Budget Line: Concept and Importance

The budget line definition is held to be a straight line with a downward slope indicating the different combination of two commodities. These two commodities are purchased by a consumer by the given market price with income allocation. It is also termed as a budget constraint. It's important to remember that the slope of the budget line corresponds to the cost ratio of two commodities. The slope of the budget limitation is particularly significant.

Budget line in economics is based on two essential components – (a) purchasing power or the income of the consumer, and (b) market price of the two commodities that have been considered.

Budget Line Equation 

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. 

Here, 

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). 

Example of Budget Line 

Suppose a consumer has an income of Rs.50, and it will be used to buy commodities 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.

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Features of 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. 

Assumptions of Budget Line

The budget line is primarily based on assumptions rather than facts. However, to achieve clear and exact results and a summary, the economist considers the following criteria in terms of a budget line:

• The consumer's income is given and remains consistent.

• Commodity prices are provided and remain constant.

• The customer is aware of the price of each commodity.

• It is expected that the customer spends and consumes the entire income.

When you have a clarity of a pricing and consumer’s income, you can easily design a budget line for that consumer by establishing the combination of the two commodities that a consumer can 'just afford' and creating a straight line that crosses through both points.

Requirements of a Budget Line

The concept of the budget line, like most economic theories, is based on assumptions in order to produce simplified and clear analytic results. Some of them are:

• A consumer's income is spent solely on the purchase of two commodities.

• A consumer's total monetary earnings are constrained and known.

• Both products' market prices are known to the customer.

• A consumer's total spending equals his or her total income.

What is Meant by a Shift in 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 the 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 quantities. 

Different Premises of Budget Line 

• 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 a 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 this 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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Consumer Budget

Consumer budget refers to a consumer's actual purchasing power, or the amount of money he or she can spend on a total of two commodities at their current pricing. It depicts an equilibrium between a family's revenue and expenditure, based on their sources of income and costs, and is a direct depiction of their living standards.

Budget Set

Provided a fixed income, the consumer budget leaves buyers with the solitary alternative of determining the quantity of their purchase. Given that they can only purchase two commodities, a customer's preference toward the number of units to purchase from both commodities is influenced by two factors: his or her money income and the price of each item. The cost of a good is calculated by multiplying the price by the amount purchased. There are two commodities in our analysis. As a result, the consumer's expenditure on both commodities must be less than or equal to his or her monetary income.