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Explanation in Hierarchy of Isocost Line

The document discusses isocost lines, which represent combinations of labor and capital inputs that a firm can acquire at a given total cost. It provides an example of a bakery that must decide how much to spend on labor and capital equipment under high, medium, and low budget scenarios. The position of the isocost line can shift based on whether the firm expands or contracts its operations and corresponding input levels.

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2023-105224
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295 views2 pages

Explanation in Hierarchy of Isocost Line

The document discusses isocost lines, which represent combinations of labor and capital inputs that a firm can acquire at a given total cost. It provides an example of a bakery that must decide how much to spend on labor and capital equipment under high, medium, and low budget scenarios. The position of the isocost line can shift based on whether the firm expands or contracts its operations and corresponding input levels.

Uploaded by

2023-105224
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd

Hierarchy of Isocost Line

Assume I own and operate a chocolate manufacturing company. What are the two basic inputs
required by my company for manufacturing? It's obvious that it requires labor and capital. The
company suddenly suffers the high pay demanded by the workers, which would eventually
harm the company's profitability.

In the long run, a specific firm has the freedom of choice to make several business decisions.
A firm can expand or contract its capital and labor force as per its requirement. Firms have the
flexibility to select different combinations of labor and capital to minimize their production cost.

Isocost line is a graph showing various possible combinations of inputs (labor and capital)
that can be purchased for an estimated total cost. Any combination of inputs on an isocost line
provides the same total cost for the output.

Isocost line is a graph that depicts potential input (labor and capital) combinations that can be
acquired at an estimated total cost.

Example of this:

A bakery that produces bread. The bakery needs to decide how much labor and capital to use
in its production process while minimizing costs.

1. High Total Cost Isocost Line suppose the bakery has a high budget and can afford to
spend a lot on labor and capital. In this case, the isocost line might represent a situation
where the bakery can hire many workers and invest in a lot of machinery and
equipment. For example, the bakery might be able to afford 10 workers and 5 industrial
ovens.
2. Medium Total Cost Isocost Line if the bakery has a moderate budget, the isocost line
would represent a situation where it can still hire some workers and invest in machinery
but not as much as in the high total cost scenario. For instance, the bakery might afford
5 workers and 3 industrial ovens.
3. Low Total Cost Isocost Line finally, if the bakery has a limited budget, the isocost line
would represent a situation where it can only afford a small amount of labor and capital.
Perhaps the bakery can only afford 2 workers and 1 industrial oven.

The major reason behind the shifts of the isocost line is the change in the number of inputs
used by a firm. Sometimes a firm might decide to expand its operations and increase its
production, and sometimes it might look to reduce its production. Depending on the
organizational strategy, the amount of inputs they use for production also varies.
In Figure 2 above, the initial isocost line is at I1. Now, if a firm decides to expand its
operations, it will require an increased amount of inputs (labor and capital). In this case, the
isocost line shifts to the right from I1 to I3 as the increased amount of inputs means increased
total cost. Likewise, if a firm decides to contract its operations, the number of inputs they
require will decrease. In this case, the isocost line will shift from I1 to I2.

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