The budget line shows all those combinations of two goods which the consumer can buy by spending his given money income on the two goods at their given price.
The budget line can be defined as a set of combinations of two commodities that can be purchased if the whole of a given income is spent on them and the slope is equal to the negative of the price ratio.
Important Note: Other names in the literature for the budget line are the Price line, Price opportunity line, Price income line, Outlay line, budget constraint, expenditure line, and consumption possibility line.
Understanding the Price Line Concept with Example:
Our Maximum Budget (M) is 40 Rs.
The cost of 1 apple is 1 Rs which is on the Y-axis and the cost of 1 Banana is 2 Rs which is on X-axis.
Maximum apple we can buy, if we don’t purchase any banana – Total Budget/ Price of Apple = 40/1 = 40 apples
The maximum banana we can buy, if we don’t purchase any apple – Total Budget/ Price of Banana= 40/2 = 20 bananas
(0,40), (20,0) are the extremes points.
Deriving Budget line Equation
Let, Px– Price of X commodity , Py – Price of Y commodity
X – commodity 1 which is on X axis , Y – commodity 2 which is on Y axis
Formula- Px(X)+ Py(Y)= M
Situation 1: If we purchase 0 (zero) units of product X, Then
Px(0) + PyY=M
Situation 2: If we purchase 0 (Zero) units of product Y, Then
PxX + PyY = M
PxX + Py(0) = M
The extreme points are (M/Px,0) , (0,M/Py)
For Finding Slope of Budget Line
We use Tan θ for finding the slope because it has relationship between perpendicular and base and in graph it is X axis (Base), Y axis (Perpendicular)
Tan θ = Perpendicular/ Base
Tan θ = M/Py / M/Px
Tan θ = M/Py multiply Px/M (M,M is cancelled out)
Tan θ = Px/Py
Note: Therefore, the Slope of the Budget line is Px/Py or we can say that The slope of the Budget line is the ratio of prices.
A budget space shows a set of all commodity combinations that can be purchased by spending the whole or a part of the given income.
Change in Price and Shift in Budget Line
Case 1: When the Price of Commodity X is reduced
Case 2: When the price of commodity Y is changed
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