Price line or Budget line

 

Price line or Budget line

A budget line is drawn on the assumption that the consumer has a given income which sets limits to his maximizing behavior. A rational consumer always wants to get maximum satisfaction, therefore, he tries to reach the highest possible indifference curve. In this activity, our consumer will be governed by the amount of money or income he has to spend on goods and the price of the goods in the market. A budget line shows all the possible combinations of two goods that a consumer can purchase with the given income.

Suppose the consumer has Rs. 15 to spend on good X and good Y and the price of good X in the market is Rs 3 per unit and the price of good Y is Rs 1 per unit. With Rs.15, he can buy 5 units of good X [=OF] or15 units of good Y[OA]. By joining points A, B, C, D, E, and F, we get the price line. It is also called the Price-income line, Price opportunity line, or Budget line. This line shows all possible combinations of two goods X and Y.

A consumer can purchase any of the combinations of two commodities, falling on the line on AF, such as B, C, D, E.  A combination like H is unattainable as it lies outside the budget line. A combination like G is attainable but in this case, the consumer can not spend his whole money. since we assume that consumers should spend all of their income, so the actual combination will lie on the budget line only.

The slope of the budget line is the ratio of the prices of the two commodities X and Y i.e Px/Py.

In other words, the slope of the budget line shows the opportunity cost of one good in terms of the other.

Geometrically, the slope of the budget line is-

Shifting the price line because of a change in money income:

If the money income of the consumer increases, while the prices of both goods remain unchanged. The consumer can purchase more quantity of both goods X and Y with his increased income. The new budget line would shift to the right, parallel to the original line.

The condition would be vice versa in the case of decreases in money income and the new budget line would be a shift to the left, parallel to the original line.

Shifting the price line because of a change in the price:

Given the money income, if the price of any of both the goods falls, the price ratio between X and Y will change and the slope of the budget line will go through a change.

Suppose if the price of good X changes, it becomes cheaper or expensive and the consumer can purchase more quantity of good X in the case of a fall in the price of good X and less quantity of good X in the case of a rise in the price of good X with no effect on good Y. Thus the budget line will originate at point A on Y-axis but changes to B to B1, and B2  on the X-axis.

If the price of good Y changes, the budget line will originate at point B on X-axis but changes to A to A1 and A2 on the Y-axis.

In the case of the changes in the price of both the goods X and Y, the  slope of the price line :

If the money income remains constant and the prices of both goods change proportionately, the change in the case is similar to an increase in income if prices fall or a decrease in income if prices rise.

Dr. Swati Gupta

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