional unit of labour. Output is held constant along an isoquant, so option about falling output is wrong.

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