Iso-Cost Line/ Outlay Line
Iso-Cost Line/ Outlay
Line
Iso-Cost Line: Iso-cost line represents the different combinations of the
two inputs which the firm can purchase at the given prices and the given amount
of the total outlay which a firm wants to spend. It is also known as price-line,
outlay-line, factor cost line, or budget-line.
Suppose the producer has total outlay Rs. 15 to spend on two
inputs factor X and factor Y and the price of factor X is Rs 3 per unit and the
price of factor Y is Rs 1 per unit. With Rs.15, he can purchase 5 units of factor
X [=OF] or 15 units of factor Y[OA]. By joining points A, B, C, D, E, and F, we
get the Iso-cost line. It is also called the Price line, Outlay line, or Budget
line. This line shows all possible combinations of two factor X and factor Y
which the producer can purchase with the given outlay.
A producer can purchase any of the combinations of two factors,
falling on the line on AF, such as B, C, D, E. A combination like H is
unattainable as it lies outside the budget line. A combination like G is
attainable but in this case, the producer can not spend his whole outlay. since
we assume that the producer should spend all of his outlay, so the actual
combination will lie on the budget line only.
The slope of the Iso-cost line is the ratio of the prices
of the two factors X and Y i.e Px/Py.
In other words, the slope of the Iso-cost line shows the opportunity cost of one factor in terms of the other.
Geometrically, the slope of the Iso-cost line is-
Where M=Total Outlay
Px= Price of factor-X
Py= Price of factor-Y
Shifting the Iso-cost line because of a change in Total
outlay:
If the total outlay of the producer increases,
while the prices of both factors remain unchanged. The Producer can purchase
more units of both factors X and Y with his increased total outlay. The new Iso-cost
line would shift to the right, parallel to the original line.
The condition would be vice versa in the case
of decreases in total outlay and the new Iso-cost line would be a shift to the
left, parallel to the original line.
The slope of the iso-cost line
represents the ratio of the price of a unit of input X to the price of a unit
of input Y. In case, the price of any one of them changes, there would be a
corresponding change in a slope of the iso-cost curve and the equilibrium point
would shift too.
Shifting the price line
because of a change in the price:
Given the total outlay, if the price of any of
both the factor decreases, the price ratio between X and Y will change and the
slope of the Iso-cost line will go through a change.
Suppose if the price of factor X changes, it
becomes cheaper or expensive and the producer can purchase more units of factor
X in the case of a fall in the price of factor X and less units of factor X in
the case of a rise in the price of factor X with no effect on good Y. Thus the Iso-cost
line will originate at point K on Y-axis but changes to L to L1, and L2
on the X-axis.
If the price of factor Y
changes, the Iso-cost line will originate at point L on X-axis but changes to K
to K1 and K2 on the Y-axis.
In the case of the changes
in the price of both the Factors X and Y, the slope of the Iso-cost line
:
If the total outlay remains
constant and the prices of both factors change proportionately, the change in
the case is similar to an increase in total outlay if prices fall or a decrease
in total outlay if prices rise.
Very good explanation
ReplyDeleteThank you, madam.
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