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Home Production Function Isocost Lines

 

Isocost Lines/Outlay Line/Price Line/Factor Cost Line: 

 

Definition:

 

A firm can produce a given level of output using efficiently different combinations of two inputs. For choosing efficient combination of the inputs, the producer selects that combination of factors which has the lower cost of production. The information about the cost can be obtained from the isocost lines.

 

Explanation:

 

An isocost line is also called outlay line or price line or factor cost line. An isocost line shows all the combinations of labor and capital that are available for a given total cost to-the producer. Just as there are infinite number of isoquants, there are infinite number of isocost lines, one for every possible level of a given total cost. The greater the total cost, the further from origin is the isocost line.

 

Example:

 

The isocost line can be explained easily by taking a simple example.

 

Diagram/Figure:

 

 

Let us examine a firm which wishes to spend $100 on a combination of two factors labor and capital for producing a given level of output. We suppose further that the price of one unit of labor is $5 per day. This means that the firm can hire 20 units of labor. On the other hand if the price of capital is $10 per unit, the firm will purchase 10 units of capital. In the fig. 12.7, the point A shows 10 units of capital used whereas point T shows 20 units of labor are hired at the given price. If we join points A and T, we get a line AT. This AT line is called isocost line or outlay line. The isocost line is obtained with an outlay of $100.

    

Let us assume now that there is no change in the market prices of the two factors labor and capita! but the firm increases the total outlay to $150. The new price line BK shows that with an outlay of $150, the producer can purchase 15 units of capital or 30 units of labor. The new price line BK Shifts upward to the right. In case the firm reduces the outlay to $50 only, the isocost line CD shifts downward to the left of original isocost line and remains parallel to the original price line.

 

The isocost line plays a similar role in the firm's decision making as the budget line does in consumer's decision making. The only difference between the two is that the consumer has a single budget line which is determined by the income of the consumer. Whereas the firm faces many isocost lines depending upon the different level of expenditure the firm might make. A firm may incur low cost by producing relatively lesser output or it may incur relatively high cost by producing a relatively large quantity.

 

Relevant Articles:

What is Production Function
Short Period Analysis of Production

Long Run Production With Variable Inputs

Isoquants
Properties of Isoquants
Isocost Lines
Marginal Rate of Technical Substitution
Optimum Factor Combination
 

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Indifference Curve Analysis of Consumer's Equilibrium
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