# NCERT Textbook - Theory of Consumer Behaviour Commerce Notes | EduRev

## Teaching : NCERT Textbook - Theory of Consumer Behaviour Commerce Notes | EduRev

``` Page 1

Chapter 2
Theor Theor Theor Theor Theory of y of y of y of y of
Consumer Behaviour Consumer Behaviour Consumer Behaviour Consumer Behaviour Consumer Behaviour
In this chapter, we will study the behaviour of an individual
consumer in a market for final goods
1
. The consumer has to decide
on how much of each of the different goods she would like to
consume. Our objective here is to study this choice problem in
some detail. As we see, the choice of the consumer depends on the
alternatives that are available to her and on her tastes and
preferences regarding those alternatives. To begin with, we will
try to figure out a precise and convenient way of describing the
available alternatives and also the tastes and preferences of the
consumer. We will then use these descriptions to find out the
consumer’s choice in the market.
Preliminary Notations and Assumptions
A consumer, in general, consumes many goods; but for simplicity,
we shall consider the consumer’s choice problem in a situation
where there are only two goods.
2
We will refer to the two goods as
good 1 and good 2. Any combination of the amount of the two
goods will be called a consumption bundle or, in short, a bundle.
In general, we shall use the variable x
1
to denote the amount of
good 1 and x
2
to denote the amount of good 2. x
1
and x
2
can be
positive or zero. (x
1
, x
2
) would mean the bundle consisting of x
1
amount of good 1 and x
2
amount of good 2. For particular values
of x
1
and x
2
, (x
1
, x
2
), would give us a particular bundle. For
example, the bundle (5,10) consists of 5 units of good 1 and 10
units of good 2; the bundle (10, 5) consists of 10 units of good 1
and 5 units of good 2.
2.1 THE CONSUMER’S BUDGET
Let us consider a consumer who has only a fixed amount of money
(income) to spend on two goods the prices of which are given in the
market. The consumer cannot buy any and every combination of
the two goods that she may want to consume. The consumption
bundles that are available to the consumer depend on the prices of
the two goods and the income of the consumer. Given her fixed
1
We shall use the term goods to mean goods as well as services.
2
The assumption that there are only two goods simplifies the analysis considerably and allows us
to understand some important concepts by using simple diagrams.
not to be republished
Page 2

Chapter 2
Theor Theor Theor Theor Theory of y of y of y of y of
Consumer Behaviour Consumer Behaviour Consumer Behaviour Consumer Behaviour Consumer Behaviour
In this chapter, we will study the behaviour of an individual
consumer in a market for final goods
1
. The consumer has to decide
on how much of each of the different goods she would like to
consume. Our objective here is to study this choice problem in
some detail. As we see, the choice of the consumer depends on the
alternatives that are available to her and on her tastes and
preferences regarding those alternatives. To begin with, we will
try to figure out a precise and convenient way of describing the
available alternatives and also the tastes and preferences of the
consumer. We will then use these descriptions to find out the
consumer’s choice in the market.
Preliminary Notations and Assumptions
A consumer, in general, consumes many goods; but for simplicity,
we shall consider the consumer’s choice problem in a situation
where there are only two goods.
2
We will refer to the two goods as
good 1 and good 2. Any combination of the amount of the two
goods will be called a consumption bundle or, in short, a bundle.
In general, we shall use the variable x
1
to denote the amount of
good 1 and x
2
to denote the amount of good 2. x
1
and x
2
can be
positive or zero. (x
1
, x
2
) would mean the bundle consisting of x
1
amount of good 1 and x
2
amount of good 2. For particular values
of x
1
and x
2
, (x
1
, x
2
), would give us a particular bundle. For
example, the bundle (5,10) consists of 5 units of good 1 and 10
units of good 2; the bundle (10, 5) consists of 10 units of good 1
and 5 units of good 2.
2.1 THE CONSUMER’S BUDGET
Let us consider a consumer who has only a fixed amount of money
(income) to spend on two goods the prices of which are given in the
market. The consumer cannot buy any and every combination of
the two goods that she may want to consume. The consumption
bundles that are available to the consumer depend on the prices of
the two goods and the income of the consumer. Given her fixed
1
We shall use the term goods to mean goods as well as services.
