Isocost/Isoquant Analysis

Prof. Anirban

The Isocost/Isoquant Graph

The analyst creates a graph showing

various combinations of factors of

production that can produce a certain

amount of output.

The Isocost/Isoquant Graph

More than 3 units of

machinery and more

than 4 units of labor

Less than 3 units of machinery and less than 4 units of labor

The Isoquant Curve

Isoquant curve – a curve that represents

combinations of factors of production that

results in equal amounts of output.

A point on the isoquant curve is technically

efficient.

The Isoquant Curve

Labor Machines Pairs of Earrings

A 3 20 60

B 4 15 60

C 6 10 60

D 10 6 60

E 15 4 60

F 20 3 60

The Isoquant Curve

The Isoquant Curve

The isoquant curve is bowed inward

because of the law of diminishing marginal

productivity.

The Isoquant Curve

Marginal rate of substitution – the rate at

which one factor must be added to

compensate for the loss of another factor,

to keep output constant.

It is the slope of the isoquant curve.

The Isoquant Curve

The absolute value of the slope at a point on the isoquant curve equals the ratio of the marginal productivity of labor to the marginal productivity of machines.

onsubstituti of rate Marginal

MP

MPSlope

machine

labor

The Isoquant Curve

Isoquant map – a set of isoquant curves

that show technically efficient combinations

of inputs that can produce different levels

of output.

An Isoquant Map

The Isocost Line

Isocost line – a line that represents

alternative combinations of factors of

production that have the same costs.

The Isocost Line

Choosing the Economically Efficient Point of Production

The least cost combination of inputs for a

given output occurs where the isocost

curve is tangent to the isoquant curve for

that output.

Choosing the Economically Efficient Point of Production

machines

machines

labor

labor

machines

labor

machines

labor

P

MP

P

MP that so

P

P–

MP

MP–

The slopes of the two curves are equal at

that point of tangency.

Choosing the Economically Efficient Point of Production

The firm is operating efficiently when an

additional output per dollar spent on labor

equals the additional output per dollar

spent on machines.

Combining Isoquant and Isocost Curves

Isocost/Isoquant Analysis