Cambridge International as and a level Economics Ebook

Figure 7.9 
Isoquants and isocosts
153
Chapter 7: The price system and the microeconomy 

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could produce these output levels. (Remember that this is 
only looking at output from a physical standpoint.)
If you look at the diagram carefully you will see that as 
production increases from 100 to 200, relatively less capital 
and labour is required per unit of output. Th
is is referred to as 
increasing returns to scale
. As production expands further, 
increasing amounts of capital and labour are needed to 
produce 100 more units and so move up to the next isoquant. 
In contrast, this indicates 
decreasing returns to scale
.
Increasing returns to scale: 
where output increases at a 
proportionately faster rate than the increase in factor inputs.
Decreasing returns to scale: 
where factor inputs increase 
at a proportionately faster rate than the increase in output.
KEY TERMS
In the long run, both labour and capital can be varied and, 
as stated above, the actual mix will depend upon their 
prices.
 Figure 7.9b
 shows what are known as isocosts: lines 
of constant relative costs for the factors of production. On 
this fi gure, therefore, each of the isocosts shown has an 
identical slope. In deciding how to produce, the fi rm will 
be looking for the most economically effi
cient or least cost 
process. Th
is is obtained by bringing together the isoquants 
and isocosts, so linking the physical and economic sides 
of the production process. Th
e point where the isocost is 
tangential to an isoquant represents the best combination of 
factors for the fi rm to employ. Hence, the expansion path or 
long-run production function of the fi rm can be shown by 
joining together all of the various tangential points and is 
therefore useful from a longer-term planning perspective.
It is important to recognise that the above analysis is 
highly theoretical. In practice:
■ 
It is oft en very diff icult for firms to determine their 
isoquants – they oft en do not have the data or the 
experience to be able to do this.
■ 
It is also assumed that in the long run it is quite possible to 
switch factors of production. This may not always be as easy 
as the theory might indicate.
■ 
Some employers may be reluctant to switch labour and 
capital – they may feel that they have a social obligation to 
their workforce and will therefore not alter their production 
plans with a change in relative factor prices (see section 
below on Diff ering objectives of a firm).