The firm or the produce seeks to maximize his gains. Given the market prices of the goods he produces and the amount of his total revenue from the sale of goods, he can maximize his profits by minimizing his cost of production. Cost is minimized, when the firm, with its given outlay on inputs, produces maximum amount of output. That is possible. Successively higher Isoquants show the higher levels of output. Isocost line shows the budget constraint, i.e. the combinations of inputs that lie within budget or outlay that he can spend on purchase of those inputs. Now, by joining these two, viz. isoquant and isocost lines in a diagram, we find out the point where they are tangent. This point of tangency gives the least cost combination or the tangency, the slope of the isoquant (given by MRTSLK) is the same as slope of the budget line (given by PL /PK) Thus, in equilibrium
MRTSLK = PL /PK
Any change in the market price of either L or K will change the slope of the budget line and this leads to a new equilibrium position.SUBMIT ASSIGNMENT NOW!