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Producer’s Equilibrium – Isoquant–Isocost Technique

After understanding isoquants (equal output) and isocost lines (equal cost), we can find producer’s equilibrium.

1. Meaning of Producer’s Equilibrium

Producer’s equilibrium is a situation where the firm achieves maximum output for a given cost or minimum cost for a given output, and has no tendency to change the factor combination.

In isoquant–isocost analysis, equilibrium occurs at the point where:

  1. Isoquant is tangent to isocost line.
  2. Slope of isoquant (MRTS) = Slope of isocost (factor price ratio).
Key Condition
At equilibrium: MRTSLK = w/r, where w = wage rate of labour and r = rental price of capital.

2. Tangency Condition – Diagram Idea

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At equilibrium point E:

  • Firm is on highest possible isoquant given its cost.
  • Any other point on same isocost gives lower output.
  • Any point on higher isoquant is not affordable.

3. MRTS and Factor Price Ratio

  • MRTSLK = units of capital that can be reduced when one more unit of labour is employed, keeping output constant.
  • Slope of isoquant = - MRTSLK.
  • Slope of isocost = - w/r.

At equilibrium:

MRTSLK = w/r

This means the rate at which firm is willing to substitute labour for capital equals the rate at which market allows substitution (given prices).

4. Second-Order Condition (Convexity)

  • Isoquant must be convex to origin at point of tangency.
  • Ensures diminishing MRTS.
  • If isoquant is concave or straight at tangency, equilibrium may be unstable.

5. Producer’s Equilibrium – Summary Steps

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6. Quick Revision Points

  • Producer’s equilibrium: maximum output for given cost or minimum cost for given output.
  • Achieved where isoquant is tangent to isocost.
  • Condition: MRTSLK = w/r and isoquant convex to origin.

7. Quiz Time 🎯

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