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    LEAST Cost Combination

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    Ismith Pokhrel
    Rational producers aim to maximize profits by minimizing costs or maximizing output. A producer's equilibrium is achieved through two conditions: [1] minimizing costs to produce a desired output level, or [2] maximizing output for a given cost level. In both cases, the optimum combination of inputs (capital and labor) is where the marginal rate of technical substitution equals the price ratio of the inputs, and the isoquant is convex to the origin at the point of tangency between the isoquant and budget line. This ensures the producer operates at lowest possible cost to reach their output goal, or highest possible output within their budget.

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    LEAST Cost Combination

    Uploaded by

    Ismith Pokhrel
    1K views4 pages
    Rational producers aim to maximize profits by minimizing costs or maximizing output. A producer's equilibrium is achieved through two conditions: [1] minimizing costs to produce a desired output level, or [2] maximizing output for a given cost level. In both cases, the optimum combination of inputs (capital and labor) is where the marginal rate of technical substitution equals the price ratio of the inputs, and the isoquant is convex to the origin at the point of tangency between the isoquant and budget line. This ensures the producer operates at lowest possible cost to reach their output goal, or highest possible output within their budget.

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    LEAST cost combination

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    Rational producers aim to maximize profits by minimizing costs or maximizing output. A producer's equilibrium is achieved through two conditions: [1] minimizing costs to produce a desired output level, or [2] maximizing output for a given cost level. In both cases, the optimum combination of inputs (capital and labor) is where the marginal rate of technical substitution equals the price ratio of the inputs, and the isoquant is convex to the origin at the point of tangency between the isoquant and budget line. This ensures the producer operates at lowest possible cost to reach their output goal, or highest possible output within their budget.

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    1K views4 pages

    LEAST Cost Combination

    Uploaded by

    Ismith Pokhrel
    Rational producers aim to maximize profits by minimizing costs or maximizing output. A producer's equilibrium is achieved through two conditions: [1] minimizing costs to produce a desired output level, or [2] maximizing output for a given cost level. In both cases, the optimum combination of inputs (capital and labor) is where the marginal rate of technical substitution equals the price ratio of the inputs, and the isoquant is convex to the origin at the point of tangency between the isoquant and budget line. This ensures the producer operates at lowest possible cost to reach their output goal, or highest possible output within their budget.

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    of 4

    LEAST-COST COMBINATION: PRODUCER’S EQUAILIBRIUM

    Rational producer will always try to maximize profit with given resources he/has. For this firm
    minimizes cost to produce desire level of output or maximizes output at desire level of cost.
    This is producer’s equilibrium condition. Those level of capital (K) and labor (L) that fulfills the
    either condition i.e 1. Minimizing cost to produce desire level of output and 2. Maximizing
    output at given level of cost then firm is said to be in equilibrium. And level of capital and labor
    is optimum level of inputs.

    Assumptions

    1. Profit maximization is main objective of firm


    2. Labor and capital are only two inputs
    3. Price of labor and capital are constant.
    4. Both labor and capital are homogeneous
    5. Perfect completion in factor market.
    a. Least cost combination/cost minimization to produce desire level of output:
    Optimum factor inputs can be achieved by firm when
    1. Necessary condition
    The necessary condition for consumer’s equilibrium or cost minimization
    factor combination is when slope of iso-cost line is equal to slope of
    isoquant that is marginal rate of technical substitution is equal to price ratio
    of labor and capital. In other word iso-cost line must be tangent to
    isoquant.
    MRTSlk =MP L / MP K =w/ r
    2. Sufficient condition:
    For sufficient condition isoquant must be convex to origin at point of
    tangency. In other word at point of tangency marginal rate of technical
    substitution is diminishing
    Both conditions can be explained in figure below.
    In above figure, the desired level of output that firm want to produce is 500 units
    which is represented by isoquant Iq. Now producer will be in equilibrium when
    such output is achieved at minimum cost. Here all three combination of capital
    and labor i.e. C,E &D lie on isoquant Iq and produces same level of output that is
    500 units. Cost minimizing combination of inputs is achieved at E that lie of lower
    budget line A’B’.at this point budget line A’B’ is tangent to isoquant Iq and also
    isoquant is convex to origin at the point of tangency. Hence the both conditions
    are satisfied. Factor combination at E where OL units of labor and OK units of
    capital used is optimum combination under given circumstances. No other
    combination such as C and D minimizes cost since they lie on higher iso-cost line
    A”B”. Finally producer won’t go beyond budget line A’B’ because desired level of
    output will not be produced.

    b. Output maximization for given cost.


    A rational producer will maximize output at given level of cost. Factor inputs at
    this output maximizing level if optimum factor combination. This is producer’s
    equilibrium condition.
    i. Necessary condition
    For necessary condition of output maximization slope of isoquant must
    be equal to slope of budget line. In others words marginal rate of
    technical substitution must be equal to ratio of prices of factor inputs.

    MRTSlk =MP L / MP K =w/ r


    ii. Sufficient condition:
    For sufficient condition isoquant must be convex to origin at point of
    tangency. In other word at point of tangency marginal rate of technical
    substitution is diminishing
    Both conditions can be explained in figure below.

    In figure above a producer has a cost or outlay he/she has to spend on


    capital and labor to maximize its output. Outlay or cost of producer is
    represented by budget line CL. With same cost or outlay a producer can
    produce any combination of labor and capital that lie on budget line CL.
    Here combination E, P & F lie of outlay line CL. But maximum output that
    producer can producer is at P on isoquant of 200 units of output. Other
    combination i.e. E and F lie on lower isoquant that producers 100 units.
    Producer cannot go beyond isoquant of 200 units of output due to cost
    constraint. Hence optimum level of capital and labor is OM and ON
    respectively.

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