Isoquant Analysis

Isoquant analysis

Constructing
isoquants
 An isoquant
45

40 Units Units Point on

of K of L diagram
35 40 5 a
20 12 b
30
Units of capital (K)

10 20 c
6 30 d
25
4 50 e
20

15

10

0
0 5 10 15 20 25 30 35 40 45 50
Units of labour (L)
 An isoquant
45

40 a
Units Units Point on
of K of L diagram
35 40 5 a
20 12 b
30
Units of capital (K)

10 20 c
6 30 d
25
4 50 e
20

15

10

0
0 5 10 15 20 25 30 35 40 45 50
Units of labour (L)
 An isoquant
45

40 a
Units Units Point on
of K of L diagram
35 40 5 a
20 12 b
30
Units of capital (K)

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

15

10

0
0 5 10 15 20 25 30 35 40 45 50
Units of labour (L)
 An isoquant
45

40 a
Units Units Point on
of K of L diagram
35 40 5 a
20 12 b
30
Units of capital (K)

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

15

10 c
d
5 e

0
0 5 10 15 20 25 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 MRS = ∆K / ∆L
Units of capital (K)

10 h

∆L = 1
8

2
isoquant
0
0 2 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 MRS = ∆K / ∆L
Units of capital (K)

10 h

∆L = 1
8
j MRS = 1
∆K = 1 k
6

∆L = 1
4

2
isoquant
0
0 2 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

I5
I4
I3
I2
0 I1
0 10 20
Units of labour (L)
 Isoquant analysis

Returns to scale
 Constant returns to scale
4

R
c
3 600
Units of capital (K)

b 500
2

400
a
1

300

200
0
0 1 2 3
Units of labour (L)
 Increasing returns to scale (beyond point b)
4

R
c
3 700
Units of capital (K)

600
b
2
500

400
a
1

300

200
0
0 1 2 3
Units of labour (L)
 Decreasing returns to scale (beyond point b)
4

R
c
3 500
Units of capital (K)

b
2

400
a
1

300

200
0
0 1 2 3
Units of labour (L)
Isoquant analysis

Isocosts
 An isocost
30

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

TC = £300 000

15

10

0
0 5 10 15 20 25 30 35 40
Units of labour (L)
 An isocost
30

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

TC = £300 000

15 a

b
10

c
5
TC = £300 000
0
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
PK = £20 000
W = £10 000
25
Units of capital (K)

TC = £200
20 000
TC = £300 000
15
TC = £400 000
10
TC = £500 000

0
0 10 20 30 40 50
Units of labour (L)
 Finding the least-cost method of production
35

30

25
s
Units of capital (K)

TC = £500 000
20

15
TC = £400 000
r
10

t
5 TPP1

0
0 10 20 30 40 50
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

25 PK = £20 000
Units of capital (K)

W = £10 000
20

15
TC = £400 000
10
r
8
5
TPP1
0
0 10 20 24 30 40 50
Units of labour (L)
Effect of a wage rise on the least-cost method of production
35
(wage rises to £20 000)

30
Assumptions

25 PK = £20 000
Units of capital (K)

W = £10 000
= £20 000
20

15
TC = £400 000
10
r
8
5
TPP1
0
0 10 20 24 30 40 50
Units of labour (L)
Effect of a wage rise on the least-cost method of production
35
(wage rises to £20 000)

30
Assumptions

25 PK = £20 000
Units of capital (K)

W = £10 000
= £20 000
20

15
r TC = £400 000
1
10
1 r
8
5
TPP1
0
0 910 20 24 30 40 50
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
O
TC

TC
1

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
O
TC
TC

TC
TC

TC

TC
TC
5
1

4
2

7
6

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
O
TC
TC

TC
TC

TC

TC
TC
5
1

4
2

7
6

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)