Budget Line
Consumer’s real purchasing power with which he can buy a combination of two goods, given their prices is known as the Consumer’s Budget. A consumer has limited income therefore the consumer’s budget shows the number of goods and services he can afford.
Let’s take an example, suppose, the income of a consumer is fixed and with that income, he can afford only two things. The prices for both the things in the market are fixed, therefore the consumer will try to choose the best combination of the goods that he wants to buy. He would look for the things that would yield him utility more than the price he has paid, this would give him maximum satisfaction.
The consumer budget includes two things: a budget set and a budget line.
Budget Set
The attainable combination of a set of products when the consumer has a fixed income, given the prices of products. Therefore, the two utmost factors that affect the choice of the consumer while purchasing a quantity are the consumer’s income and the price of the quantity. The total expenditure that is incurred while purchasing a good or service is the price times quantity for each. Therefore, if the consumer is buying two goods, the expenditure spent on them must be less than or equal to the income of the consumer. This is known as the budget constraint that a customer faces. The mathematical equation for a budget set it-
where P1 = Price of good 1
P2 = Price of good 2
X1 = Quantity of good 1
X2 = Quantity of good 2
M = total budget or total expenditure
The bundles satisfying the criterion set to form a part of the budget set and the consumer can choose out of any of these bundles which one to consume.
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)
[Where,
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.
What is the Budget Line in Economics?
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 the 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.
Example of Budget Line
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.
When all the bundles which mean the combinations of good 1 and good 2 cost the consumer exactly his income, this line is known as the budget line, sometimes, price line.
P1X1 + P2X2 = M
where P1 = Price of good 1
P2 = Price of good 2
X1 = Quantity of good 1
X2 = Quantity of good 2
M = total budget or total expenditure
John has Rs. 50 to buy chocolate. He only has a few options to allocate his income so that he can receive maximum utility from the limited salary.
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.
Properties of the Budget Line
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.
Requirements of a Budget Line
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 and Budget Line 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.
FAQs on Consumer Budget
1. What are the assumptions made while outlining a budget line graph?
The assumptions made while outlining a budget line graph are as follows-
Income of the Consumers- The income of the consumers is designated to buy only two commodities and is limited.
Two Commodities- An assumption made by economics is that consumers purchase only two commodities with their income.
Expense is Similar to Income- Another assumption is that the consumer spends and consumes his whole income.
Market Price- The customer knows the cost for each commodity.
2. What are consumer preferences?
Let us understand consumer preference with an example. Suppose there are two goods 1 and 2 and their prices are P1 and P2 respectively. The quantities consumed for good 1 and good 2 are X1 and X2respectively. Now suppose the income of the consumer is M. The combination of quantities of two goods that the consumer is willing to buy is the consumer preference. The combination of two goods, good 1 and good 2 is known as a bundle.
3. What are the monotonic preferences?
The consumer who is rational will always prefer more goods and less price. Therefore, if there are two bundles, one with more goods as compared to the second, the consumer will always prefer the first one. Even when there is the same of the first good in the first bundle but more of the other good, then also the consumer will prefer the first one. This concept can be described as monotonic preference.
For example, in Bundle 1- (5,10) Bundle 2- (4,9), the consumer will prefer Bundle 1
4. What is meant by the term Consumer’s equilibrium?
Whenever a consumer wants to buy a commodity and he feels that he cannot earn more, spend more, or change the quantities of the commodities he is willing to buy and cannot change his condition at any point, the consumer is said to be in equilibrium. A commodity is purchased by a rational consumer up to the point where the price of the commodity and the utility obtained from the commodity are equal.
To learn more about consumer equilibrium in detail students can visit Vedantu’s study material on Consumer Equilibrium.
5. What is meant by the term price discrimination?
The pricing strategy which charges the consumers different prices for identical or same goods or services is known as pricing discrimination. For example in Cineplex, the same tickets are sold on the basis of age. Along with that, different prices are charged for different days as on Tuesdays tickets are sold at cheap prices while on weekends tickets are sold at high prices. It is the classic example that defines price discrimination. Price discrimination can be further classified into three categories- first degree, second degree, and third degree.
6. Why does a Budget Line have a downward slope?
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.
7. What does a shift in the Budget Line mean?
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 the 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.