2
The assumption that there are only two goods simplifies the analysis considerably and allows us
to understand some important concepts by using simple diagrams.
not to be republished
income and the prices of the two goods, the consumer can afford to buy only
those bundles which cost her less than or equal to her income.
2.1.1 Budget Set
Suppose the income of the consumer is M and the prices of the two goods are p
1
and p
2
respectively.
3
If the consumer wants to buy x
1
units of good 1, she will
have to spend p
1
x
1
amount of money. Similarly, if the consumer wants to buy x
2
units of good 2, she will have to spend p
2
x
2
amount of money. Therefore, if the
consumer wants to buy the bundle consisting of x
1
units of good 1 and x
2
units
of good 2, she will have to spend p
1
x
1
+ p
2
x
2
amount of money. She can buy this
bundle only if she has at least p
1
x
1
+ p
2
x
2
amount of money. Given the prices of
the goods and the income of a consumer, she can choose any bundle as long as
it costs less than or equal to the income she has. In other words, the consumer
1
, x
2
) such that
p
1
x
1
+ p
2
x
2
= M (2.1)
The inequality (2.1) is called the consumer’s budget constraint. The set of
bundles available to the consumer is called the budget set. The budget set is
thus the collection of all bundles that the consumer can buy with her income at
the prevailing market prices.
EXAMPLE  2.1
Consider, for example, a consumer who has Rs 20, and suppose, both the goods
are priced at Rs 5 and are available only in integral units. The bundles that this
consumer can afford to buy are: (0, 0), (0, 1), (0, 2), (0, 3), (0, 4), (1, 0), (1, 1),
(1, 2), (1, 3), (2, 0), (2, 1), (2, 2), (3, 0), (3, 1) and (4, 0). Among these bundles,
(0, 4), (1,3), (2, 2), (3, 1) and (4, 0) cost exactly Rs 20 and all the other bundles
cost less than Rs 20. The consumer cannot afford to buy bundles like (3, 3) and
(4, 5) because they cost more than Rs 20 at the prevailing prices.
3
Price of a good is the amount of money that the consumer has to pay per unit of the good she
wants to buy. If rupee is the unit of money and quantity of the good is measured in kilograms, the
price of good 1 being p
1
means the consumer has to pay p
1
rupees per kilograms of good 1 that she
Spoilt for Choice
9
Theory of Consumer Behaviour
not to be republished
Page 3

Chapter 2
Theor Theor Theor Theor Theory of y of y of y of y of
Consumer Behaviour Consumer Behaviour Consumer Behaviour Consumer Behaviour Consumer Behaviour
In this chapter, we will study the behaviour of an individual
consumer in a market for final goods
1
. The consumer has to decide
on how much of each of the different goods she would like to
consume. Our objective here is to study this choice problem in
some detail. As we see, the choice of the consumer depends on the
alternatives that are available to her and on her tastes and
preferences regarding those alternatives. To begin with, we will
try to figure out a precise and convenient way of describing the
available alternatives and also the tastes and preferences of the
consumer. We will then use these descriptions to find out the
consumer’s choice in the market.
Preliminary Notations and Assumptions
A consumer, in general, consumes many goods; but for simplicity,
we shall consider the consumer’s choice problem in a situation
where there are only two goods.
2
We will refer to the two goods as
good 1 and good 2. Any combination of the amount of the two
goods will be called a consumption bundle or, in short, a bundle.
In general, we shall use the variable x
1
to denote the amount of
good 1 and x
2
to denote the amount of good 2. x
1
and x
2
can be
positive or zero. (x
1
, x
2
) would mean the bundle consisting of x
1
amount of good 1 and x
2
amount of good 2. For particular values
of x
1
and x
2
, (x
1
, x
2
), would give us a particular bundle. For
example, the bundle (5,10) consists of 5 units of good 1 and 10
units of good 2; the bundle (10, 5) consists of 10 units of good 1
and 5 units of good 2.
