Interactive modelAdvanced Microintermediate

Producer Theory (Isoquants & Isocosts)

The firm's version of consumer theory: input mixes, returns to scale, and cost-minimizing bundles.

Equilibrium: L* = 50.0, K* = 40.0

Current equations

Isocost line: K = 80 − 0.8·LIsoquant: K = 2000·L^-1Expansion path: K = 0.8·L

The firm's version of consumer choice. The straight line shows every input mix a budget can buy at current wages and machine costs; the curve shows mixes that produce the same output. The cheapest way to hit an output target is where the isoquant just touches the isocost line.

Source: Varian, Intermediate Microeconomics, ch. 19-21

Shift the curves

Total cost budget0

A bigger budget shifts the isocost line out: the firm can afford more of both inputs.

The Producer Theory (Isoquants & Isocosts) model, in writing

Definition

The firm-side twin of consumer choice: isoquants map input combinations yielding equal output, isocost lines map equal spending, and cost minimization is their tangency.

At the optimum: MRTS = MPL/MPK = w/r

The intuition

If a dollar of labor currently adds more output than a dollar of machinery, shift spending toward labor, keep going until the last dollar works equally hard in both directions. Returns to scale describe what happens when you scale ALL inputs together.

Exam tip

MRTS diminishes along an isoquant for the same reason MRS does, that's what makes the tangency an optimum.

Related models in Advanced Micro

Consumer Theory (Indifference Curves) →Cournot Competition →Adverse Selection (Lemons Problem) →Auction Theory →