In order to determine the best combination of capital and labor to produce that output, one has to know the amount of finance available to the producer to spend on the inputs and also the prices of the input. Suppose that the producer has at its disposal Rs. 10,000 for the two inputs, and that the prices of the two inputs as Rs. 1000 per unit of capital and Rs. 200 per unit of labor. The firm will have three alternative possibilities before it .
a) To spend the money only on capital and secure 10 units of it .
b) To spend the amount only on labor and secure 50 unit of labor
c) To spend the amount partly on capital and partly on labor .
The factor price line is also known as isocost line because it represents various combinations of inputs that may be purchased for the given amount of money allocated . The slope of the factor price line shows the price ratio of capital and labor i.e.. 1:5.
By combining the isoquant and the factor price line , one can find out the optimum combination of factors which will maximize output .
Equal product curves IQ1 , IQ2 , and IQ3 represents output of 1000 units , 2000 units and 3000 units respectively . AB is the factor price line . At point E the factor-price line is tangent to isoquant IQ2 representing 2000 units of output . Point E indicates the maxi- -mum amount of capital and labor which the firm can combine to produce 2000 units of output . The isoquant IQ3 falls outside the factor price line AB and therefore cannot be chosen by the firm . On the other hand , Isoquant IQ1 will not be preferred by the firm even though between R and S it falls within the factor price line .Points R and S are not suitable because output can be increased without increasing additional cost by the selection of a more appropriate input combination . Point E , therefore ,is the ideal combination which maximizes output or minimizes cost per unit , it is the point at which the firm is in equilibrium .