2.1 THE CONSUMER’S BUDGET
Let us consider a consumer who has only a fixed amount of money
(income) to spend on two goods the prices of which are given in the
market. The consumer cannot buy any and every combination of
the two goods that she may want to consume. The consumption
bundles that are available to the consumer depend on the prices of
the two goods and the income of the consumer. Given her fixed
1
We shall use the term goods to mean goods as well as services.
2
The assumption that there are only two goods simplifies the analysis considerably and allows us
to understand some important concepts by using simple diagrams.
not to be republished
income and the prices of the two goods, the consumer can afford to buy only
those bundles which cost her less than or equal to her income.
2.1.1 Budget Set
Suppose the income of the consumer is M and the prices of the two goods are p
1
and p
2
respectively.
3
If the consumer wants to buy x
1
units of good 1, she will
have to spend p
1
x
1
amount of money. Similarly, if the consumer wants to buy x
2
units of good 2, she will have to spend p
2
x
2
amount of money. Therefore, if the
consumer wants to buy the bundle consisting of x
1
units of good 1 and x
2
units
of good 2, she will have to spend p
1
x
1
+ p
2
x
2
amount of money. She can buy this
bundle only if she has at least p
1
x
1
+ p
2
x
2
amount of money. Given the prices of
the goods and the income of a consumer, she can choose any bundle as long as
it costs less than or equal to the income she has. In other words, the consumer
1
, x
2
) such that
p
1
x
1
+ p
2
x
2
= M (2.1)
The inequality (2.1) is called the consumer’s budget constraint. The set of
bundles available to the consumer is called the budget set. The budget set is
thus the collection of all bundles that the consumer can buy with her income at
the prevailing market prices.
EXAMPLE  2.1
Consider, for example, a consumer who has Rs 20, and suppose, both the goods
are priced at Rs 5 and are available only in integral units. The bundles that this
consumer can afford to buy are: (0, 0), (0, 1), (0, 2), (0, 3), (0, 4), (1, 0), (1, 1),
(1, 2), (1, 3), (2, 0), (2, 1), (2, 2), (3, 0), (3, 1) and (4, 0). Among these bundles,
(0, 4), (1,3), (2, 2), (3, 1) and (4, 0) cost exactly Rs 20 and all the other bundles
cost less than Rs 20. The consumer cannot afford to buy bundles like (3, 3) and
(4, 5) because they cost more than Rs 20 at the prevailing prices.
3
Price of a good is the amount of money that the consumer has to pay per unit of the good she
wants to buy. If rupee is the unit of money and quantity of the good is measured in kilograms, the
price of good 1 being p
1
means the consumer has to pay p
1
rupees per kilograms of good 1 that she
Spoilt for Choice
9
Theory of Consumer Behaviour
not to be republished
10
Introductory Microeconomics
2.1.2 Budget Line
If both the goods are perfectly
divisible
4
, the consumer’s budget set
would consist of all bundles (x
1
, x
2
)
such that x
1
and x
2
are any numbers
greater than or equal to 0 and p
1
x
1
+
p
2
x
2
= M. The budget set can be
represented in a diagram as in
Figure 2.1.
All bundles in the positive
quadrant which are on or below the
line are included in the budget set.
The equation of the line is
p
1
x
1
+ p
2
x
2
= M (2.2)
The line consists of all bundles which
cost exactly equal to M. This line is
called the budget line. Points below
the budget line represent bundles which cost strictly less than M.
The equation (2.2) can also be written as
5
1
21
22
p
M
xx
pp
=-
(2.3)
The budget line is a straight line with horizontal intercept
1
M
p
and vertical
intercept
2
M
p
. The horizontal intercept represents the bundle that the consumer
can buy if she spends her entire income on good 1. Similarly, the vertical intercept
represents the bundle that the consumer can buy if she spends her entire income
on good 2. The slope of the budget line is
1
2
–
p
p
.
Budget Set. Quantity of good 1 is measured
along the horizontal axis and quantity of good 2
is measured along the vertical axis. Any point in
the diagram represents a bundle of the two
goods. The budget set consists of all points on
or below the straight line having the equation
p
1
x
1
+ p
2
x
2
= M.
