Meaning of Budget Line
Budget line refers to straight line with downward slope indicating the distinct combinations of two commodities that can be afforded by customer at given market price and particular income allocation. In simple terms, it is a graphical representation of all feasible combinations of two commodities, purchasable with given income and cost such that each one of these combinations is equal to customer earnings. It is also known as budget constraint due to its nature of only exhibiting those product combinations falling within the purchasing power of customer at given market price. The budget line forms its basis on 2 essential components: a) Purchasing power of customers b). Market value of 2 products that are in consideration. Also, it is key to note that scope of budget line is in correlation with the cost of 2 commodities.
Therefore, the income level and market price of commodities are two robust constraints faced by consumer striving to attain maximum utility across indifference curve. Income serves as main constraint because of the fact that only a particular height can be reached in indifference curve at given level of income.
Equation of Budget line
The understanding of budget line equation is must in order to know this concept in more detailed manner. This equation is as represented below: –
M = Px × Qx + Py × Qy
Px =Price of product X
Py =Price of product Y
Qx =Quantity of product X
Qy =Quantity of product Y
M =Money income of consumer
The equation indicates that for buying commodity X and Y, customer cannot incur expenditure in excess of his or her income level (M).
Features of Budget line
A Budget line carries special features that distinguish it from other available tools of economics. Such features of budget line are as described below: –
- Negative Slope- The negative downward sloping line indicates inverse relationship in between the purchase of 2 products.
- Real Income Line- Real income line is dependent upon the individual’s income aspect and expenditure capacity. It is basically an indicator of income and spending size of customer.
- Straight Line- This line in budget line shows present market rate of exchange for each of the combination shown.
- Tangent to indifference curve- It is a point where indifference curve meets the budget line and is also known as consumer’s equilibrium.
Assumptions of Budget Line
The budget line concept, similar to most of the economic theories, is based on assumptions and not reality. For getting simple and precise results, the below mentioned points are taken into consideration by economists.
- Two commodities- It is assumed by economists that income is spend by customers on purchase of two commodities only.
- Market price- Customer is fully aware of each product’s market price.
- Customer’s income- The total monetary earnings of customer is constraint and designated for purchase of two products only.
- Similarity in income and expense- It is assumed that whatever income consumer earns, he spends whole of it.
Shift in Budget Line
Consistency of budget line is influenced by following factors: – Consumer income, price of two commodities and volume of two commodities purchased.
The quantity of product purchased is up to certain extend under the control of consumer, however its price and income of consumer varies with time. These change leads to shift in the budget line.
Shift due to price change: Price of product keeps on changing from time to time. Like suppose, if price and income of product A remains same and price of product B falls down then purchasing power for product B will automatically rise up. In the same manner, if Product B price increases and other factors remain constant then automatically its demand will fall down.
Shift due to income change: The change in income makes huge change thereby leading to variations in budget line. High income with customer means high purchasing power whereas low income means low purchasing potential, making budget line to shift.
Premises of Budget Line
The premises of budget line are as follows-
- Determination of commodities market price- Budget line presumes that customer is always updated about the market price of two products in consideration. The line will become infeasible if there are any alteration in prices.
- Number of commodities- Presence of only two commodities form the basis of establishment for budget line concept. It is presumed that there are necessarily only two commodities for fulfilling the demand of customer.
- Detail on consumer income- Budget line assumes that consumer’s income pertains to limited amount that is known accurately. In addition to this, only know number of products is utilized for allocation of resources.
Example of Budget line
A person has Rs. 100 to buy biscuits. He has following options available for allocating his amount in order to derive maximum utility from limited income.
|Combination||Plain Biscuit(@10 per Biscuit)||Chocolate Biscuit(@20 per Biscuit)||Budget Allocation|
|1||0||5||10 × 0 + 20 × 5 = 100|
|2||2||4||10 × 2 + 20 × 4 = 100|
|3||4||3||10 × 4 + 20 × 3 = 100|
|4||6||2||10 × 6 + 20 × 2 = 100|
|5||8||1||10 × 8 + 20 × 1 = 100|
|6||10||0||10 × 10 + 20 × 0 = 100|
The above-mentioned options are only one customer can choose to derive maximum utility out of his limited income amount i.e., Rs100. If he wants to purchase more of one commodity then he needs to sacrifice the other commodity.
Therefore, we can say, budget line is a component of budget set that includes all feasible combinations of 2 products and focuses on expenditure of total income. This works on principle of sacrificing one commodity for buying more units of other commodities within limited level of income and at particular market price.