MODULE 3: COSTS OF PRODUCTION AND THE ORGANIZATION OF THE FIRM ISOQUANTS AND ISOCOSTS Isoquants The word 'ISO'

is of Greek origin and means equal or same and 'quant' means quantity. An isoquant may be defined as a curve showing all the various combinations of two factors that can produce a given level of output. The isoquant shows the whole range of alternative ways of producing the same level of output. The modern economists are using isoquant, or "ISO" product curves for determining the optimum factor combination to produce certain units of a commodity at the least cost. The concept of isoquant or equal product curve can be better explained with the help of .schedule given below: Isoquant Schedule

Combinations A B C D E

Factor X 1 2 3 4 5

Factor Y 14 10 7 5 4

Total Output 100 METER 100 METER 100 METER 100 METER 100 METER

In the table given above, it is shown that a producer employs two factors of production X and Y for producing an output of 100 meters of cloth. There are five combinations which produce the same level of output (100 meters of cloth). The factor combination A using 1 unit of factor X and 14 units of factor Y produces 100 meters of cloth. The combination B using 2 units of factor X and 10 units of factor Y produces 100 meters of cloth. Similarly combinations C, U and E, employing 3 units of X and 7 units of Y, 4 units of

X and 5 units of Y, 5 units of X and 4 units of Y produce 100 units of output, each. The producer, here., is indifferent as to which combination of inputs he uses for producing the same amount of output. The alternative techniques for producing a given level of output can be plotted on a graph.

The figure 12.1 shows y the 100 units isoquant plotted to ISO product schedule. The five factor combinations of X and Y are plotted and are shown by points a, b, c, d and e. if we join these points, it forms an 'isoquant'. An isoquant therefore, is the graphic representation of an iso-product schedule. It may here be noted that all the factor combinations of X and Y on an iso product curve are technically efficient combinations. The producer is indifferent as to which combination he uses for producing the same level of output. It is in this way that an iso product curve is also called 'production indifference curve'. In the figure 12.1, ISO product IP curve represents the various combinations of the two inputs which produce the same level of output (100 meters of cloth). Isoquant Map An isoquant map shows a set of iso product curves. Each isoquant represents a different level of output. A higher isoquant shows a higher level of output and a lower isoquant represents a lower level of output.

In the figure 12.2, a family of three Iso product curves which produce various level of output is shown. The iso product IQ1 yields 100 units of output by using quantities of inputs X and Y. So is also the case with isoquant IQ3 yielding 300 units of output. We conclude that an isoquant map includes a series, of jso-product curves. Each isoquant represents a different level of output. The higher the isoquant output, the further right will be the isoquant. Propeties of Isoquant The main properties of the isoquants are similar to those of indifference curves. These properties are now discussed in brief.

(i) An Isoquant slopes downward from left to right:

This implies that the Isoquant is a negatively sloped curve. This is because when the quantify of factor K (capital) is increased, the quantity of L (labor) must be reduced so as to keep the same level of output. The figure (12.3) depicts that an isoquant IP is negatively sloped curve. This curve shows that as the amount of factor K is increased from one unit to 2 units, the units of factor L are decreased from 20 to 15 only so that output of 100 units remains constant. (ii) An Isoquant that lies above and to the right of another represents a higher output level:

It means a higher isoquant represents higher level of output. The figure 12.4 represents this property. It shows that greater output can be secured by increasing the quantity combinations of both the factors X and Y. The producer increases the output from 100 units to 200 units by increasing the quantity combination of both the X and Y. The combination of OC of capital and OL of labor yield 100 units of production. The production can be increased to 200 units by increasing the capital from OC to OC1 and labor from OL to OL.

(iii) Isoquants cannot cut each other:

The two isoquants cannot intersect each other. If two isoquant are drawn to intersect each other as is shown in this figure 12.5, then it is a negation of the property that higher Isoquant represents higher level of output to a lower Isoquant. The intersection at point E shows that the same factor combination can produce 100 units as well as 200 units. But this is quite absurd. How can the same level of factor combination produce two different levels of output, when the technique of production remains unchanged. Hence two isoquants cannot intersect each other. (iv) The isoquants are convex to the origin: This property implies that the marginal significance of one factor in terms of another factor diminishes along an ISO product curve. In other words, the isoquants are convex to the origin due to diminishing marginal rate of substitution, In this figure 12.6 MRSKL diminishes from 5:1 to 4:1 and further to 3:1. This shows that as more and more units of capital (K) are employed to produce 100 units of the product, lesser and lesser units of labor (L) are used. Hence diminishing marginal rate of technical substitution is the reason for the convexity of an isoquant.

(v) Each isoquant is oval shaped: The iso product curve, is elliptical. This means that the firm produces only those segments of the iso-product curves which are convex to the origin and lie between the ridge lines. This is the economic region of production.

ISOCOST LINE A firm can produce a given level of output using efficiently different combinations of two inputs. For choosing efficient combination of the inputs, the producer selects that combination of factors which has the lower cost of production. The information about the cost can be obtained from the isocost lines.

Let us examine a firm which wishes to spend $100 on a combination of two factors labor and capital for producing a given level of output. We suppose further that the price of one unit of labor is $5 per day. This means that the firm can hire 20 units of labor. On the other hand if the price of capital is $10 per unit, the firm will purchase 10 units of capital. In the fig. 12.7, the point A shows 10 units of capital used whereas point T shows 20 units of labor are hired at the given price. If we join points A and T, we get a line AT. This AT line is called isocost line or outlay line. The isocost line is obtained with an outlay of $100. Let us assume now that there is no change in the market prices of the two factors labor and capita! But, the firm increases the total outlay to $150. The new price line BK

shows that with an outlay of $150, the producer can purchase 15 units of capital or 30 units of labor. The new price line BK Shifts upward to the right. In case the firm reduces the outlay to $50 only, the isocost line CD shifts downward to the left of original isocost line and remains parallel to the original price line.

MINIMIZING COST

The firm minimizes its cost at the point e where the isoquant Q is tangent to the isocost line AB. The optimal combination of factors is OK and OL. The optimal combination takes place at the point e where the given output can be produced at the least cost. Points below 'e' are desirable but are not attainable for output Q. Points above 'e' are on higher isocost lines and they show higher costs. Hence, the point 'e' is the least cost point and it is the lowest cost combination of factors for producing the output Q. It is produced by OK amount of capital and OL amount of labour. At the point of tangency, that is, at point 'e', the slope of isocost line is equal to the slope of the isoquant. This is the first condition for the equilibrium. The second condition is that the isoquant should be convex to the origin at the point of equilibrium. Thus at the point e the ratio of marginal product of two factors is equal to the ratio of their factor prices.