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Marginal Rate of Technical Substitution (MRTS)

The measure with which one input factor is reduced while the next factor is increased without changing the output

What is the Marginal Rate of Technical Substitution (MRTS)?

The marginal rate of technical substitution (MRTS) is the measure with which one input factor is reduced while the next factor is increased without changing the output. It is an economic illustration that explains the level at which one factor of input must decline. While maintaining the same level of production, another factor of production is increased. It shows how you can replace one input with another input without altering the resulting output.

 

Marginal Rate of Technical Substitution (MRTS)

 

Summary

  • The marginal rate of technical substitution (MRTS) examines the level where one input can be replaced for another resource with production remaining constant.
  • The rate of one factor of production is decreased, and another factor is increased while the output level is maintained.
  • When input utilization is optimal, the marginal rate of technical substitution is equivalent to the cost of the inputs.

 

Understanding Marginal Rate of Technical Substitution

By substituting two input factors, the producer will need less amount of money to achieve an equilibrium where the firm realizes maximum profitability with minimum cost.

For example, the labor input can be decreased while the capital input increased with the production level remaining constant. The MRTS demonstrates the value by which one resource can be substituted with another input of production without altering the level of output.

The formula for MRTS is as follows:

 

Marginal Rate of Technical Substitution

 

Where:

  • MP is the Margin Product of each input
  • Δ K/Δ L is the Capital that can be reduced
  • K is the Capital
  • L is the Labor

 

How MRTS Works

The marginal rate of technical substitution ascertains the amount of cost which a specific input can be replaced for another resource of production while maintaining a constant output. Therefore, the marginal rate of technical substitution explains when a producer is planning to replace one input of production with the next one.

The company may choose several combinations of inputs that can be alternatively substituted to produce the same level of output. The pair of inputs determined by the management must be able to achieve the best results.

For example, when factor A can produce a maximum quantity of output than factor B with the same cost incurred, the producer may end up choosing factor A instead of B.

 

Principle of Marginal Rate of Technical Substitution

The marginal rate of technical substitution focuses on the rate at which the producer combines two inputs of production and substitutes one factor by decreasing it further upon every consecutive substitution. Generally, the marginal rate of technical substitution specifies the rate at which factors of production can be substituted without any change in the unit of output.

For example, the MRTS of labor for the unit of capital is the inputs of capital that can be switched with one input of labor with the output level being constant.

The principle states that one input of production decreases with every subsequent replacement by another factor of production. This decline, combined with a constant level of output, is known as the principle of diminishing marginal of technical substitution.

 

How Marginal Rate of Technical Substitution Diminishes

The marginal rate of technical substitution diminishes when the producer keeps on substituting one resource of production with another input of production. The following are the main factors as to why the MRTS diminishes over time during production.

 

1. Scarcity of the factor of production

Continuous substitution of one factor of production with another one causes inadequacy of the input of production being replaced. In this case, the factor being substituted will not be able to deliver maximum contribution for systematic production. Hence, although more inputs of capital were made, the MRTS declined with successive substitutions.

 

2. Imperfect substitution of factors of production

It is impossible for two factors of production to substitute each other perfectly since their usage in the production process is different. Besides, if the two factors could substitute perfectly, a decrease or an increase in either of them cannot cause any change in the MRTS.

 

The marginal rate of technical substitution allows the management to determine the factors that can provide the highest cost-efficient combination for producing a specific quantity of output and find a production point where the combined factors are minimized to decrease the cost of production.

 

MRTS Graph

An isoquant is a graphical illustration that explains how much input of labor and capital will produce a constant output. The gradient of the isoquant indicates the MRTS, any point along the slope specifies how much labor will be required to replace a unit of capital at that production point.

 

More Resources

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In order to help you become a world-class financial analyst and advance your career to your fullest potential, these additional resources will be very helpful:

  • Economics of Production
  • Substitution Effect
  • Marginal Cost of Production
  • Economic Capital

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