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Microeconomics - Essay Example

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One of the approaches is the lowest isocost rule, whereby the firm should produce at the point where the isoquant is in contact with the lowest iso-cost line…
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Download file to see previous pages In other words, the firm should produce at a point whereby if it spends a dollar on a unit of labour, this should give us most output as a dollar it spends on extra capital. The above graph shows the point at which the firm minimizes the cost of production. In other words, the iso-cost line is in tangency with the isoquant. This is at the point whereby the last dollar spent on labour yields as must output as the dollar that the firm spends on capital. This is as the below function explains. The slope of the isoquant is the marginal rate of substitution of labour and Capital (MRTSKL). This should be equal to the slope of the iso-cost line (w/r).
From the function, the last dollar spent on labour yields MPL/w that is equivalent to the output of the last dollar that the firm spends on capital MPX/r. At this point, the level of production is optimal. In other words, the firm minimizes the cost of production (Quirk, 2012).
For a monopolistic firm that is facing a demand curve that is linear, it must produce at a point whereby the demand curve is elastic. In other words, the firm must produce at a point whereby there is a high demand elasticity of price change. This is because for the firm to increase its revenue, it has to sell additional units of output. In addition, for the firm to sell the additional units of output, it has to reduce its prizes per unit. This happens at the point where the demand curve is elastic. At this point, the sale for an extra unit yields more revenue since the percentage decrease of the price is lower than the percentage increase in the quantity demanded (Nicholson, 2008). At any other point other than the elastic point, decrease in price would not result to increase in the revenue. For example, at the inelastic point, the reduction in price would result in a reduction in revenue. This is because the percentage drop-off in price is higher in comparison with the ...Download file to see next pagesRead More
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