Home Page                      Contact Us                      About Us                      Privacy Policy                       Terms of Use                      Advertise 
 

Home » Indifference Curve Analysis of Consumer's Equilibrium » Price Line or Budget Line

Price Line or Budget Line:

 

Definition and Explanation:

 

The understanding of the concept of budget line is essential for knowing the theory of consumer’s equilibrium.

 

"A budget line or price line represents the various combinations of two goods which can be purchased with a given money income and assumed prices of goods".

 

For example, a consumer has weekly income of $60. He purchases only two goods, packets of biscuits and packets of coffee. The price of each packet of biscuits is $6  and the price of each packet of coffee is $12. Given the assumed income and the price, of the two goods, the consumer can purchase various combination of goods or market combination of goods weekly.

 

Schedule:

 

The various alternative market baskets (combinations of goods) are shown in the table below:

 

Market Basket Packets of Biscuits Per Week Packets of Coffee Per Week
A 10 0
B 8 1
C 6 2
D 4 3
E 2 4
F 0 5

Income $60 Per Week = Packets of Biscuits Costs $6 = Packets of Coffee is Priced $12 Each

 

(i) Market basket A in the table above shows that if the whole amounts of $60 is spent on the purchase of biscuits, then the consumer buys 10 packets of biscuits at a price of $6 each and nothing is left to purchase coffee.

 

(ii) Market basket F shows the other extreme. If the consumer spends the entire amount of $60 on the purchase of coffee, a maximum of 5 packets of coffee can be purchased with it at a price of $12 each with nothing left over for the purchase of biscuits.

 

(iii) The intermediate market baskets B to E shows the mixes of packets of biscuits and packets of coffee that the cost a total of $60. For example, in combination of market basket C, the consumer can purchase 6 packets of biscuits and 2 packets of coffee with a total cost of $60.

 

Budget Line:

 

The budget line is an important element analysis of consumer behavior. The indifference map shows people’s preferences for the combination of two goods. The actual choices they will make, however, depends on their income. The budget line is drawn as a continuous line. It identifies  the options from which the  consumer can choose the combination of goods.

 

Diagram/Figure:

 

 

In the fig. 3.9 the line AF shows the various combinations of goods the consumer can purchase. This line is called the budget line.

 

It shows 6 possible combinations of packets of biscuits and packets if coffee which a consumer can purchase weekly. These combinations are indicated by points A, B, C, D, E and. Point A indicates that 10 packet of biscuits can be purchased if the entire income of $60 is devoted to the purchase of biscuits. Similarly, point F shows the purchase of 5 packets of coffee for the entire income of $60 per week.

 

The budget line AF indicates all the combinations of packets of biscuits and packets of coffee which a consumer can buy given the assumed prices and income. In case, a consumer decides to purchase combination of goods inside the budget line such as G, then it involves  a total outlay that is smaller then the amount of $60 per week. Any point outside the budget line such as H requires an outlay larger than the consumer’s weekly income of $60.

 

The slope of the budget line indicates how many packets of biscuits a purchaser must give up to buy one more packet of coffee. For example, the slope at point B on the budget line is ∆Y / ∆X or two packets of biscuits 1 = packet of coffee. This indicates that a move from B to C involves sacrificing two packets of biscuits to gain an additional one packet of coffee. Since AF budget line is straight, the slope is constant at -2 packets of biscuits per one packet of coffee at all points along the line.

 

Shifts in Budget Line:

 

The price line is determined by the income of the consumer and the prices of goods in the market. If there is a change in the income of the consumer or in the prices of goods, the price line shifts in response to a exchange in these two factors.

 

(i) Income changes: When there is change in the income of the consumer, the prices of goods remaining the same, the price line shifts from the original position. It shifts upward or to the right hand side in a parallel position with the rise in income.

 

A fall in the level of income, product prices remaining unchanged, the price line shifts left side from the original position. With a higher income, the consumer can purchase more of both goods than before but the cost of one good in terms of the other remains the same.

 

 

In the fig. 3.10 (a), a change in income is shown when product prices remain unchanged. The rise in income results in a parallel upward shifts in the budget line from L/ M/ to L2M2. The consumer is able to purchase more of both the goods A and B.

 

(ii) Price changes. Now let us consider that there is a change in the price of one good. The income of the consumer and price of other good is held constant. When there is a fall in the price of one good say commodity A, the consumer purchases more of that good than before. A price change causes the budget line to rotate about point L fig. 3.10 (b).

 

 

It becomes flatter and give the new budget line from LM/ to LM2. A flatter budget line means that the relative price of the good A on the horizontal axis is lower. If the greater amount is spent on the purchase of good A, the consumer can buy increased OM2 amount of good A.

Relevant Articles:

» Theory of Ordinal Utility
» Marginal Rate of Substitution
» Properties of Indifference Curves
» Price Line or Budget Line
» Consumer's Equilibrium Through Indifference Curves
» Application of Indifference Curve Analysis
» Comparison Between Indifference Curve Analysis and Marginal Utility Analysis
» Consumer's Surplus

A D V E R T I S E M E N T

 
Principles and Theories of Micro Economics
Definition and Explanation of Economics
Theory of Consumer Behavior
Indifference Curve Analysis of Consumer's Equilibrium
Theory of Demand
Theory of Supply
Elasticity of Demand
Elasticity of Supply
Equilibrium of Demand and Supply
Economic Resources
Scale of Production
Laws of Returns
Production Function
Cost Analysis
Various Revenue Concepts
Price and output Determination Under Perfect Competition
Price and Output Determination Under Monopoly
Price and Output Determination Under Monopolistic/Imperfect Competition
Theory of Factor Pricing OR Theory of Distribution
Rent
Wages
Interest
Profits
Principles and Theories of Macro Economics
National Income and Its Measurement
Principles of Public Finance
Public Revenue and Taxation
National Debt and Income Determination
Fiscal Policy
Determinants of the Level of National Income and Employment
Determination of National Income
Theories of Employment
Theory of International Trade
Balance of Payments
Commercial Policy
Development and Planning Economics
Introduction to Development Economics
Features of Developing Countries
Economic Development and Economic Growth
Theories of Under Development
Theories of Economic Growth
Agriculture and Economic Development
Monetary Economics and Public Finance

History of Money
 

A D V E R T I S E M E N T

                   Home Page                Contact Us                About Us                Privacy Policy                Terms of Use                Advertise               

All the material on this site is the property of economicsconcepts.com. No part of this website may be reproduced without permission of economics concepts.
All rights reserved Copyright
© 2010 - 2015