Watching developments by modeling diffusion

Chapter 6: Production Magic: Pulling a Rabbit Out of the Hat

Assume your total cost is $4,000 a day, and labor costs $20 per hour, and capital costs $5 per machine-hour. Given this information, your isocost curve equation is

Some possible combinations of labor and capital you can employ for a total cost of $4,000 are 50 hours of labor and 600 machine-hours of capital, 100 hours of labor and 400 machine-hours of capital, and 150 hours of labor and 200 machine hours of capital. Any combination of labor and capital that results in total cost being $4,000 would be on the same — $4,000 — isocost curve.

I illustrate the isocost curve for this equation in Figure 6-3.

101

Figure 6-3:

An isocost curve showing possible combinations of labor and capital you can employ for $4,000.

Changes in input prices shift the isocost curve. If the input on the horizontal axis becomes cheaper, the isocost curve rotates out on that axis as illustrated in Figure 6-4. If the input on the vertical axis becomes cheaper, the isocost curve rotates as illustrated in Figure 6-5. More expensive inputs cause shifts in the opposite direction.

102 Part II: Considering Which Side You’re On in the Decision-Making Process

Figure 6-4:

Lower input price on the horizontal axis.

Figure 6-5:

Lower input price on the vertical axis.

Making the most with the least: Cost minimization

In order to maximize profits, you must produce your output at the lowest possible cost.