Producer’s Equilibrium
Economic production is the result of the output we produce by
employing factors like land, labour, capital, and entrepreneurship. It
is possible to determine the optimum amount of production
possible considering different combinations of these inputs. Such a
determination is called the producer’s equilibrium.
Producer’s Equilibrium
The value of all assets used for production is limited. Hence, the
producer has to use such a combination of inputs as would provide
him with maximum output and profits. This optimum level of
production, also called producer’s equilibrium, is achieved when
maximum output is derived from minimum costs.
In order to achieve this, producers first have to classify their
resources into different combinations. Each combination would
provide production in different quantities. The combination that
provides the highest amount of produce at the least amount of costs is
the optimum level of production.
In order to find out producer’s equilibrium, we first need to
understand isoquant curves and iso-cost lines. These two concepts
help us calculate optimum production.
Isoquant Curves
These lines represent various input combinations which produce the
same levels of output. The producer can choose any of these
combinations available to him because their outputs are always the
same. Thus, we can also call them equal-product curves or
production indifference curves.
Just like indifference curves, isoquants are also negatively-sloping
and convex in shape. They never intersect with each other. When
there are more curves than one, the curve on the right represents
greater output and curves on the left show less output.
Consider the table below. It shows four combinations, i.e. A, B, C
and D, which produce varying levels of output.
Factor combinations Units of Labour Units of Capital
A 5 9
B 10 6
C 15 4
D 20 3
Plotting these figures on a graph provides us with this curve (Figure
1):
Source:[Link]
The X-axis shows units of labour, while the Y-axis represents units
of capital. Points A, B, C and D are combinations of factors on which
IQ is the level of output, i.e. 100 units. IQ1 and IQ2 represent greater
potential output.
Isocost Lines
Isocost lines represent combinations of two factors that can be bought
with different outlays. In other words, it shows how we can spend
money on two different factors to produce maximum output. These
lines are also called budget lines or budget constraint lines.
Let’s assume that a farmer has Rs. 1,000 to spend on labour costs and
plows for farming. The cost of one such plow and wage per labourer
is Rs. 100. Considering his total outlay of Rs. 1,000, he can spend
that money in the following combinations:
10 20 30 40 50 60 70 80 90 100
Plows 0
0 0 0 0 0 0 0 0 0 0
Labou 100 90 80 70 60 50 40 30 20 10
0
r 0 0 0 0 0 0 0 0 0 0
The farmer, in this case, can either spend the entire sum of Rs. 1,000
on just plows by buying 10 of them. Similarly, he can also spend it
all on labour by employing 10 labourers. He can even purchase both,
labour and plows using different combinations as shown above. The
total outlay of Rs. 1,000 will remain the same. Hence, the isocost line
will remain straight as shown below:
The x-axis represents units of plows, and Y-axis would show units of
labour. Output levels are shown by a straight line because they
remain constant.
Production Equilibrium
Isoquant curves, as we learned above, show us input combinations
that we can employ to produce certain levels of output. Furthermore,
isocost lines help us determine combinations of two factors in which
we can invest our outlays to produce output. A combination of these
two graphs is what gives us the optimum production level, i.e. the
producer’s equilibrium.
Using this equilibrium, the producer can determine different
combinations to increase output. He can also use this information to
find ways to cut costs using the same inputs and consequently
generate more profit. We can find out the least expensive
combinations of factors by superimposing isoquant curves on
isoquant lines.
Plotting Producer’s Equilibrium
The graph below shows how we can use isoquant curve and isocost
lines to determine optimum producer’s equilibrium.
Source:[Link]
In the figure shown above, the isoquant curve represents targeted
output, i.e. 200 units. Icocost lines EF, GH and KP show three
different combinations in which we can utilize the total outlay of
inputs, i.e. capital and labour.
The isoquant curve crosses all three isocost lines on points R, M and
T. These points show how much costs we will incur in producing 200
units. All three combinations produce the same output of 200 units,
but the least costly for the producer will be point M, where isocost
line GH is tangent to the isoquant curve.
Points R and T also cross the isoquant curve and equally produce 200
units, but they will be more expensive because they are on the higher
isocost line of KP. At point R the producer will spend more on
capital, and labour will be more expensive on point T.
Thus, point M is the producer’s equilibrium. It will produce the same
output of 200 units, but will a more profitable combination as it will
cost less. The producer must, therefore, spend OC amount on capital
and OL amount on labour.
Solved Example for You
Question: Briefly explain how isoquant curves and isocost lines
determine the producer’s equilibrium.
Answer: Isoquant curve shows combinations of inputs employable to
produce a certain output. Isocost lines portray cost combinations of
two inputs like capital and labour which produce the same amount of
output. A combination of both these graphs helps us determine how
inputs must be employed to produce maximum output with the least
expensive costs underlying them.
