Iso-cost lines or Factor Price lines:
Iso-cost or equal cost lines iso-cost line represents the prices of factors. It
shows various combinations of two factors which the firm can buy with given
outlay. Suppose a firm has Rs 10,000 to spend on the two factors i.e. labour
and capital. If the price of labour is Rs 100 and that of capital is Rs 200, the
firm can spend its outlay on labour and capital in various ways. It can spend
the entire amount on labour and thus buy 100 units of labour and zero units
of capital or it can spend the entire outlay on capital and buy 50 units of it
with zero units of labour factor. In between it can have any combination of
labour and capital.
We can show iso- cost line diagrammatically also. The X axis shows the units of
labour and Y-axis the units of capital. When entire Rs 10000 are spent on
labour we get OB and when entire amount is spent on capital we get OA. The
straight line AB which joins points A and B will pass through all combinations
Y capital which the firm can buy with outlay of Rs 10000. The line
of labour and
AB is called iso-cost line.
Y
Figure 1: Iso cost line
A
0
Y
B
X
Figure 1 shows various iso-cost lines representing different combinations of factors with
different outlays. Thus an iso-cos tline can be defined as the ratio of prices of two factors of
production. Any point on an iso-cost line represents this ratio as given in the following
equation
𝑃𝑘
𝑃𝑙
Effect of change in outlay:
With an increase or decrease in outlay, prices of the factor of production
remaining same the isocost line will shift outward or inward. However, the sift
will be a parallel shift. An increase in outlay from Rs 10000 to Rs 20000 will
enable the producer in buying more of both the input and there will be an
outward shift. Similarly, will a reduction in the outlay from Rs 10000 to Rs
5000, the quantity of both the inputs will decline and the isocost line will shift
inward as shown in figure 2.
Y
Figure 2: Effect of change in outlay
CAPITAL
A
A
A
0
B
B
B
X
LABOUR
Effect of change in factor price:
There will be a change in the slope of the isocost line due to the change in
factor prices. Capital is measured on Y axis. Due to the change in the price of
capital the slope of isocost line will change on y axis. With an increase in the
price of capital less of it will be purchased and vice versa. This is shown in
figure 3.
Figure3: Effect of change in price of capital
CAPITAL
Y
A2
A
A1
0
B
LABOUR
X
AB is the original iso-cost line and with an increase in the price of capital the
new iso-cost line will be A1B, whereas a reduction in the price of capital will
cause a shift from AB to A2B. Thus an increase in the price of capital will
cause a downward shift in iso-cost line on Y axis and a reduction will result in
upward shift of iso-cost line on Y axis. Similarly a change in the price of labour,
which is measured on X axis will cause a change in the slope of iso-cost line.
As can be seen in figure 4, due to the change in the price of labour the slope of
iso-cost line will change on x axis. With an increase in the price of labour less
of it will be purchased and vice versa.
CAPITAL
Y
A
O
B1
B
B2
X
Figure 4: Effect of change in price of labour
AB is the original iso-cost line and with an increase in the price of labour the
new iso-cost line will be AB1, whereas a reduction in the price of labour will
cause a shift from AB to AB2. Thus an increase in the price of labour will cause
an inward shift in iso-cost line on X axis and a reduction will result in outward
shift of iso-cost line on X axis.