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Isoquant Analysis

Isoquant analysis

Constructing
isoquants
An isoquant
45
Units Units Point on
40 of K of L diagram
40 5 a
35 20 12 b
Units of capital (K)

10 20 c
6 30 d
30
4 50 e

25

20

15

10

5 Units of labour (L)


An isoquant
45
a
Units Units Point on
40 of K of L diagram
40 5 a
35 20 12 b
Units of capital (K)

10 20 c
6 30 d
30
4 50 e

25

20

15

10

5 Units of labour (L)


An isoquant
45
a
Units Units Point on
40 of K of L diagram
40 5 a
35 20 12 b
Units of capital (K)

10 20 c
6 30 d
30
4 50 e
b
25

20

15

10

5 Units of labour (L)


An isoquant
45
a
Units Units Point on
40 of K of L diagram
40 5 a
35 20 12 b
Units of capital (K)

10 20 c
6 30 d
30
4 50 e
b
25

20
c
15 d
e

10

5 Units of labour (L)


Isoquant analysis

Diminishing marginal
rate of substitution
Diminishing marginal rate of factor substitution

14
g
12 ∆ K = 2
MRS = 2 MRS = ∆ K / ∆ L
Units of capital (K)

10 ∆ L=1

4 isoquant

2
Units of labour (L)
Diminishing marginal rate of factor substitution

14
g
12 ∆ K = 2
MRS = 2 MRS = ∆ K / ∆ L
Units of capital (K)

10 ∆ L=1

j MRS = 1
∆ K=1 k
8
∆ L=1
6

4 isoquant

2
Units of labour (L)
Isoquant analysis

An isoquant map
An isoquant map
30
Units of capital (K)

20

I5
10 I4
I3
I2
I1

Units of labour (L)


Isoquant analysis

Returns to scale
Constant returns to scale
4

R
c
600
Units of capital (K)

b 500

2
400
a

300

1 200

Units of labour (L)


Increasing returns to scale (beyond point b)
4

R
c
700
Units of capital (K)

3
600
b
500

2
400
a

300

1 200

Units of labour (L)


Decreasing returns to scale (beyond point b)
4

R
c
500
Units of capital (K)

2
400
a

300

1 200

Units of labour (L)


Isoquant analysis

Isocosts
An isocost
30

Assumptions
25 PK = £20 000
W = £10 000
Units of capital (K)

TC = £300 000
20

15

10

5
Units of labour (L)
An isocost
30

Assumptions
25 PK = £20 000
W = £10 000
Units of capital (K)

TC = £300 000
20
a

15 b

c
10
TC = £300 000
d
5
Units of labour (L)
Isoquant analysis

The least-cost
method of production
Finding the least-cost method of production
35
Assumptions

30 PK = £20 000
W = £10 000
Units of capital (K)

25 TC = £200
000
TC = £300 000
20
TC = £400 000

15 TC = £500 000

10

5
Units of labour (L)
Finding the least-cost method of production
35

30

s
Units of capital (K)

25 TC = £500 000

20
TC = £400 000
r
15
t
TPP1
10

5
Units of labour (L)
Isoquant analysis

Effect of a rise in
the wage rate
Effect of a wage rise on the least-cost method of production
35

30 Assumptions

PK = £20 000
Units of capital (K)

W = £10 000
25

20
TC = £400 000

15 r
8

10 TPP1

5 24
Units of labour (L)
Effect of a wage rise on the least-cost method of production
(wage rises to £20 000)
35

30 Assumptions

PK = £20 000
Units of capital (K)

W = £10 000
25 = £20 000

20
TC = £400 000

15 r
8

10 TPP1

5 24
Units of labour (L)
Effect of a wage rise on the least-cost method of production
(wage rises to £20 000)
35

30 Assumptions

PK = £20 000
Units of capital (K)

W = £10 000
25 = £20 000

20
r TC = £400 000
1
15
1 r
8

10 TPP1

5 9 24
Units of labour (L)
Isoquant analysis

The maximum output


for a given cost
Finding the maximum output for a given total cost
Units of capital (K)

TPP5
TPP4
TPP3
TPP2
TPP1
O
Units of labour (L)
Finding the maximum output for a given total cost
Units of capital (K)

Isocost

TPP5
TPP4
TPP3
TPP2
TPP1
O
Units of labour (L)
Finding the maximum output for a given total cost

r
s
Units of capital (K)

u TPP5
TPP4
v TPP3
TPP2
TPP1
O
Units of labour (L)
Finding the maximum output for a given total cost

r
s
Units of capital (K)

K1
t

u TPP5
TPP4
v TPP3
TPP2
TPP1
O L1
Units of labour (L)
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 200
LRAC = TC2 / 200

100 200
TC TC
O
1 2

Units of labour (L)


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
100 200
TC TC TC TC TC TC TC
O
1 2 3 4 5 6 7

Units of labour (L)


Deriving an LRAC curve from an isoquant map
Units of capital (K)

Expansion path

700

600
500
400
300
100 200
TC TC TC TC TC TC TC
O
1 2 3 4 5 6 7

Units of labour (L)


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)

300
TC =
£60 000
TC =
TC = £40 000 200
£20 000
100
O
Units of labour (L)
Deriving short-run costs from an isoquant map

The long-run situation:


both factors variable

Expansion path
Units of capital (K)

300
TC =
£60 000
TC =
TC = £40 000 200
£20 000
100
O
Units of labour (L)
Deriving short-run costs from an isoquant map

The short-run situation:


capital fixed in supply

Expansion path
Units of capital (K)

K1
300
TC =
£60 000
TC =
TC = £40 000 200
£20 000
100
O
Units of labour (L)
Deriving short-run costs from an isoquant map

Expansion path
Units of capital (K)

K1
300
TC =
£60 000
TC =
TC = £40 000 200
£20 000
100
O L1

Units of labour (L)


Deriving short-run costs from an isoquant map

Expansion path
Units of capital (K)

K1
300
TC = TC =
£22 000 £60 000
TC =
TC = £40 000 200
£20 000
100
O L2 L1

Units of labour (L)


Deriving short-run costs from an isoquant map

Expansion path
Units of capital (K)

K1
300
TC = TC =
TC =
£22 000 £60 000
£65 000
TC =
TC = £40 000 200
£20 000
100
O L2 L1 L3

Units of labour (L)


Deriving short-run costs from an isoquant map

Expansion path
Units of capital (K)

bL
K2

a bS
K1
300
TC = TC =
TC =
£22 000 £60 000
£65 000
TC =
TC = £40 000 200
£20 000
100
O L2 L1 L4 L3

Units of labour (L)