Isoquant analysis

Isoquant analysis

Constructing isoquants

An isoquant
45 40 35

Units of capital (K)

30 25 20 15 10 5 0 0 5 10 15 20 25

Units of K 40 20 10 6 4

Units of L 5 12 20 30 50

Point on diagram a b c d e

30

35

40

45

50

Units of labour (L)

An isoquant
45 40 35

Units of capital (K)

30 25 20 15 10 5 0 0 5 10 15 20 25

Units of K 40 20 10 6 4 b

Units of L 5 12 20 30 50

Point on diagram a b c d e

30

35

40

45

50

Units of labour (L)

An isoquant
45 40 35

Units of capital (K)

30 25 20 15 10 5 0 0 5 10 15 20 25

Units of K 40 20 10 6 4 b

Units of L 5 12 20 30 50

Point on diagram a b c d e

c d e

30

35

40

45

50

Units of labour (L)

Isoquant analysis

Diminishing marginal rate of substitution

Diminishing marginal rate of factor substitution

14 12

g
K = 2

MRS = 2 h

Units of capital (K)

MRS = K / L

10 8 6 4 2 0 0 2
L = 1

isoquant
4 6 8 10 12 14 16 18 20

Units of labour (L)

Diminishing marginal rate of factor substitution

14 12

g
K = 2

MRS = 2 h

Units of capital (K)

MRS = K / L

10 8 6 4 2 0 0 2
L = 1

j
K = 1 L = 1

MRS = 1 k

isoquant
4 6 8 10 12 14 16 18 20

Units of labour (L)

Isoquant analysis

An isoquant map

An isoquant map
30

Units of capital (K)

20

10

0 0 10

I1
20

Units of labour (L)

An isoquant map
30

Units of capital (K)

20

10

0 0 10

I1 Units of labour (L)

I2
20

An isoquant map
30

Units of capital (K)

20

10

0 0 10

I1 Units of labour (L)

I2
20

I3

An isoquant map
30

Units of capital (K)

20

10

I4
0 0 10

I1 Units of labour (L)

I2
20

I3

An isoquant map
30

Units of capital (K)

20

10

I5 I4
0 0 10

I1 Units of labour (L)

I2
20

I3

Isoquant analysis

Returns to scale

Constant returns to scale

4

R Units of capital (K)

3

c 600

500

400

300
0 0 1 2

200
3

Units of labour (L)

Increasing returns to scale (beyond point b)

4

R Units of capital (K)

3

c 700 600

b 500 400

300
0 0 1 2

200
3

Units of labour (L)

Decreasing returns to scale (beyond point b)

4

R Units of capital (K)

3

500

400

300
0 0 1 2

200
3

Units of labour (L)

Isoquant analysis

Isocosts

An isocost
30

25

Assumptions PK = 20 000 W = 10 000 TC = 30 000 a

Units of capital (K)

20

15

10

TC = 30 000
0 0 5 10 15 20 25 30 35 40

Units of labour (L)

An isocost
30

25

Assumptions PK = 20 000 W = 10 000 TC = 30 000 a b

Units of capital (K)

20

15

10

TC = 30 000
0 0 5 10 15 20 25 30 35 40

Units of labour (L)

An isocost
30

25

Assumptions PK = 20 000 W = 10 000 TC = 30 000 a b

Units of capital (K)

20

15

10

c TC = 30 000

0 0 5 10 15 20 25 30 35 40

Units of labour (L)

An isocost
30

25

Assumptions PK = 20 000 W = 10 000 TC = 30 000 a b

Units of capital (K)

20

15

10

c TC = 30 000 d
0 5 10 15 20 25 30 35 40

Units of labour (L)

Isoquant analysis

The least-cost method of production

Finding the least-cost method of production

35

Assumptions
30 25

PK = 20 000 W = 10 000 TC = 200 000 TC = 300 000

Units of capital (K)

20 15

TC = 400 000
10 5 0 0 10 20 30 40 50

TC = 500 000

Units of labour (L)

Finding the least-cost method of production

35 30 25

Units of capital (K)

20 15 10 5

TPP1
0 0 10 20 30 40 50

Units of labour (L)

Finding the least-cost method of production

35 30 25

Units of capital (K)

20 15

TC = 400 000
10

8
5

TPP1
0 0 10 30 24 Units of labour (L) 20 40 50

Finding the least-cost method of production

35 30 25

Units of capital (K)

