Production -Isoquants, producer's equilibrium.pdf

BUSINESS ECONOMICS

1. PRODUCTION

2. ISOQUANTS
The term isoquant has been derived from a Greek word
‘Iso’ + a Latin word ‘quantus’ meaning quantity.
Isoquant curve is known as Equal Product Curve.
An isoquant curve represents different combinations of two inputs
(capital and labour) producing same level of output.
An isoquant is locus of points representing different combinations of
two inputs --labour and capital yielding the same output.
A firm’s production function can be represented by a series of
isoquants associated with different levels of output.

3. Assumptions
There are only two inputs
Both inputs are variable
These inputs can be substituted for one
another, upto a certain extent.
Labour and capital is perfectly divisible.

4. Properties of Isoquants
Isoquants are negatively sloped.
Isoquants are convex to the origin.
Higher isoquants represent a higher level of
output.
Isoquants cannot intersect each other.

5. ISOQUANT MAPS
When a number of isoquants are combined in a
single diagram, it is called as an isoquant map.
An isoquant map is another way of describing a
production function.
Each isoquant describes corresponds to a
different level of output.
A higher isoquant represents a higher level of
output.

6. Isoquants

7. Marginal Rate of Technical Substitution
or MRTS
Marginal rate of technical substitution of labour for capital is the amount by which the input of
capital can be reduced when one extra unit of labour is used, so that output remains constant.
The slope of isoquants (-Δ K/ΔL) defines the degree of substitutability of the factors of
production.
The slope of isoquant decreases as we move downwards along the isoquant, showing the
increasing difficulty in substituting Capital for Labour.
The slope of isoquant is called the marginal rate of technical substitution or MRS of factors.
– Δ K/ΔL =MRTS
L, K
It has been proved that MRTS is equal to the ratio of marginal products of the factors of
production.
MRTS
L, K = Δ K/ΔL = MP
L/ MP
K = w/r

8. Diminishing MRTS
Diminishing marginal rate of technical substitution.
MRTS falls as we move downward to the right along an
isoquant.
It implies that the productivity of one input is limited.
As more and more labour is added to the production
process in place of capital, the productivity of labour
falls.
Similarly, when more and more capital is added in place of
labour, the productivity of capital falls.

9. ISOCOST LINE
An isocost line shows all possible combinations of labour
and capital that can be purchased for a given total cost.
The cost of hiring factor inputs is represented by a firm’s
isocost lines.
C= wL + rK
 w= Price of labour i.e. wage rate
 r= Price of capital i.e. rental cost of capital.
Isocost line has a slope of Δ K/ΔL = w/r

10. IsocostLine

11. Cost minimisation and Output
maximisation
Isocost curves describes the combination of inputs
to the production that cost the same amount to
the firm.
The point at which the Isocost curve is tangent to
the isoquant it shows that the output can be at
minimum cost with a given combination of labour
and capital.

12. Cost minimization or producer’s
equilibrium

13. Expansion Path
The curve passing through the points of tangency
between the firm’s isocost lines and its isoquants
is its expansion path.
The expansion path describes the combinations of
labour and capital that firm will choose to
minimise costs at each output level.

14. Expansion Path

15. Elasticity of Substitution
The elasticity of substitution between factors of production is defined as the
percentage change in the capital labour ratio, divided by the percentage
change in the rate of technical substitution.
elasticity of substitution= percentage change in K/L
percentage change in MRTS
A high elasticity of substitution means that the factors can be substituted freely
for one another.
In case of low elasticity of substitution factors can be substituted only in limited
proportions.