4
The goods considered in Example 2.1 were not divisible and were available only in integer units.
There are many goods which are divisible in the sense that they are available in non-integer units
also. It is not possible to buy half an orange or one-fourth of a banana, but it is certainly possible to
buy half a kilogram of rice or one-fourth of a litre of milk.
5
In school mathematics, you have learnt the equation of a straight line as y = c + mx where c is the
vertical intercept and m is the  slope of the straight line. Note that equation (2.3) has the same form.
Derivation of the Slope of the Budget Line
The slope of the budget line measures
the amount of change in good 2
required per unit of change in good
1 along the budget line. Consider any
two points (x
1
, x
2
) and (x
1
+ ?x
1
, x
2
+
?x
2
) on the budget line.
a
It must be the case that
p
1
x
1
+ p
2
x
2
= M (2.4) and
p
1
(x
1
+ ?x
1
) + p
2
(x
2
+ ?x
2
) = M
(2.5)
not to be republished
Page 4

Chapter 2
Theor Theor Theor Theor Theory of y of y of y of y of
Consumer Behaviour Consumer Behaviour Consumer Behaviour Consumer Behaviour Consumer Behaviour
In this chapter, we will study the behaviour of an individual
consumer in a market for final goods
1
. The consumer has to decide
on how much of each of the different goods she would like to
consume. Our objective here is to study this choice problem in
some detail. As we see, the choice of the consumer depends on the
alternatives that are available to her and on her tastes and
preferences regarding those alternatives. To begin with, we will
try to figure out a precise and convenient way of describing the
available alternatives and also the tastes and preferences of the
consumer. We will then use these descriptions to find out the
consumer’s choice in the market.
Preliminary Notations and Assumptions
A consumer, in general, consumes many goods; but for simplicity,
we shall consider the consumer’s choice problem in a situation
where there are only two goods.
2
We will refer to the two goods as
good 1 and good 2. Any combination of the amount of the two
goods will be called a consumption bundle or, in short, a bundle.
In general, we shall use the variable x
1
to denote the amount of
good 1 and x
2
to denote the amount of good 2. x
1
and x
2
can be
positive or zero. (x
1
, x
2
) would mean the bundle consisting of x
1
amount of good 1 and x
2
amount of good 2. For particular values
of x
1
and x
2
, (x
1
, x
2
), would give us a particular bundle. For
example, the bundle (5,10) consists of 5 units of good 1 and 10
units of good 2; the bundle (10, 5) consists of 10 units of good 1
and 5 units of good 2.
2.1 THE CONSUMER’S BUDGET
Let us consider a consumer who has only a fixed amount of money
(income) to spend on two goods the prices of which are given in the
market. The consumer cannot buy any and every combination of
the two goods that she may want to consume. The consumption
bundles that are available to the consumer depend on the prices of
the two goods and the income of the consumer. Given her fixed
1
We shall use the term goods to mean goods as well as services.
2
The assumption that there are only two goods simplifies the analysis considerably and allows us
to understand some important concepts by using simple diagrams.
not to be republished
income and the prices of the two goods, the consumer can afford to buy only
those bundles which cost her less than or equal to her income.
2.1.1 Budget Set
Suppose the income of the consumer is M and the prices of the two goods are p
1
and p
2
respectively.
3
If the consumer wants to buy x
1
units of good 1, she will
have to spend p
1
x
1
amount of money. Similarly, if the consumer wants to buy x
2
units of good 2, she will have to spend p
2
x
2
amount of money. Therefore, if the
consumer wants to buy the bundle consisting of x
1
units of good 1 and x
2
units
of good 2, she will have to spend p
1
x
1
+ p
2
x
2
amount of money. She can buy this
bundle only if she has at least p
1
x
1
+ p
2
x
2
amount of money. Given the prices of
the goods and the income of a consumer, she can choose any bundle as long as
it costs less than or equal to the income she has. In other words, the consumer
1
, x
2
) such that
p
1
x
1
+ p
2
x
2
= M (2.1)
The inequality (2.1) is called the consumer’s budget constraint. The set of
bundles available to the consumer is called the budget set. The budget set is
thus the collection of all bundles that the consumer can buy with her income at
the prevailing market prices.
