You are on page 1of 3

Production function

Isocost
The prices of factors are represented by the isocost line .the isocost line plays an important role in determining what factors of production the firm will choose for the production.an isocost line shows various combinations of two factors that the firm can buy with the given outlay / expenditure. An isocostis defined as the locus of various combinations of factors which a firm can buy with constant outlay . the iso-cost line is also called the price line or the outlay line. Let us illustrate with the help of a table followed by its graph: We are considering a firm which is working under perfect competition in the factor markets.suppose the firm or the producer has 100 rupees to spend and the prices of the land and the labour are rs. 5 and rs. 10 respectively. Combination A B C Land 20 10 0 Labour 0 5 10 Total Expenditure 100 100 100

Plotting the points A,B and C , we get a line AC which is called the budget line or iso-cost line. Therefore , the slope of the iso-cost line can be proved to be equal to the ratio of price of labour(w) and price of capital(r) . The equation of iso-cost line line is: C=W.L + R.K Where, W = wage rate L = labour R = price per unit of capital K = the quantity of capital used

Equilibrium of the firm


The equilibrium of the firm is indicated by the tangency between the budget line and the isoquant. The least cost combination shows equilibrium position of the firm. In the figure, the least cost combination is indicated by point c . it is at this point that the budget line or iso-cost curve touches the highest possible iso-quant. The iso-quant curve i.e. IP3 is beyond the reach of the firm as it crosses the budget line of the producer i.e. AB and IP1 shows the under utilisation of resources i.e. its below the optimum combination for the firm. Thus, the combination of land and labour at point C(i.e. CD+OD) is the least cost combination. It is the equilivrium position of the firm .

Marginal Rate of Technical Substitution(MRTS)


MRTS indicates the rate at which factors can be substituted at margin withoutaltering the level of output. Therefore , MRTS of labour for capital may be defined as the number of units of capital which can be replaced by one unit of labour , the level of output remaining unchanged. Factor combinations A B C D E Units of labour(L) 1 2 3 4 5 Units of capital(K) 12 8 5 3 2 MRTS of L for K 4 3 2 1

Each of the factor combinations A,B,C,D and E yields the same level of output. Moving down from combination A to combination B , 4 units of capital are substituted by 1 unit of labour in the production process without any change in the level of output. Therefore MRTS of labour for capital is 4 at this stage.Switching from input cobination B to input combination C involves the replacement of 3 units of capital by an additional unit of labour , output remaining the same , Thus the MRTS is now 3. Likewise MRTS of labour for capital between factor combination C and D is 2 and between factor combination D and E , it is 1.

MRTS of Labour for capital = slope = An Important point to be noted about MRTS is that it is equal to the ratio of the marginal physical products of the two factor.