The Least Cost Combination of Factors Isoquants.

If a producer seeks to minimize the cost of producing a given amount of output the condition of the equilibrium, is that the marginal rate of technical substitution must be equal to the factor price ratio.

A single isoquant P, in the figure denotes the desired level of output, but there is a set of iso-cost lines representing various levels of total cost outlay.

An isocost line closer to origin indicates a lower total cost outlay. Iso-cost lines are parallel and thus have the same slope PL/PK, because they have been drawn on the assumption of constant prices of factors.

Also read | Foreign Investment Policy India 1948-1990.

Iso-cost line K1L1 is just not relevant because the output level represented by the isoquant P is not producible by any factor combination available on this iso-cost line.

P level output can be produced by the factor combinations represented by the points F & G which are on iso-cost line K3 L3

The producer can attain P level of output by the factor combination represented by point E, which is no iso-cost line K2L2. Since K2142 is closer to origin as compared to the iso-cost line 1(3L3, it represents relatively lower cost.

By moving from F to E or from G to E, the producer attains the same output level at a lower cost.

The producer minimizes his costs by employing OB amount of capital plus OA amount of labor determined by the tangency of the isoquant P with the iso-cost line K2L2.

Also read | Foreign Investments and Collaborations in the 90s is largely due to Policy Liberalization.

Points representing factor combinations below E are certainly preferable because they represent lower costs but they can’t be considered as they can’t help in providing the output level represented by the iso-quant P.

Tags: Ba Economics

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