Scribd
Upload
13 views3 pages

Notes On Isocosts and Isoquants

Hobby and Craft

Uploaded by

tomahawkags2017
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
13 views3 pages

Notes On Isocosts and Isoquants

Hobby and Craft

Uploaded by

tomahawkags2017
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
You are on page 1/ 3

Notes on Isocosts and Isoquants

Firms produce and sell with the objective of maximizing profits (π).
Total Revenue – Total Cost = π. Costs are dependent upon technology relationships between
inputs in production.
Production Function
Q = f (L, K)  the amount obtainable from different amounts of input.
Q=Output, L= Labor, K=Capital
Short Run – at least one input is held constant
Long Run – all inputs may become variable.

Isoquant
K - Capital

Q0

L - labor

Isoquant – Defined - All combinations of labor and capital that produce the same level of output.
Law of Diminishing Marginal Returns – an increase of additional units of L (labor) holding K
(capital) constant, leads to a decreasing amount of additional output. ∂ MPL / ∂L <0.
Convex shape of the Isoquant is due to the Law of Diminishing Marginal Returns. ∂ MPl / ∂L
<0.
Note that as we move from left to right along an isoquant, we increase the amount of labor while
decreasing the amount of capital. By the Law of Diminishing Returns MPL decreases and MPk
increases, decreasing the absolute slope making the isoquant flatter, giving rise to convexity.
The absolute slope of an isoquant is called Marginal Rate of Technology Substitution, which is
interpreted as the rate labor can be substituted for capital holding output constant.
Slope = - MPL /MPk
Profit maximization requires Cost Minimization
Isocost Line - all combinations of L and K which cost the same. Isocost derived from total
cost function.
Total Cost = (w * L) + (r * K); where w=wage rate, L=Labor, r=rental rate K=capital.
Rewriting this in terms of the variable K allows us to plot into our input space diagram, K=
(TC/r) – (w/r) L = > slope = - (w/r) = -(PL/PK).
K - Capital

TC0

L - labor

The steeper the isocost the more expensive labor is relative to capital. Of course, the converse
also holds, the flatter the cheaper labor is relative to capital.
The least cost input bundle lies on the isocost line tangent to the Isoquant. In other words, the
slopes of the two are equal: -MPL/MPK = -PL/PK. Cross multiplying leads to MPL/PL =
MPK/PK, which is interpreted as that the output per $ spent is equal across all inputs. If this
were not the case, then the firm could substitute the cheaper input for the more expensive and
thus lower costs.
The condition to profit maximizes is: MPL/PL = MPK/PK and remember that MRTS = -
MPL/MPk = - PL/PK
K - Capital

K*
Q0
How the firm responds to a change in input price.
A change in the price of an input, either labor or capital, will change the wage rental ratio and
consequently change the slope of the isocost curve. For example, if wages decrease, the isocost
line becomes flatter. Now the cost minimizing firm will need to seek a new set of inputs because
of the price change. Seeking the new tangency between the isoquant and the new isocost the
firm will substitute labor for capital until their slopes are equal moving from L1, K1 down and to
the right to L2, K2 (hire more labor and less capital at the new point).
K - capital
K2
K1

w(1)/r Q0

w(2)/r

L1 L2 L - labor

You might also like