BUDGET LINE
DEFINITION:
A budget line is a straight line that slopes downwards and consists of all
the possible combinations of the two goods which a consumer can buy at
a given market price by allocating all his income. It is an entirely
different concept from that of an indifference curve, though they are
both are essential for consumer equilibrium.
The two essential components of a budget line are:
• The purchasing power of a consumer, i.e. his income;
• The market price of both commodities.
EQUATION:
To explain the concept of the budget line in a precise form, the
following equation has been given:
Px * Qx + Py * Qy = M
Equation of Budget Line Where Px is the price of goods X;
Qx is the quantity of goods X;
Py is the price of goods Y;
Qy is the quantity of goods Y;
M is the income of the consumer
EXAMPLE:
A person has 50/- for buying pens. He has the following options for
allocating his amount such that he derives the maximum utility from
limited income:
The above Budget schedule can be plotted on a graph to obtain the
appropriate budget line for this instance;
Budget Set: Budget set defines all such combinations of the two goods
lying within the affordability limit of a consumer.
PROPERTIES OF BUDGET LINE:
It has specific characteristics which distinguish it from other economic
tools.
Some of these features are discussed below:
• Negative Slope:
It slopes downward showing an inverse relationship between the
buying of the two goods.
• Straight Line:
It is a straight line which denotes the constant market rate of
exchange at each combination.
• Real Income Line:
It functions on the principle of income and the spending capacity
of a consumer.
• Tangent to Indifference Curve:
The indifference curve touches the budget line at a point, and this
point is known as the consumer’s equilibrium.
ASSUMPTIONS OF BUDGET LINE:
As we know that economics is mostly based on assumptions, so goes for
the budget line.
To make the results and analysis more clear and easy to understand, the
economist assumes the following in respect of a budget line:
• Two Commodities:
It is believed that the consumer will spend all his income on
purchasing only two goods.
• Income of the Consumer is Known:
The consumer’s income is limited and is known, even the income
is wholly allocated for buying only two commodities.
• Market Price is Known:
The market price of both the goods are known to the consumer.
• Expenditure is equal to the Income:
We assume that the consumer spends all his income.
SHIFT IN BUDGET LINE:
A budget line consists of consumer’s income, the price of the goods and
the quantity in which they are purchased where the volume of products
is a controllable agent while the other two may vary with time.
Therefore, it shifts from its original position due to the following two
primary reasons:
• Shift due to Change in Price:
The price of a commodity is volatile in nature and change from
time to time. The market price of the goods will either decrease or
increase.
If the other factors like income and price of goods Y remain
constant and the price of one commodity say X decreases, the
buying capacity of the consumer for goods X will automatically
increase.
If the other factors remain constant and the price of goods X
increases, the buying capacity of the consumer for goods X will
automatically decrease.
• Shift due to Change in Income:
Income is another vital agent that leads to a shift in the budget line.
An increase in the consumer’s income means expansion of his
purchasing power and vice-versa, thus leading to a shift in budget line
too.
COCLUSION:
A budget line is that part of the budget set which highlights all possible
combinations of two commodities and focuses on the expenditure of
total income.
It works on the principle of sacrificing one commodity to acquire more
of the other goods within a limited income and at a specified market
Price.