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The Austrian position on Isoquant-isocost diagrams

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Consumariat posted on Sun, Nov 4 2012 10:21 AM

In mainstream econ classes, when analysing the impact of relative price changes in Labour and Capital, an Isoquant-Isocost diagram is used.

 

This shows Labour on the x-axis measured in labour hours, and Capital on the y-axis. The isocost line (in other words the budget available) shows all possible combinations of labour and capital for a given budget, and the isoquant (the curved line) shows how much output it is possible to produce at that particular combination of labour and capital. 
 
Now, Labour is supposedly measured in labour hours. This is all very well, but my question is about how it is possible to measure 'capital' in general. There are many different types of capital ranging from screwdrivers to CNC machines and anything in between. So what unit of measurement to mainstream economists use to measure capital?
 
I asked my lecturer this, and his answer was that it is usual to measure capital in the value of the capital used, but there seems something wrong with this. 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? If Capital is measured in the price of that Capital, then the answer to the question "how much capital can you buy with £300,000 would be... er... £300,000s worth. Well, yeah. Great. And then, changing the price of capital would not change the position of where the isocost line touches the y-axis, and as such it would be impossible to assess how capital price changes affect output.
 
What do Austrians say about this issue? How to Austrians analyse capital-labour ratios and input-output relations? Do they have a critique of the mainstream use of isocosts and isoquants?
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I can't help you there, but I would like to ask what level your class is so I can know when to expect to learn about these diagrams.

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I'm a first year undergrad in my first semester. It's the microeconomics part of an Econ101 module. Don't know how Econ101 differs from university to university, but I imagine it's pretty much the same syllabus at all universities. When are you starting your course?

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Well, I've already taken AP Marco and Micro, so I will not be repeating the intro level econ classes. I start my econ next semester (I'm just Computer Science for now).

I've noticed that the AP exam doesn't really cover many of the topics in the syllabus of the intro classes, which is weird, given they use the same books. For example, I never learned about the Keynesian Cross or the above diagrams. I also don't remember learning indifference curves. That's why I am currently reading an intro Macro and Micro textbook so that I am not behind when I begin my semester.

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Let me be blunt.   Whenever anyone comes on here with a fairly technical topic, and asks "What is the Austrian take on this?", the standard response will you get is "I have never heard of this, nor do I really understand it, but it looks mathematical so it can't be right."  I'm sorry, but that's the truth.  Don't expect Austrians to have a uniform stance on every technical topic you learn in undergraduate economics, especially microeconomics.  

 

 

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It seems like he's been on the forums long enough to know what to expect, so maybe you shouldn't waste your breath.

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Capital is heterogenous. Those diagrams assume "fungible capital" so I would say that the Austrian position is probably that youre up to your eyeballs in a theory that can only ever carry a distant passing resemblance to reality.
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"Do they have a critique of the mainstream use of isocosts and isoquants?"

Is the Pope Catholic? http://mises.org/journals/scholar/Block12.pdf

It's a long and detailed critique of monopsony by Block, but I'm sure you can find your answer in there.

An idealist is one who, on noticing that roses smell better than a cabbage, concludes that it will also make better soup. -H.L. Mencken
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I was taught not to put too much emphasize on the numbers per se, but to use iso curves to help when thinking about a problem. I know there some Professors who want you to be able to derive the different numbers in the model, but I don't place much importance on that. 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. 

So, to answer your question, capital in iso curves are being referred to in an abstract manner. 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. The problem is when students and Professors alike forget that we're assuming homogenous capital for the sake of convenience and not seriously proposing all capital is the same. 

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. I advise this because the Austrian theory of value breaks apart if there isn't some homogenous nature to things. 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. If the Austrian theory of value is flawed then there are problems with other Austrian economic perspectives. Capital is certainly not 100% homogenous, but it isn't 100% heterogenous either. 

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

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Like a machine or something, where XK 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.

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

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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.

Freedom of markets is positively correlated with the degree of evolution in any society...

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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.

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"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.

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