Posted by Anjali Kaur on Jul 02, 2020
The budget line

What does the budget line show?

The way we have a budget in our family to look after the household expenditure, in the same way, we use a budget line to show our income levels beyond that we can not spend. Today, we will learn about the budget line and the concepts related to it. Let’s learn.

What is Budget line?

A budget line shows all the possible combinations of consumption bundle that a consumer can afford given the prices of both commodity and income of the consumer.

or

The budget line shows a set of commodities of two goods that can be purchased if full income is spent on them.

Why do we assume only two commodities in economics?

We choose two commodities, to create a better understanding of a concept and it is easier to represent two commodities on XY-coordinates; two-dimensional.

What is budget line equation?

P1X +P2Y = M

P1; Price of X commodity

X; Units or quantity of X commodity

P2; Price of Y commodity

Y; Units or quantity of Y commodity

M; Money income or income.

If you combine P1X, it shows total expenditure on X and P2Y, shows total expenditure on Y.

What are the intercepts in a budget line?

A budget contains two intercepts namely; Horizontal intercept which is on the X-axis and Vertical intercept which is on the Y-axis.

Any intercept on budget line shows the full income spending on that good, For example, Horizontal intercept is on X axis; It indicates full income spend on X commodity and the units that can be bought of X commodity. Similarly, vertical intercept is on Y axis, it indicates full income spend on Y commodity and the units that can be bought of Y commodity.

Horizontal Intercept; X= M/P1

Vertical Intercept; Y=M/P2

What is the slope of the budget line?

The slope of the budget line is the ratio of the prices of the commodities.

Slope= -p1/p2

Graphical representation of a budget line

Suppose a consumer has a budget of $20 to be spent on two commodities bread and buns, if the price of bread is $4 and the price of buns is $2 each. Then the consumer can determine various consumption bundles that they can afford. let’s see how?

Price of Bread, X= P1 = $4

Price of Buns, Y = P2 =$2

Income =M= $20

Now, by hit and trial method and by assuming values for X and Y, we can determine different combinations of a commodity that a consumer can buy. The budget equation after placing the values of price and income becomes:

4X+2Y = 20 equation (1)

Now, assume X is 0 and put this value in the above equation, Y becomes 10. Similarly, we can find all the values for Y, that will fall under the budget of the consumer ($20).

X (Assumed)
Y
010
18
26
34
42
50
Note: All the above values cost exactly $20.

The following is the graphical representation of the above (X, Y) points, after joining these points, we will get the negatively sloped budget line.

Remember, on the X-axis, we represent the number of X commodities, and on the Y-axis, we represent the number of Y commodities.

Budget Line

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