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    Producer Equilibrium/Least Cost Combination: Assumptions

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    Jessy Singh
    The document discusses producer equilibrium, which occurs when a producer earns maximum profit from an optimal combination of factors of production. It provides three key points: 1) Producer equilibrium is reached when the isoquant curve, representing all combinations of inputs that produce a given output, is tangent to the isocost curve, representing all combinations that cost the same amount. This tangency point minimizes costs. 2) For a true minimum, the slope of the isoquant must equal the slope of the isocost curve, where the marginal rates of technical substitution of inputs equals their price ratios. 3) The isoquant must be convex to the origin at the tangency point for the equilibrium to be stable.

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    Producer Equilibrium/Least Cost Combination: Assumptions

    Uploaded by

    Jessy Singh
    2K views5 pages
    The document discusses producer equilibrium, which occurs when a producer earns maximum profit from an optimal combination of factors of production. It provides three key points: 1) Producer equilibrium is reached when the isoquant curve, representing all combinations of inputs that produce a given output, is tangent to the isocost curve, representing all combinations that cost the same amount. This tangency point minimizes costs. 2) For a true minimum, the slope of the isoquant must equal the slope of the isocost curve, where the marginal rates of technical substitution of inputs equals their price ratios. 3) The isoquant must be convex to the origin at the tangency point for the equilibrium to be stable.

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    25.3.20

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    The document discusses producer equilibrium, which occurs when a producer earns maximum profit from an optimal combination of factors of production. It provides three key points: 1) Producer equilibrium is reached when the isoquant curve, representing all combinations of inputs that produce a given output, is tangent to the isocost curve, representing all combinations that cost the same amount. This tangency point minimizes costs. 2) For a true minimum, the slope of the isoquant must equal the slope of the isocost curve, where the marginal rates of technical substitution of inputs equals their price ratios. 3) The isoquant must be convex to the origin at the tangency point for the equilibrium to be stable.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    2K views5 pages

    Producer Equilibrium/Least Cost Combination: Assumptions

    Uploaded by

    Jessy Singh
    The document discusses producer equilibrium, which occurs when a producer earns maximum profit from an optimal combination of factors of production. It provides three key points: 1) Producer equilibrium is reached when the isoquant curve, representing all combinations of inputs that produce a given output, is tangent to the isocost curve, representing all combinations that cost the same amount. This tangency point minimizes costs. 2) For a true minimum, the slope of the isoquant must equal the slope of the isocost curve, where the marginal rates of technical substitution of inputs equals their price ratios. 3) The isoquant must be convex to the origin at the tangency point for the equilibrium to be stable.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    of 5

    Producer Equilibrium/Least Cost

    Combination
    Producer’s equilibrium or optimisation occurs when he earns
    maximum profit with optimal combination of factors. In the theory of
    production, the profit maximisation firm is in equilibrium when,
    given the cost-price function, it maximises its profits on the basis of
    the least cost combination of factors. For this, it will choose that
    combination which minimizes its cost of production for a given
    output. This will be the optimal combination for it.
    Assumptions:
    1 There are two factors, labour and capital.
    2. All units of labour and capital are homogeneous.
    3.The prices of units of labour (w) and that of capital (r) are given
    and constant.
    4. The cost outlay is given.
    Assumption Contd
    5. The firm produces a single product.
    6. The price of the product is given and
    constant.
    7. The firm aims at profit maximisation.
    8. There is perfect competition in the
    factor market.
    Producer Equilbrium
    Explanation

    Like budget line in the consumer theory the isocost line is an important component
    when analysing producer’s behaviour. The isocost line illustrates all the possible
    combinations of two factors that can be used at given costs and for a given producer’s
    budget. In simple words, an isocost line represents a combination of inputs which all
    cost the same amount.

    Given these assumptions, the point of least-cost combination of factors for a given level
    of output is where the isoquant curve is tangent to an iso-cost line. In the given Figure
    the iso-cost line GH is tangent to the isoquant 200 at point M.
    The firm employs the combination of ОС of capital and OL of labour to produce 200
    units of output at point M with the given cost-outlay GH. At this point, the firm is
    minimising its cost for producing 200 units. Any other combination on the isoquant 200,
    such as R or T, is on the higher iso-cost line KP which shows higher cost of production.
    The iso-cost line EF shows lower cost but output 200 cannot be attained with it.
    Therefore, the firm will choose the minimum cost point M which is the least-cost factor
    combination for producing 200 units of output.
    M is thus the optimal combination for the firm. The point of tangency between the iso-
    cost line and the isoquant is an important first order condition but not a necessary
    condition for the producer’s equilibrium.
    Conditions for Producer / Firm Equilibrium
    1. The first condition/Necessary condition is that the slope of the iso-cost line
    must equal the slope of the isoquant curve.
    Slope of Isoqunt= MRTS= MPL/MPK
    Slope of Isocost line= P L/PK= price of labour (w) to the price of capital (r)
    Thus the equilibrium condition for optimality can be written as:
    W/r = MPL/MPK = MRTSLK
    2.The second condition / sufficient /supplementary condition is that at the point
    of tangency, the isoquant curve must be convex to the origin. In other words, the
    marginal rate of technical substitution of labour for capital (MRTSLC) must be
    diminishing at the point of tangency for equilibrium to be stable. In Figure 18, S
    cannot be the point of equilibrium, for the isoquant IQ 1 is concave where it is
    tangent to the iso-cost line GH.
    At point S, the marginal rate of technical. substitution between the two factors
    increases if move to the right or left on the curve lQ1 .Moreover, the same output
    level can be produced at a lower cost CD or EF and there will be a corner solution
    either at С or F. If it decides to produce at EF cost, it can produce the entire output
    with only OF labour. If, on the other hand, it decides to produce at a still lower cost
    CD, the entire output can be produced with only ОС capital.

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