The concept of price line or 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 for 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.
Table or Schedule:
The various alternative of market baskets (combinations of goods) are shown in the table below:
(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.
Explanation with Diagram:
The budget line is an important element for 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.
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 of coffee which a consumer can purchase weekly. These combinations are indicated by points A, B, C, D, E and F. 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.
Slope of Budget Line:
The slope of the budget line indicates how many packets of biscuits which 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.
Factors of 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 L1M1 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 LM1 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.