In microeconomics, the budget line represents the graphical representation of all possible combinations of two goods that can be purchased with a given income and prices. It is a crucial concept that determines the consumer’s ability to purchase a particular combination of goods, which depends on the income and prices of the goods. In this article, we will discuss the slope and shift of the budget line.
The consumer budget refers to the purchasing power of the consumer from which he can purchase certain quantitative bundles of two goods at a given price. It means a consumer can only purchase those combinations (bundles) of goods, which cost less than or equal to his income.
The budget line represents the locus of different combinations of the two goods which the consumer consumes and which cost exactly his income. It is a graphical representation of all possible combinations of two goods that can be purchased with a given income and prices, such that the cost of each of these combinations is equal to the money income of the consumer.
Let us consider an example to understand the concept of the budget line. Suppose a consumer has an income of Rs. 20, and he wants to spend it on two commodities: X and Y, both priced at Rs. 10 each.
The consumer has three options to spend his entire income: (i) Buy 2 units of X; (ii) Buy 2 units of Y; or (iii) Buy 1 unit of X and 1 unit of Y. It means possible bundles can be: (2, 0); (0, 2) or (1, 1). When all these three bundles are represented graphically, we get a downward sloping straight line, known as the ‘budget line’ or ‘price line.’
The budget set is the set of all possible combinations of the two goods that a consumer can afford, given his income and prices in the market. In addition to the three options, some more options are available to the consumer within his income, even if his entire income is not spent. The budget set includes all the bundles with a total income of Rs. 20, i.e., possible bundles or consumer’s bundles are: (0, 0); (0, 1); (0, 2); (1, 0); (2, 0); (1, 1). The consumer’s bundle is a quantitative combination of two goods that can be purchased by a consumer from his given income.
Diagrammatic Explanation of Budget Line
Suppose a consumer has a budget of Rs. 20 to be spent on two commodities: apples (A) and bananas (B). If apple is priced at Rs. 4 each and banana at Rs. 2 each, then the consumer can determine the various combinations (bundles), which form the budget line.
Slope of the Budget Line
The slope of the budget line represents the rate at which the consumer can trade off one good for the other while keeping the same level of satisfaction. The slope of the budget line is calculated as the ratio of the prices of the two goods. In other words, the slope of the budget line measures the opportunity cost of one good in terms of the other.
For example, if the price of apples is Rs. 4 and the price of bananas is Rs. 2, then the slope of the budget line is 2/4 or 0.5. This means that for every apple the consumer wants to buy, he has to give up 0.5 bananas. Similarly, for every banana he wants to buy, he has to give up 2 apples.
Shifts of the Budget Line
The budget line can shift due to changes in the consumer’s income or the prices of the two goods. A change in income will cause the budget line to shift outward or inward, depending on whether the income increases or decreases.
For example, if the consumer’s income increases from Rs. 20 to Rs. 30 while the prices of apples and bananas remain constant, then the budget line will shift outward, allowing the consumer to purchase more of both goods. On the other hand, if the income decreases from Rs. 20 to Rs. 10, the budget line will shift inward, forcing the consumer to buy less of both goods.
Similarly, a change in the price of one good will cause the budget line to rotate around the intercept of the other good. If the price of apples increases while the price of bananas remains constant, then the budget line will rotate around the intercept of bananas. This means that the consumer will have to give up more bananas to buy the same amount of apples as before.