Least Cost Combination

    by Surbhi Chhabra (2910010)
   Introduction

·        A rational firm/producer seeks maximisation of profit.

·        For this, he tries to minimise its cost of production.

·        The cost is minimum, when input combination is optimal.

·        Optimal input combination indicates the maximum returns to the factors employed.

·        Thus, a rational firm would combine the various factors of production its  function in such a way that with the minimum input and maximum output is obtained at the minimum cost.

·        Such a combination is referred to as the least cost combination.

·        Producer’s equilibrium occurs when he earns maximum profit with optimal combination of factors.

·        A profit maximisation producer faces two choices of optimal combination of factors(inputs)

        To minimise its cost for a given output.

        To maximise its output for given cost.

·        Thus the least cost combination of factors refers to a firm producing the largest volume of output to a firm producing  from a given cost & producing a given  level of output with the minimum cost when the factors output are combined in an optimum manner.

Assumption of least cost combinations

1. There are two factors of production – labour & capital.

2. All units of labour & capital are homogeneous.

3. The prices of units of labour (w) & capital (r) are given & constant.

4. The cost outlay is given.

5. The firm aims at profit maximisation.

6. There is perfect competition in the factor market.

 

 

·        The isoquant curve is tangent to an isocost line.

·        The isocost line GH is tangent to the isoquant 2000 at point M.

·        The firm employs the combination of OC of capital & OL of labour to produce 2000 units of output at point M with the given cost-outlay GH.

·        At this point, the firm is minimising its cost for producing 2000 units.

·        Any other combination on the isoquant 2000, such as R or T is on the higher isocost line KP which shows higher cost of production.

·        The isocost line EF shows lower cost but output 2000 cannot be attained with it.

·        Therefore, the firm will choose the minimum cost point is which is the least cost factor combination for producing 2000 unit of output.

·        M is the optimal combination for the firm.

 Limitation of least cost combinations

i.        Factors may not be perfectly divisible – perfect substitutions may not be possible.

ii.      It will be very difficult to calculate the marginal product of each factor.

iii.    The producer has to decide not only the best proportion of factors, but also the best scale of production.