Cost Minimization

Chapter 21

Learning goals for today

We ask how to minimize cost for a given

quantity that needs to be produced

Short-run
Long-run

Understanding isocost lines

The role of returns to scale

Profit Maximization vs.

Cost Minimization

Profit = pQ wL rK = pF(L,K) wL rK
Profit Maximization

Firm chooses L and K (and by default Q) to maximize profits

Solve for labor demand and capital demand LLR(p,w,r) and
KLR(p,w,r)

Cost Minimization

Q is fixed
Choose L and K to minimize costs
Solve for conditional factor demands

K(
L(
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The Isocost Line

Definition: Set of input

bundles that cost the
same (given w and r)

If use only labor:

If use only capital:

K
TC/r

Slope = -w/r

TC/w
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Isocost Lines Cover the Plane

There are many isocost

lines for a cost-minimizing
firm.
The goal of the cost
minimizing firm is get on
the lowest isocost line
given the output
constraint,

TC5
TC4
TC3
TC2
TC1

Graphically:
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The Cost Minimization Problem

How to produce units of

output at minimum cost?

Want to be on LOWEST
isocost line
F(L,K)=Q
L
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The Cost Minimization Problem

Tangency Condition:

LLR and KLR satisfy

slope of isoquant =
slope of isocost
MRTS = w/r

Also must satisfy

constraint:

KLR
F(L,K)= Q

LLR
Graphically:
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Conditional Factor Demand

Functions
Solutions to the LR Cost

Minimization Problem

These are the output

constrained or
conditional factor
demand functions
in words

If the firm faces wage rate,

w, and rental rate on
capital, r, the costminimizing way for it to
produce units of output
requires units of labor

L
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Comparing LR profit max and LR

Cost Min

Solution to LR Profit Max

Solution to LR Cost Min

LLR(p,w,r)
KLR(p,w,r)

LLR(,w,r)
KLR(,w,r)

Our C-D Example

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The C-D LR Profit Max Example

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The C-D LR Profit Max Example

continued

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continued

If p=4

and w=1 and r=1

LR Cost Min

And if and p=4 and w=1 and r=1

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Average Cost

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Returns to Scale: Q1<Q2

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Average Cost and Returns to

Scale
Average Cost

Increasing
Returns to Scale

Constant Returns to Scale

Decreasing
Returns to Scale

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Long-Run and Short-Run Costs

So far in this chapter, we have been talking

about all factors as flexible the long-run
But just as before, the short-run is defined as the
period during which K is fixed and L is flexible

LSRQ(w,,)

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18

Important learning points

Cost-minimizing firms choose LQLR and KQLR

to produce a fixed amount of output in the
lowest-cost way possible

Cobb-Douglas Example

Tangency condition and output constraint

Make sure you can expand this to other types of
problems

Returns to Scale

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