OPTIMUM COMBINATION OF INPUTS

ISOCOST LINE

An isocost line is a graph of combinations of labor and capital, or any other two
factors of production, such that the total cost remains the same. An isocost line is the producers
what a budget line is to a consumer.
-Shows the maximum amount which a firm willing to expend on production.
Example:

An isocost cost line can be drawn for any two factors of production if we know the total
cost budget and prices per unit of each input. Assume you manage a large fast-food chain
which has hundreds of outlets. You must decide whether to lease out self-serve kiosks (capital)
or hire workers (labor). Your annual budget is $1 million, monthly lease cost of a kiosk is $500
and wage rate per hour is $15.

There are two extreme cases of allocation of the budget between labor and capital:

(a) spend the whole budget on kiosks and do not hire new workers or

(b) hire new workers but no new unit of capital.

In the first case, $1 million enables you to rent 2,000 kiosks ($1,000,000 divided by $500).
In the second case, $1 million is sufficient to acquire 66,667 labor hours. If we plot capital on y-
axis and labor on x-axis, there two cases give us two points on the graph: (0, 66667) and
(2000,0).
If C is total cost, r is the user cost of capital, w is the wage rate and K and L are the units of
capital and labor respectively, we can write a general equation for isocost line as follows:

C r x K +w x L

Converting this to the standard straight-line equation format, we get:

OPTIMUM COMBINATION OF INPUTS

The optimum combination is also called the least cost combination. It is the number
of factors that is used by companies to produce a specific product at the least possible price.
-It is the efficiency of the company in other words.
What is optimal input combination?
optimal input combination is that input combination which maximizes output given
the costs faced by the firm
Characteristics of the Optimal Input Combination:
1. The optimal input combination occurs where the slope of the isoquant is equal to the
slope of the isocost curve.
What is the meaning of Isoquant?

'Iso' means equal and 'quant' means quantity. Therefore, an isoquant represents a constant
quantity of output.

CHOICE OF OPTIMUM EXPANSION PATH

The choice of optimal expansion path refers to the combinations of factors of production that
enable the firm to produce various levels of output at the least cost while relative factor prices remain
constant. Its analysis is done in relation to the short run and the long run.

Optimal Expansion Path in the Long Run:

In the long run, the firm can change its old machines, equipment and plants, scale of
production, organization and management in order to expand its output. The firm’s objective is
the choice of optimal expansion path in order to minimize its costs or maximize its
profits. The expansion path is the locus of different points of firm’s equilibrium when it
changes its total outlay to expand output while relative factor prices remain constant.
 In other words, the expansion path shows how factor proportions change when
output changes, relative factor prices remaining constant. “With given factor prices (w,
r) and given production function, the optimal expansion path is determined by the points of
tangency of successive isocost lines and successive isoquants.”

Explanations:

Given these assumptions, in order to maximize its profits or to have the least cost
combination, the firm combines labor and capital in such a way that the ratio of their
MP is equal to the ratio of their prices, i.e., MPL/MPK = w/ r. This equality occurs at the
point of tangency between an isocost line and an isoquant curve.
This is explained in Figure 18, where С1L1 C2L2 and C3L3are the different isocost lines. The
line C2L2shows higher total outlay than the line C1L1 and С3L3 still higher total outlay than
the line C2L2. They are shown parallel to each other thereby reflecting constant factor
prices. There are three isoquants 100, 200 and 300 representing successively higher
levels of output.

The firm is in equilibrium at point P where the isoquant 100 is tan-gent to its
corresponding isocost line С1L1 and similarly the other two isoquants 200 and 300 are tangent
to isocost lines С2L2and C3L3 respectively at points Q and R. Each point of tangency implies
optimal combination of labour and capital that produces an optimal output level. The line OS
joining these equilibrium points P, Q and R through the origin is the expansion path of the firm.
The firm expands its output along this line keeping factor prices as constant.
 Optimal Expansion Path in the Short Run:

In the short run, the firm can increase only the vari-able factors and not the fixed factors
in order to increase its output, while relative factor prices remain constant. Sup-pose capital is
the fixed factor and labour is the variable factor, other assumptions remaining the same. The
firm cannot choose the optimal expansion path OS. It can ex-pand its output only along the line
С С’, as shown in Figure 21. But this is not the optimal expansion path because points P, S and T
are not on the isocline.

CHANGE IN INPUT PRICES AND INPUT COMBINATION

for optimal input combinations, the ratio of input prices must equal the ratio of input
marginal products