Isocost/Isoquant

Analysis

Chapter 10 Appendix

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 The Isocost/Isoquant
Graph
■ The analyst creates a graph showing
various combinations of factors of
production that can produce a certain
amount of output.

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 The Isocost/Isoquant
Graph

More than 3 units of

machinery and more
than 4 units of labor

Less than 3
units of
machinery
and less than
4 units of
labor

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 The Isoquant Curve
■ Isoquant curve – a curve that represents
combinations of factors of production that
results in equal amounts of output.
■ A point on the isoquant curve is technically
efficient.

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 The Isoquant Curve

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 The Isoquant Curve

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 The Isoquant Curve
■ The isoquant curve is bowed inward
because of the law of diminishing marginal
productivity.

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 The Isoquant Curve
■ Marginal rate of substitution – the rate at
which one factor must be added to
compensate for the loss of another factor,
to keep output constant.
■ It is the slope of the isoquant curve.

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 The Isoquant Curve
■ The absolute value of the slope at a point
on the isoquant curve equals the ratio of
the marginal productivity of labor to the
marginal productivity of machines.

MPlabor
Slope =
MPmachine
= Marginal rate of substitution

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 The Isoquant Curve
■ Isoquant map – a set of isoquant curves
that show technically efficient
combinations of inputs that can produce
different levels of output.

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 An Isoquant Map

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 Isoquants and
indifference curves
■ have most of the same properties
■ biggest difference:
● isoquant holds something measurable,
quantity, constant
● indifference curve holds something that
is unmeasurable, utility, constant

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 3 major properties of
isoquants
follow from the assumption that
production is efficient:
1. further an isoquant is from the origin, the
greater is the level of output
2. isoquants do not cross
3. isoquants slope down

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 Shape of isoquants
■ curvature of isoquant shows how readily a
firm can substitute one input for another
■ extreme cases:
● perfect substitutes: q = x + y
● fixed-proportions (no substitution):

q = min(x, y)
■ usual case: bowed away from the origin

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 Perfect Substitutes: Fixed
Proportions

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 Cannot be Substituted
■ Complementary inputs MRTS=0

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 The Isocost Line
■ Isocost line – a line that represents
alternative combinations of factors of
production that have the same costs.

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 The Isocost Line

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 Choosing the
Economically Efficient
Point of Production
■ The least cost combination of inputs for a
given output occurs where the isocost
curve is tangent to the isoquant curve for
that output.

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 Choosing the
Economically Efficient
Point of Production
■ The slopes of the two curves are equal at
that point of tangency.

– MP labor – Plabor MP labor MP machines

= so that =
MP machines Pmachines Plabor Pmachines

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 Choosing the
Economically Efficient
Point of Production
■ The firm is operating efficiently when an
additional output per dollar spent on labor
equals the additional output per dollar
spent on machines.

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 Recall: Production Isoquants

Isoquants show the substitution between capital and

labour that is required to maintain a particular level
of output.
The slope of an isoquant is - MPPL/MPPK
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 Producer Equilibrium

Isocost curve
slope is -w/r

This graph shows a firm minimizing cost subject to an

output constraint. The constraint is represented by
isoquant Q=100 units of output.
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 Isoquant analysis

The least-cost
method of production

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 35

Finding the least-cost

30 Assumptions

method of production
25 P = £20 000 K
W = £10 000
20
Units of capital (K)

15
TC = £200
000
10 TC = £300 000

5 TC = £400 000

0 TC = £500 000
0 10 20 30 40 50

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 35

Finding the least-cost

30

method of production
25

20
s
Units of capital (K)

TC = £500 000
15

10

5 TC = £400 000
r
0
0 10 20 30 40 50
t
TPP1

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Units of labour
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 Isoquant analysis

The maximum output

for a given cost

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 Finding the maximum
output for a given total
cost
Units of capital (K)

TPP5
TPP4
TPP3
TPP2
TPP1
O
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 Finding the maximum
output for a given total
cost
Units of capital (K)

Isocost

TPP5
TPP4
TPP3
TPP2
TPP1
O
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 Finding the maximum
output
r for a given total
costs
Units of capital (K)

u TPP5
TPP4
v TPP3
TPP2
TPP1
O
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 Finding the maximum
output
r for a given total
costs
Units of capital (K)

K1
t

u TPP5
TPP4
v TPP3
TPP2
TPP1
O L1
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 Combining Isoquant and
Isocost Curves

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 Isocost/Isoquant
Analysis

End of Chapter 10 Appendix

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