Budget line is also termed as a budget constraint due to the fact that even though a consumer will strive to achieve maximum utility across the indifference curve, he or she faces two very robust constraints - market price of commodities and limited income.
Income acts as a major constraint because there is only a particular height which may be reached in the indifference curve, given the income. It is this budgetary constraint that is exhibited in the budget line equation below.
PX = Price of commodity X
PY = Price of commodity Y
QX = Quantity of commodity X
QY = Quantity of commodity Y
S = Consumer income
The equation indicated above shows that the expenditure incurred by a consumer for purchasing commodity X and Y can never exceed his or her income (S).
Suppose, a consumer has an income of Rs.50, and it will be used to buy commodity X and Y. To derive maximum utility from the said income, only the following options are available.
The required budget line is obtained by plotting the above budget against the following graph. In the graph, the X-axis represents commodity X, and Y-axis represents commodity Y.
Figure: Budget line
The features or properties of the budget line have been indicated below.
Real Income Line - The real income line is dependent on the aspect of income and expenditure capacity of an individual.
Straight Line - The straight line indicated in the budget line signifies the existing market exchange rate for every combination shown.
Negative Slope - The negative downward slope of the budget line shows the inverse relationship between the purchase of two commodities.
For example - Consider A and B are two commodities, and both are to be purchased in 10 units each within an income of Rs.200. If 15 units of A is purchased, then only 5 units of B can be purchased. It is due to the fact that income remains constant at Rs.200.
Indifference Curve Tangent - The indifference curve creates consumer’s equilibrium in the point that it touches the budget line.
The consistency in budget line is controlled by the following factors –
Income of consumer
Prices of the two commodities
Volume of the two commodities purchased
While the quantity of the commodities purchased is, to a certain extent, in the control of the consumer, its price and consumer income changes with time. It is this change that leads to the shift in budget line.
Impact of Change in Income - Reduction in income means contraction of his or her purchasing power and vice versa, causing the budget line to shift.
Impact of Change in Price - Commodity price experiences volatility, and that it is inversely proportional to the purchases made by the consumer. If the commodity prices reduce, it is likely that it may be purchased in greater quantity.
Determination of Market Prices of Commodities
The budget line assumes that the market prices of the two commodities taken into consideration will always be in the knowledge of the consumer. Any alterations in that regard will make the line infeasible.
Information on Consumer Income
It presumes that the income of the consumer pertains to a limited amount and that it is known accurately. Also, the allocation of resources is undertaken only for a known number of commodities.
Number of Commodities
The concept of budget line is established based on only two commodities. It assumes that the demand of a consumer will be necessarily limited to only two commodities and not more. It can be understood that it is clearly not the case.
Do You Know? There are other simple assumptions as well, which are adopted for determining the budget line. What parameter can you think of, that is taken as an assumption?
(Hint: Expenditure considered to be equal to income, without any provision of savings or investment)
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1. What is the Meaning of Budget?
Budget, applicable for a specific period, relates to an estimated projection of revenue generation and expenditure that are likely to incur. It is usually compiled at the beginning of a financial year. Budget may be utilised by businesses, governments and individuals.
2. What is the Equation of the Budget Line?
The budget line equation is as under –
(PA X QA) + (PB X QB) = I
PA = Price of commodity A
QA = Qty. of commodity A
PB = Price of commodity B
QB = Qty. of commodity B
I = Consumer income]
3. Why is the Slope Downward in the Budget Line?
The downward slope in the straight line indicates an inverse relationship between purchase of two commodities. Due to such inverse nature, if one commodity is purchased at a greater quantity, then the consumer will have to necessarily forego a little more quantity of another commodity, as the income is limited.
The inverse relationship between the two commodities gives rise to the declining slope in the budget line.