Page 99 - DECO101_MICRO_ECONOMICS_ENGLISH

Micro Economics

Notes The equation shows that the total cost of the firm (C) is equal to the sum of its expenditures on

labour (wL) and capital (rK). This equation is a general one of the firm’s isocost line or equal-cost

line. It shows the various combinations of labour and capital that the firm can hire or rent at a
given total cost.

Example: If C = 900 units, w = 10 units and r = 10 units, the firm could either hire 10 L or

rent 10 K or any combination of L and K shown on isocost line AB in figure 10. For each unit of

capital the firm gives up, it can hire one additional unit of labour. Thus the slope of the isocost
line is - 1.
By subtracting wL from both sides of the equation above and then dividing by r, we get the
general equation of the isocost line in the following more useful form:
C wL
K = -
r r
where,
C/r is the vertical intercept of the isocost line and

-w/r is its slope.
Thus for C=100 units and w/r=10 units, the vertical intercept is c/r = 100/10=10K, and the slope

is -w/r = -10/10 = -1. A different total cost by the firm would define a different but parallel
isocost line, while different relative input prices would define an isocost line with a different

slope.

Isocost Line

7.5 Producer’s Equilibrium

The theory of production may be viewed from two angles which are dual to each other. A fi rm
may decide to produce a particular level of output and then attempt to minimise the cost of total
inputs or it may attempt to maximise its output subject to a cost constraint.
A firm spends money on two inputs only, X and Y. It decides its budget and knows the price of

each of the inputs which remains constant. If the firm spends all its budget it can buy either OB

units of input X or OA units of input Y or a combination of X and Y represented by a point lying
on the straight line AB in Figure 7.3. The line AB is the budget line of the fi rm.

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