The iso-cost line is the counterpart of the budget line or the price line of consumer theory. It shows all the combinations of the two factors (say, labour and capital) that the firm can buy with a given outlay for a given set of prices of the two factors.
It plays an important part to determine the combinations of factors, the firm will choose for production ultimately to minimise cost.
Fig. 7.9 shows the way iso-cost line is drawn. We measure the units of factor ‘X’ on the
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X-axis and those of factor ‘Y’ on the Y-axis. Suppose, the firm has at its disposal Rs. 200 for the two factors. The price of the factor ‘X’ is Rs. 10 per unit and that of factor ‘Y’ is Rs. 5 per unit. With outlay of Rs. 200, the firm can buy either 10 units of ‘X’ (OA) or 5 units of ‘Y’ (OB), if it spends exclusively on the purchase of only one factor ‘X’ or ‘Y’ as the case may be.
In the above two cases, the firm will be at point ‘A’ and ‘B’ respectively. The firm can also choose any point on the straight line joining points ‘A’ and ‘B’ (except points ‘A’ and ‘B’), if it partly spends on one factor and partly on the other.
The straight line AB will pass through all combinations of factors ‘X’ and ‘Y’ which the firm can buy with outlay of Rs. 200, if it spends the entire outlay on these (either one or both). This line is called iso-cost line, as, the firm has to incur the same outlay or cost, whichever combination of the factors lying on it, the firm may choose to buy at the given prices of the factors.
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An iso-cost line is defined as the locus of factor combinations that can be purchased for a given total outlay. Thus, the iso-cost line is also called outlay line. The slope of this line is equal to the price ratio of the two factors (Px /Py). So, the other name for iso-cost line is factor-price line. In the current example, the slope of the factor price line (like that of price line in indifference curve analysis), i.e., price ratio of the two factors is
The slope of the isocost line indicates the rate at which the market allows the producer to exchange one factor for the other.
It is clear from the above discussion that the iso-cost line depends upon two things (i) prices of factors of production, and (ii) the total cost outlay (C) that a firm has to incur on these factors. There will be parallel outward shift in the iso-cost line, if the total outlay that the firm spends on the factors increases or prices of both the factors decline in the same proportion and vice-versa.
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The reason is that more of both the factors can be purchased with the increase in outlay or proportionate decline in the prices of the two factors and vice-versa. In the present example, if the outlay is doubled (increased from Rs. 200 to Rs. 400), keeping the prices of factors constant, quantities of both the factors can be purchased twice as much as earlier (80 instead of 40).
Same result will follow, if the prices of both the factors become half of the initial situation (total outlay remaining constant). Thus, any number of iso-cost lines can be drawn, all parallel to one another, by either change in the total outlay (given prices of factors) or by same proportionate change in the prices of the two factors (given total outlay).
