Constructing Isocost Lines

An isocost line is a line that represents all combinations of a firms factors of production
that have the same total cost.
Factors of production are generally classified as either capital (K) or labor (L).
Wage (W) is the price a firm has to pay for labor and rent (r) is the price it has to pay for
capital.
The slope of an isocost line represents the cost of one factor of production in terms of the
other.
Rational firms want to minimize costs; that is, they want an isocost line close to the origin.
You can represent the total costs of production
with an isocost line. The isocost line is a
firms budget constraint when buying factors
of production.
To calculate the isocost line for a firm, begin
with the total cost equation,
TC = (W x L) + (r x K) and solve for K.
W= wages, L =labor, r = the rent (what
you pay for the use of capital), and K =
capital.

In the example on the left, if the firms budget

is $100 and the rent (r) for each unit of
capital (K) is $10, then the vertical intercept
is the total cost (TC) expressed only in terms
of capital. In other words the entire budget is
spent on capital and nothing is spent on labor.

Similarly, the horizontal intercept is the point

at which the entire budget is spent on labor.
The TC is expressed only in terms of labor.
The isocost line represents all combinations of
capital and labor that have the same total
cost. Therefore, any values of capital and
labor that the firm can choose must satisfy the
equation on the left that you previously
derived.
Then slope of the isocost line is W/r or the
relative price of the inputs. W/r is the
opportunity cost of labor; that is, it tells the
firm how many units of capital it has to forego
to get another worker.

Because isocost lines are determined by the

budget, any change in a firms total budget
would cause the budget to shift in or out, as
shown on the left.
An outward shift represents an increase in the
budget (right graph), and an inward shift
represents a decrease in the budget (left
graph). The middle graph on the left shows
the original isocost line.
The slope of the isocost line represents the
relative prices of the inputs, labor and capital.
When the price of one changes relative to the
price of the other, the line does not shift, but
the slope changes.
In the lower panel on the far left, the price of
capital has increased relative to labor, making
labor relatively cheaper.
In the lower far right graph, the price for labor
has increased making labor relatively
expensive.
The middle graph is the original isocost line.