Question

Please use Isoquant-isocost graph to explain. Thank You!

remember: isoquant curve would not change, just need to generate Q1 level of electricity.

here are asking about the changes in production cost

•Suppose a power plant can use a mixture of coal and renewable resources to generate Q1 level of electricity. And the price of coal is Pc and price of renewable resources is Pr. Notice that the use of coal or renewable resources will subject to law of diminishing marginal product. Now, evaluate the following policies on the production cost of electricity.

a)Government imposes the technology based effluent standards (TBES)* on air pollution generated by the power company. It limits the use of coal of the power company.

b)A tax on the use of coal.

c)A subsidy on the use of renewable resources.

Answer 1

Let’s present production function Q = f (K, L) in three-dimensional space to visualize what happens to output when more and more input combinations are used. By assumption of efficient use of factor inputs in production, the greater the employment of factor inputs, the greater the amount of output it will produce. That means to say, production function can produce Q1 level of output using K1 and L1 input combination, while it can produce Q2 level of output, the greater amount of output than Q1, using K2 and L2 input combination as represented along vertical output axis.

You can observe outlines of equal heights above KL plane corresponding to Q1 and Q2 level of outputs. These outlines are termed as isoelevation contours, and are as equal in height as corresponding Q1 and Q2 output levels. In fact, these contours are isoquants representing the same respective level of outputs, Q1 and Q2, that can be produced employing various respective input combinations lying in KL plane.

For the sake of simplicity, let us assume that these contours are projected to KL plane. And these contours – called isoquants – show various combinations of inputs that can produce particular level of outputs. Thus, each isoquant corresponds to a specific level of output and shows technologically efficient ways of producing that output. Hence, the simplified form of isoquants will be as follows:

Also note, higher level of isoquant shows higher level of output i.e. Q2 is greater in amount than Q1. Thus, set of isoquants can depicts a production function.

FOR EXAMPLE: