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3 - Least-Cost or Optimal Input Combinations - Ready

The document discusses least-cost input combinations for firms. It explains that firms aim to produce goods at the lowest possible cost or maximize output for a given expenditure. This requires using inputs in an optimal combination. The document outlines two cases - producing a given output at minimum cost or maximum output for a given cost. It introduces the concepts of iso-cost lines, which represent combinations of inputs a firm can afford, and isoquants, which represent equal output combinations. The least-cost combination occurs where the iso-cost line is tangent to the isoquant. It also discusses expansion paths and ridge lines, which define the economically efficient region of production.

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354 views14 pages

3 - Least-Cost or Optimal Input Combinations - Ready

The document discusses least-cost input combinations for firms. It explains that firms aim to produce goods at the lowest possible cost or maximize output for a given expenditure. This requires using inputs in an optimal combination. The document outlines two cases - producing a given output at minimum cost or maximum output for a given cost. It introduces the concepts of iso-cost lines, which represent combinations of inputs a firm can afford, and isoquants, which represent equal output combinations. The least-cost combination occurs where the iso-cost line is tangent to the isoquant. It also discusses expansion paths and ridge lines, which define the economically efficient region of production.

Uploaded by

haridhra
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPT, PDF, TXT or read online on Scribd
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Least-cost (or optimal) input

combinations
• Whatever the firm, chooses to produce, it wishes to
produce it at the least possible cost.

• Or, whatever expenditure the entrepreneur wishes to


make, the highest output with that expenditure is desired.

• To accomplish either of the two tasks, production must


be organized in the most efficient manner, i.e., the
resources must be used in an optimal combination.
» We discuss in 2 cases
• With the help of above information, the firm can
determine the maximum amount of capital and maximum
amount of labour which the firm can employ.
Case 1 : - Production of given output at minimum
cost
Case 2 : - Production of given output at maximum
output
• In order to determine, which combination of two
factors the firm should use in order to produce a
given a level of output with lowest cost, it is
necessary to show the following: -

• The amount of finance available to the producer or


firm, which the firm can spend on the inputs. This
is called as “monetary cost outlay”.

• The price of the Labour (L).

• The price of the Capital (K).


Iso-cost or Equal-cost Line

• If the different combinations of capital and labour


which a firm can employ…
with a given monetary outlay and
given prices of capital and labour…
is plotted on a diagram, we will get
a straight line which will slope downward to the right.

• This curve or line is shown in the figure and is called


as Iso-cost or Equal-cost line.

• It is also known as Factor Price Line.


• In the figure MC if the Iso-cost line.

• Thus, “Iso-cost line is the locus of all the combinations of


factors the firm can purchase with a given monetary outlay”

Y
M
20

C
0 X
40
• We can now show to determine the ideal or best factor
combination to produce a given level of output, with a given
monetary outlay and given prices of capital and labour.

• This is illustrated with the help of the figure:

Capital

Ko E

IQ3
IQ2
C IQ1 X
0 Lo
• In the figure, the firm can produce only on IQ2,
because IQ3, though offers a higher output, is
beyond the reach since it lies above the MC i.e., the
Iso-cost line.

• So the highest attainable IQ is the 2nd i.e., IQ2.

• Here, also, the firm can employ only one


combination at point E where the firm employs 0Ko
amount of capital and 0Lo units of labour.

• Thus, it is the best factor combination.

• This, “the best or least-cost factor combination is


one where the iso-cost line is tangent to the
Isoquant”.
• In the figure, E is the point
where
The slope of Isoquant = The slope of the Iso-cost line.

• The slope of the Isoquant indicates the Marginal Rate


of Technical Substitution (MRTS) b/w L & K

• The slope of the Iso-cost line indicates, the ratio of


factor prices.

• Hence, the condition for least cost combination of


factors is
Slope of Isoquant = Slope of Iso-cost line

MRTS(L,K) = Price of L i.e., PL


Price of K PK
Expansion Path
• Expenditure on inputs increases – it would lead to parallel shift in the budget line or the iso-
cost line.

• Giving you out a new equilibrium point

• If we join these equilibrium points, we get a curve know as “Expansion path”.


Ridge Lines : Economic region of Production
• Economic theory believes that the producer operates on
the efficient ranges of output.
• These are the ranges over which the Marginal product of
the inputs are diminishing but positive.
• When MP = negative then the methods of production are
considered inefficient.
» The firm should not, therefore, use combinations of
inputs with negative marginal products, no matter
how cheap they are (unless the firm is compensated
some to face the loss of inefficiency)

• The efficient range of output will be represented by the


portion of an Isoquant that has a negative slope, while the
inefficient combinations of inputs are represented by the
positively sloped portion of an Isoquant.
• What is happening in this situation is that the marginal product
of one of the inputs is negative (i.e., its add.nal use will lead to a
fall in output) so in order to maintain the output at the same
level, more the other inputs (having positive marginal product)
will have to be used.

• So, in order to separate the efficient ranges of output from


the inefficient ranges, we need to draw lines b/w the
negatively sloped and the positively sloped portions of the
Isoquants.

» Such lines are known as Ridge lines.

• A is “the locus of points of Isoquants


where Marginal product of input is zero”.
Before going to the diagram….

• Upper lines joins all the such points where


MP of Y {say Capital (k)} = 0

• Lower lines joins all the such points where


MP of X {say Labour (L)} = 0

• The Production techniques are technically


efficient inside the “Ridge lines”.
• The lines
connecting the
points where the
Marginal product
of an input is
equal to zero (one
line for each
input) in the
Isoquant map and
forming the
boundary for the
economic region
of production.
• The Economic region of production is the range in an Isoquant
diagram where both inputs have a positive marginal product. It
lies inside the ridge lines.
• Outside the ridged lines, the marginal product of the inputs are
negative. Obviously, no rational producer would like to operate
outside the ridged line.

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