The idea of a budget is extremely crucial while managing expenses, be it in a large economy or a simple household. It gives a clear picture of what to buy and how much to buy within a given income.
In this section, you will study about consumer budget, what is budget set, and budget line in Economics. Read on to find detailed explanations on these topics with examples.
The existent purchasing capacity of a consumer with which he/she can purchase a total of two goods, given their prices, is known as consumer budget.
It presents us with an equilibrium between incomes and expenditures of a family, according to their sources of earnings and grounds of expenses, and is a direct representation of their living standards.
Provided a fixed income, the consumer budget leaves customers with the only choice of deciding the quantity of their purchase. Given they can purchase only two commodities, two aspects influence a customer’s inclination towards the number of units to purchase from both commodities: his/her money income and price of each item.
The total cost incurred in purchasing a commodity is known by multiplying the price (Pn) of each unit with their quantity of purchase (Qn). For two commodities, the total expenditure can be calculated by adding the aforementioned products for both goods. This sum must be less than or equal to the consumer’s money income (M). This is referred to as the budget restraint that a consumer faces and is represented as:
P1.X1 + P2.X2 <= M – equation (i)
P1 represents the price of product 1
X1 stands for the quantity of product 1
P2 represents the price of product 2
X2 stands for the quantity of product 2
M is the total monetary earning of a consumer]
These combinations of bundles that a consumer can afford to purchase according to his/her income and item prices, collectively constitute the budget set.
Now if we slightly modify the equation mentioned earlier to make total expenses equivalent to total income, and plot the same on a graph, it will present us with a budget line.
The budget line is a graphical representation of all such combinations of two commodities that a customer can afford according to his/her earnings and given market prices in such a manner that the total expenditure on these combinations is exactly equal to money income of the consumer.
Budget Line Equation
Following is a representation of a budget line in the equation.
P1.X1 + P2.X2 = M
Where the letters represent the same values as that in equation (i).
Graph of Budget Line
Refer to the image provided below for a graphical representation of a budget line.
[Image will be uploaded soon]
Here, the quantity of product 1 (X) has been represented on the x-axis, while the quantity of product 2 (Y) has been represented on the y-axis.
The horizontal intercept of the graph represents the ratio of consumer’s income to cost of product 1 at Y = 0, that is the customer does not buy product 2. It can be calculated as:
x-intercept = M / P1
Vertical intercept of the graph represents the ratio of consumer’s income to cost of product 2 at X = 0, that is the customer does not buy product 1. It can be calculated as:
y-intercept = M / P2
Point K inside the budget line stands for a feasible bundle which is a part of a given budget set and forms expenses less than total money earnings of the consumer. Point H, on the other hand, represents a bundle that is not included in the provided budget set and is, therefore, more expensive than total income.
Look at a practical example in order to understand the function of the budget set and budget line better.
Shalini wants to buy T-shirts and go to the movies. Movie tickets cost Rs. 7 per piece and each T-shirt comes at Rs. 14. She can spend a total of Rs. 56 on them. She has to plan her expenditure in a way that she can avail maximum benefit from a limited income.
Following is a table planning out all possible combinations of bundles within given income.
Refer to the graph provided below to understand how a budget line can be plotted with the prepared table of budget sets.
[Image will be uploaded soon]
Here, the horizontal axis represents the quantity of T-shirts and the vertical axis represents the quantity of movie tickets. This budget line denotes the affordability margin of a consumer and all points inside and on this line represent budget sets of two items less than and equal to total money income respectively.
Some salient features of a budget line have been listed below.
Straight Line: Budget line comes with a straight line which implies the sustained rate of market exchange for each set of bundles.
Real Income Line: This line is representative of the total income and expenditure power of a consumer.
Negative or Downward Slope: Graphs of budget lines have a downward slope which points to an inverse proportionality between purchases of two given commodities.
Tangent to Indifference Curve: Budget line acts as a tangent to the indifference curve at a point which can be referred to as consumer’s equilibrium.
The theory of the budget line is mostly based on assumptions, like a majority of economic theories, in order to bring out simpler and clearer analytic results. Some of them are mentioned below:
Revenue of a consumer is spent on the purchase of two commodities only.
Total money earning of a consumer is limited and known.
The consumer knows the market prices of both products.
The entire income of a consumer is equal to his/her total expenditure.
Consumer budget is a crucial topic in CBSE Class 12 Commerce and comes with multiple complex concepts from which students may need to attempt questions in their board exams. Stay ahead of the crowd with a Budget Line in Economics PDF available on Vedantu’s website. For more information on such topics, download our app today.
Q1. What is meant by Monotonic preferences?
Ans. An average consumer tends to prefer bundles with greater quantities of both commodities when offered a choice of combinations. This shows his/ her tendency to consume more at a given price. These choices of quantity over quality are also known as monotonic preferences.
Q2. Why does a Budget Line have a downward slope?
Ans. With a fixed income, a consumer has to let some units of one product off the cart in order to purchase more of another product, thus, leading to an inverse correlation between the two given products. This is what is represented by a downward slope of the budget line.
Q3. What does a shift in Budget Line mean?
Ans. A budget line is a reflection of a consumer’s total income, price of two products and their quantity of purchase. There can be a change or shift in budget line when there is a change in income leading to an increase or decrease in purchasing quantity, or change in market price, with income remaining constant, affecting the purchasing power of a consumer.