20 15

TC = 400 000
10

8
5 0 0 10 30 24 Units of labour (L) 20

TC = 500 000 t

TPP1
50

40

Isoquant analysis

Effect of a rise in the wage rate

Effect of a wage rise on the least-cost method of production

35 30 25

Assumptions PK = 20 000 W = 10 000

Units of capital (K)

20 15

TC = 400 000
10

8
5

TPP1
0 0 10 30 24 Units of labour (L) 20 40 50

Effect of a wage rise on the least-cost method of production (wage rises to 20 000) 35
30 25

Assumptions PK = 20 000 W = 10 000 = 20 000

Units of capital (K)

20 15

TC = 400 000
10 5

TPP1
0 0 10 30 24 Units of labour (L) 20 40 50

Effect of a wage rise on the least-cost method of production (wage rises to 20 000) 35
30 25

Assumptions PK = 20 000 W = 10 000 = 20 000

Units of capital (K)

20 15

11

r r

TC = 400 000

10

8
5

TPP1
0 0

910

30 24 Units of labour (L)

20

40

50

Isoquant analysis

The maximum output for a given cost

Finding the maximum output for a given total cost

Units of capital (K)

TPP1 O Units of labour (L)

TPP5 TPP4 TPP3 TPP2

Finding the maximum output for a given total cost

Units of capital (K)

Isocost

TPP1 O Units of labour (L)

TPP5 TPP4 TPP3 TPP2

Finding the maximum output for a given total cost

r Units of capital (K)

v O Units of labour (L)

TPP1

TPP5 TPP4 TPP3 TPP2

Finding the maximum output for a given total cost

r s Units of capital (K)

u v O Units of labour (L)

TPP1

TPP5 TPP4 TPP3 TPP2

Finding the maximum output for a given total cost

r s Units of capital (K)

u v O Units of labour (L)

TPP1

TPP5 TPP4 TPP3 TPP2

Finding the maximum output for a given total cost

r s Units of capital (K)

K1

u v O L1 Units of labour (L)

TPP1

TPP5 TPP4 TPP3 TPP2

Isoquant analysis

Deriving an LRAC curve from an isoquant map

Deriving an LRAC curve from an isoquant map

Units of capital (K)

At an output of 100 LRAC = TC1 / 100

100

Units of labour (L)

1 TC

Deriving an LRAC curve from an isoquant map

Units of capital (K)

At an output of 200 LRAC = TC2 / 200

100 200

Units of labour (L)

1 TC

2 TC

Deriving an LRAC curve from an isoquant map

Units of capital (K)

700 600 500 400 300

7 TC

100 200

5 TC

Units of labour (L)

1 TC

TC 3 TC

2 TC

6 TC

Deriving an LRAC curve from an isoquant map

Note: increasing returns to scale up to 400 units; decreasing returns to scale above 400 units

Units of capital (K)

700 600 500 400 300

7 TC

100 200

5 TC

Units of labour (L)

1 TC

TC 3 TC

2 TC

6 TC

Deriving an LRAC curve from an isoquant map

Units of capital (K)

Expansion path

700 600 500 400 300

7 TC

100 200

5 TC

Units of labour (L)

1 TC

TC 3 TC

2 TC

6 TC

Isoquant analysis

Deriving short-run costs from an isoquant map

Deriving short-run costs from an isoquant map

The long-run situation: both factors variable
Units of capital (K) Expansion path

300 TC = 60 000 TC = 20 000 TC = 40 000 100 200

O Units of labour (L)

Deriving short-run costs from an isoquant map

The short-run situation: capital fixed in supply
Units of capital (K) Expansion path

K1
300 TC = 60 000 TC = 20 000 TC = 40 000 100 200

O Units of labour (L)

Deriving short-run costs from an isoquant map

Units of capital (K)

Expansion path

K1
300 TC = 60 000 TC = 20 000 TC = 40 000 100 200

L1

Units of labour (L)

Deriving short-run costs from an isoquant map

Units of capital (K)

Expansion path

K1
300

TC = 22 000
TC = 20 000 TC = 40 000

TC = 60 000 200 100

L2

L1

Units of labour (L)

Deriving short-run costs from an isoquant map

Units of capital (K)

Expansion path

K1
300

TC = 22 000
TC = 20 000 TC = 40 000

TC = 60 000

TC = 65 000 200 100

L2

L1

L3

Units of labour (L)

Deriving short-run costs from an isoquant map

Units of capital (K)

Expansion path K2 K1 a bL bS
300

TC = 22 000
TC = 20 000 TC = 40 000

TC = 60 000

TC = 65 000 200 100

L2

L1

L4

L3

Units of labour (L)