Budget Line: Concept & Explanation

We have seen that Indifference Curve is a tool through which a consumer can measure his utility of consuming goods. But in real life, a consumer is always constrained by two things in order to maximize his utility. One is his limited money income, and the other is the price of the commodities.

Both limited money income and prices of the goods act as a constraint to the utility-maximizing behaviour of the consumer. This is known as a budgetary constraint.

Symbolically:

Px*X + Py*Y ≤ M …………………………… (a)

This equation is known as the budget line of a consumer, where Px and Py are the prices of the two goods X and Y. X and Y are the respective quantities of X and Y, which a consumer consumes given his money income M and prices of these goods.

Hence according to this budget line, a consumer always decides about how much quantity of goods to be consumed based on his money income and the prices of the consumer. Then from this set of goods, he tries to choose which combination would give him the maximum utility.

Now if we adjust the above budget line equation for X, then we get: X = M/Px – Y*Py/Px

Here this –Py/Px is also known as the slope of the budget line. Now if X=0, then Y= M/Py and if Y=0, then X= M/Px.

Plotting these points on a graph, we get the following curve as the budget line:

Hence as per the budget line, all the points which come inside or on the budget line represent a feasible area as given the income of the consumer and prices of the goods the consumer can consume any combination. But if the combination costs more than his given income, then that will fall outside the budget line, which is represented by an infeasible area in the above graph.

Thus, the budget line is drawn based on the money income of the consumer and the prices of the goods. Therefore, if any of these factors change, then the budget line will also change.

If the money income of the consumer changes, then the budget line will shift either outside or inside as follows:

As it can be clearly seen from the above diagram if the money income of the consumer changes from M to M’, the budget line moves upward as now, with more of his income, he can consume more of both the goods and vice versa.

Now if the prices of the goods change, then it will pivot the budget line as follows:

As it can be clearly seen from the above graph that if the price of X increases from Px to Px’, then given his money income M, he will reduce the consumption of X as now X has become expensive. However, he will continue consuming the same quantity of Y. Hence the budget line will pivot inward to BL₂.

Similarly, if the price of X reduces from Px to Px’’, then he can increase his consumption of X as now, given his money income M, X has become relatively cheaper. Hence the budget line will pivot outward to BL₁.

Read More- Microeconomics

1. Microeconomics: Definition, Meaning and Scope
2. Methods of Analysis in Economics
3. Problem of Choice & Production Possibility Curve
4. Concept of Market & Market Mechanism in Economics
5. Concept of Demand and Supply in Economics
6. Concept of Equilibrium & Dis-equilibrium in Economics
7. Cardinal Utility Theory: Concept, Assumptions, Equilibrium & Drawbacks
8. Ordinal Utility Theory: Meaning & Assumptions
9. Indifference Curve: Concept, Properties & Shapes
10. Budget Line: Concept & Explanation
11. Consumer Equilibrium: Ordinal Approach, Income & Price Consumption Curve
12. Applications of Indifference Curve
13. Measuring Effects of Income & Excise Taxes and Income & Excise Subsidies
14. Normal Goods: Income & Substitution Effects
15. Inferior Goods: Income & Substitution Effects
16. Giffen Paradox or Giffen Goods: Income & Substitution Effects
17. Concept of Elasticity: Demand & Supply
18. Demand Elasticity: Price Elasticity, Income Elasticity & Cross Elasticity
19. Determinants of Price Elasticity of Demand
20. Measuring Price Elasticity of Demand
21. Price Elasticity of Supply and Its Determinants
22. Revealed Preference Theory of Samuelson: Concept, Assumptions & Explanation
23. Hicks’s Revision of Demand Theory
24. Choice Involving Risk and Uncertainty
25. Inter Temporal Choice: Budget Constraint & Consumer Preferences
26. Theories in Demand Analysis
27. Elementary Theory of Price Determination: Demand, Supply & Equilibrium Price
28. Cobweb Model: Concept, Theorem and Lagged Adjustments in Interrelated Markets
29. Production Function: Concept, Assumptions & Law of Diminishing Return
30. Isoquant: Assumptions and Properties
31. Isoquant Map and Economic Region of Production
32. Elasticity of Technical Substitution
33. Law of Returns to Scale
34. Production Function and Returns to Scale
35. Euler’s Theorem and Product Exhaustion Theorem
36. Technical Progress (Production Function)
37. Multi-Product Firm and Production Possibility Curve
38. Concept of Production Function
39. Cobb Douglas Production Function
40. CES Production Function
41. VES Production Function
42. Translog Production Function
43. Concepts of Costs: Private, Social, Explicit, Implicit and Opportunity
44. Traditional Theory of Costs: Short Run
45. Traditional Theory of Costs: Long Run
46. Modern Theory Of Cost: Short-run and Long-run
47. Modern Theory Of Cost: Short Run
48. Modern Theory Of Cost: Long Run
49. Empirical Evidences on the Shape of Cost Curves
50. Derivation of Short-Run Average and Marginal Cost Curves From Total Cost Curves
51. Cost Curves In The Long-Run: LRAC and LRMC
52. Economies of Scope
53. The Learning Curve
54. Perfect Competition: Meaning and Assumptions
55. Perfect Competition: Pricing and Output Decisions
56. Perfect Competition: Demand Curve
57. Perfect Competition Equilibrium: Short Run and Long Run
58. Monopoly: Meaning, Characteristics and Equilibrium (Short-run & Long-run)
59. Multi-Plant Monopoly
60. Deadweight Loss in Monopoly
61. Welfare Aspects of Monopoly
62. Price Discrimination under Monopoly: Types, Degree and Equilibrium
63. Monopolistic Competition: Concept, Characteristics and Criticism
64. Excess Capacity: Concept and Explanation
65. Difference Between Perfect Competition and Monopolistic Competition
66. Oligopoly Market: Concept, Types and Characteristics
67. Difference Between Oligopoly Market and Monopolistic Market
68. Oligopoly: Collusive Models- Cartel & Price Leadership
69. Oligopoly: Non-Collusive Models- Cournot, Stackelberg, Bertrand, Sweezy or Kinked Demand Curve
70. Monopsony Market Structure
71. Bilateral Monopoly Market Structure
72. Workable Competition in Market: Meaning and Explanation
73. Baumol’s Sales Revenue Maximization Model
74. Williamson’s Model of Managerial Discretion
75. Robin Marris Model of Managerial Enterprise
76. Hall and Hitch Full Cost Pricing Theory
77. Andrew’s Full Cost Pricing Theory
78. Bain’s Model of Limit Pricing
79. Sylos Labini’s Model of Limit Pricing
80. Behavioural Theory of Cyert and March
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82. Prisoner’s Dilemma: Concept and Example