Isocosts and Isoquants

11 - Abhinay Chidurala
15 - Anil Desai 20 - Crystal DSouza 26 - Mariette Fernandes 28 Joanna Joseph

Production Function

A mathematical function
that captures the features of technology by means by which an organisation transforms resources like land, labour into goods or services like steel or cement

F(x1 .......xn) Idea Of Efficiency

Cost Function

A mathematical
relationship that relates the expenses an organisation incurs on the quantity of output it produces and to the unit prices it pays.

E C (y , p1,....pn) C = f(X, T, Pf)

Production Function
Factor Inputs Labour Capital Method A Method B Factor Inputs Labour Capital Method A Method C

3 4

4 4

3 4

2 5

Q = f(N, L, K,E,T)
Q = f(L,K)

Production Function
Fixed proportions Production Function Variable proportions Production Function

Importance of the Functions

Offer equivalent information
about the structure of production technology

Theory of Supply &

Demand

Nature of Scale Economies Degree of Input

Substitutability

Extent of Production
Inefficiency

Isoquants

Iso-quants

Isoquant Equation

Isoquants Showing All Combinations of Capital and Labour That Can Be Used to Produce 50, 100, and 150 Units of Output
(Figure 7A.1)

The Slope of an Isoquant Is Equal to the Ratio of MPL to MPK (Figure 7A.2)

PROPERTIES OF ISOQUANTS

1.

An Isoquant is downward sloping to the right. i.e. NEGATIVELY INCLINED. This implies that for the same level of output, the quantity of one variable will have to be reduced in order to increase the quantity of other variable.

2.

A higher Isoquant represents larger output. That is with the same quantity of 0ne input and larger quantity of the other input, larger output will be produced.

PROPERTIES OF ISOQUANTS

3. 4.

No two Isoquants intersect or touch each other. If the two Isoquants do touch or intersect that means that a same amount of two inputs can produce two different levels of output which is absurd. Isoquant is convex to the origin. This means that the slope declines from left to right along the curve. That is when we go on increasing the quantity of one input say labour by reducing the quantity of other input say capital, we see less units of capital are sacrificed for the additional units of labour.

TYPES OF ISOQUANTS
1. 2. 3. 4.
Linear Isoquant Right-angle Isoquant Convex Isoquant Kinked Isoquant

LINEAR ISOQUANT

In

linear Isoquants substitutability of inputs.

there

is

perfect

For example in a power plant equipped to burn

oil or gas. Various amounts of electricity could be produced by burning gas, oil or a combination. I.E. Oil and gas are perfect substitutes. Hence the isoquant would be a straight line.

RIGHT-ANGLE ISOQUANT

In right-angle Isoquants there is complete nonsubstitutability between inputs. For example two wheels and a frame are required to produce a by cycle these cannot be interchanged. This is also known as Leontief Isoquant or input-output Isoquant.

CONVEX ISOQUANT
Continuous substitutability of capital and labour over a
certain range, beyond which the factors cannot substitute each other.

The traditional economic theory has adopted this Isoquant

the more realistic form of a kinked Isoquant because as the

number of process become infinite, the Isoquant becomes a smooth curve.

for analysis since it is uncomplicated.

KINKED ISOQUANT

Only limited substitutability of capital and labour. There are only a few processes for producing any
one commodity

The O substitutability of factors is possible only at

the kinks

Iso-cost

 Now suppose that a producer has a total budget of Rs

Combinations Units of Capital Units of Labour Total expenditure Price = 150Rs A B C D E 8 6 4 2 0 Price = 100 Rs 0 3 6 9 12 ( in Rupees) 120 120 120 120 120

120 and for producing a certain level of output, he has to spend this amount on 2 factors A and B. Price of factors A and B are Rs 15 and Rs. 10 respectively.

The isocost line shows all the possible combinations of two factors Labour and capital.

Equation of Isocost
Suppose you have 2 inputs, capital K & labor L. The price of a unit of capital is PK. The price of a unit of labor is PL. Let a particular outlay amount be R. Then all combinations of K & L such that PLL+ PKK = R lie on the isocost curve associated with that outlay.
If we rewrite the equation as K = R/PK (PL/PK)L , we see that the slope of the isocost is (PL/PK) & the vertical intercept is R/PK .

Graph of an Isocost
For example, suppose youre interested in the outlay amount $10,000. Suppose also that Labor cost $10 per unit & capital cost $100 per unit. K R/PK= 100 Then the slope of the isocost is PL/PK = 10/100 = 0.1 .

The vertical intercept would be 10,000/100 = 100 & the horizontal intercept is 10,000/10 = 1,000.

slope = PL/PK = 0.1 R/PL = 1000 L

Maximizing output for a given cost level

isoquant s
At points A & B, were spending the outlay associated with this isocost, but were not producing as much as we can. Were only making Q1 units of output. We cant produce Q3 or Q4 with this outlay. Those output levels would cost more.

At point E, were producing the most for the money, where the isocost is tangent to an isoquant.

isocost

E B Q2 Q1 Q3

Q4

At the tangency of the Isocost & Isoquant, the slopes of those curves are equal. We found previously that the slope of the isoquant is MPL/MPK , & the slope of the isocost is PL/PK . So at the tangency, MPL/MPK = PL/PK
or, multiplying by -1, MPL/MPK = PL/PK .

This expression is equivalent to MPL/PL = MPK/PK.

MPL/PL = MPK/PK

This condition means that to get the most output for your money, you should employ inputs such that the marginal product per dollar is equal for all inputs. (Notice the similarity to the utility maximization condition that the marginal utility per dollar is equal for all goods.)

Minimizing cost for a given output level

At points A & B, were producing the desired quantity, but were not using the cheapest combination of inputs, so were spending more than necessary.

We cant produce the desired output level at cost level C1. We need more money.

At point E, were producing the desired output at the lowest cost, where the isoquant is tangent to an isocost.

E B isocosts C1 C2 Q1 isoquant L

So whether were maximizing output for a given cost level, or minimizing cost for a given output level, the condition is the same: MPL/PL = MPK/PK

The marginal product per dollar is equal for all inputs.