Least cost combination principle

 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 production 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)
1. To minimise its cost for a given output.
2. to maximise its output for given cost.
 Thus the least cost combination of factors refers
to a firm producing the largest volume of output
from a given cost & producing a given level of
output with the minimum cost when the factors
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 least cost combination may be stated
thus –
Marginal productivity of labour Marginal product of capital
=
Price of labour Price of capital

MPL MPC
= =
PL PC

MPL = marginal productivity of labour

PL = Price of labour

MPC = marginal productivity of capital

Pc = price of capital
Appendix 7A
Table 7A-2
Least cost combination principle between two factors

Combination Labour Capital (PC = Total cost

(PL = $2) $ 3)

A 1 6 20

B 2 3 13

C 3 2 12

D 4 1 15
 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
1. Factors may not be perfectly divisible – perfect
substitutions may not be possible.
2. It will be very difficult to calculate the marginal
product of each factor.
3. The producer has to decide not only the best
proportion of factors, but also the best scale of
production.