Budget Line or Price Line

Budget line or price line

An IC cannot possibly predict consumer behavior because it leaves two important types of information, the income of the consumer and the prices of the commodities.

Price and income information is supplied in an indifference curve diagram by another curve which is called the budget line or the price line.

Study of budget line is essential to have the knowledge of consumer’s equilibrium through IC analysis. It is also known as Price line, consumption possibility line.

Assumptions Consumer’s income is constantConsumer know the price of all the thingsConsumer can spend his income in small

quantitiesConsumer is rationalConsumer is fully aware of indifference

curveGoods are divisible.

Income Apples (Rs= 1) Oranges (Rs. 0.50)

Four 0 8

Four 1 6

Four 2 4

Four 3 2

Four 4 0

Shifting of the budget lineChange in income.

A

B 0

A'

B'

Figure 1A.5 Changes in the Price of Good X

A

B '' B ' B0

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Indifference MapAn indifference map is a complete set of

indifference curves.It indicates the consumer’s preferences

among all combinations of goods and services.

The farther from the origin the indifference curve is, the more the combinations of goods along that curve are preferred.


Indifference Map


Budget ConstraintThe indifference map only reveals the

ordering of consumer preferences among bundles of goods. It tells us what the consumer is willing to buy.

It does not tell us what the consumer is able to buy. It does not tell us anything about the consumer’s buying power.

The budget line shows all the combinations of goods that can be purchased with a given level of income.


The Budget Line


Consumer EquilibriumThe indifference map in combination with

the budget line allows us to determine the one combination of goods and services that the consumer most wants and is able to purchase. This is the consumer equilibrium.

The demand curve for a good can be derived from indifference curves and budget lines by changing the price of one of the goods (leaving everything else the same) and finding the equilibrium points.


Consumer Equilibrium

The consumer maxi-mizes satisfaction by purchasing the combination of goods that is on the indifference curve farthest from the origin but attainable given the consumer’s budget.

Deriving a Demand Curve from the Indifference CurveDemand is the quantity of a good that a

person will buy at various prices.

Deriving a Demand Curve from the Indifference CurveThe point of tangency of the indifference

curve and the budget line gives the quantity that a person would buy at a given price.

Deriving a Demand Curve from the Indifference Curve


Deriving the Demand Curve

By changing the price of one of the goods and leaving everything else the same, we can derive the demand curve.

In (a), the price of a gallon of gasoline doubles, rotating the budget line from Y1 to Y2. The consumer equilibrium moves from point C to E, and the quantity demanded of gasoline falls from 3 to 2.

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Budget Line or Price Line