EXAMPLE  2.1
Consider, for example, a consumer who has Rs 20, and suppose, both the goods
are priced at Rs 5 and are available only in integral units. The bundles that this
consumer can afford to buy are: (0, 0), (0, 1), (0, 2), (0, 3), (0, 4), (1, 0), (1, 1),
(1, 2), (1, 3), (2, 0), (2, 1), (2, 2), (3, 0), (3, 1) and (4, 0). Among these bundles,
(0, 4), (1,3), (2, 2), (3, 1) and (4, 0) cost exactly Rs 20 and all the other bundles
cost less than Rs 20. The consumer cannot afford to buy bundles like (3, 3) and
(4, 5) because they cost more than Rs 20 at the prevailing prices.
3
Price of a good is the amount of money that the consumer has to pay per unit of the good she
wants to buy. If rupee is the unit of money and quantity of the good is measured in kilograms, the
price of good 1 being p
1
means the consumer has to pay p
1
rupees per kilograms of good 1 that she
Spoilt for Choice
9
Theory of Consumer Behaviour
not to be republished
10
Introductory Microeconomics
2.1.2 Budget Line
If both the goods are perfectly
divisible
4
, the consumer’s budget set
would consist of all bundles (x
1
, x
2
)
such that x
1
and x
2
are any numbers
greater than or equal to 0 and p
1
x
1
+
p
2
x
2
= M. The budget set can be
represented in a diagram as in
Figure 2.1.
All bundles in the positive
quadrant which are on or below the
line are included in the budget set.
The equation of the line is
p
1
x
1
+ p
2
x
2
= M (2.2)
The line consists of all bundles which
cost exactly equal to M. This line is
called the budget line. Points below
the budget line represent bundles which cost strictly less than M.
The equation (2.2) can also be written as
5
1
21
22
p
M
xx
pp
=-
(2.3)
The budget line is a straight line with horizontal intercept
1
M
p
and vertical
intercept
2
M
p
. The horizontal intercept represents the bundle that the consumer
can buy if she spends her entire income on good 1. Similarly, the vertical intercept
represents the bundle that the consumer can buy if she spends her entire income
on good 2. The slope of the budget line is
1
2
–
p
p
.
Budget Set. Quantity of good 1 is measured
along the horizontal axis and quantity of good 2
is measured along the vertical axis. Any point in
the diagram represents a bundle of the two
goods. The budget set consists of all points on
or below the straight line having the equation
p
1
x
1
+ p
2
x
2
= M.
4
The goods considered in Example 2.1 were not divisible and were available only in integer units.
There are many goods which are divisible in the sense that they are available in non-integer units
also. It is not possible to buy half an orange or one-fourth of a banana, but it is certainly possible to
buy half a kilogram of rice or one-fourth of a litre of milk.
5
In school mathematics, you have learnt the equation of a straight line as y = c + mx where c is the
vertical intercept and m is the  slope of the straight line. Note that equation (2.3) has the same form.
Derivation of the Slope of the Budget Line
The slope of the budget line measures
the amount of change in good 2
required per unit of change in good
1 along the budget line. Consider any
two points (x
1
, x
2
) and (x
1
+ ?x
1
, x
2
+
?x
2
) on the budget line.
a
It must be the case that
p
1
x
1
+ p
2
x
2
= M (2.4) and
p
1
(x
1
+ ?x
1
) + p
2
(x
2
+ ?x
2
) = M
(2.5)
not to be republished
11
Theory of Consumer Behaviour
Price Ratio and the Slope of the Budget Line
Think of any point on the budget line. Such a point represents a bundle which
costs the consumer her entire budget. Now suppose the consumer wants to have
one more unit of good 1. She can do it only if she gives up some amount of the
other good. How much of good 2 does she have to give up if she wants to have an
extra unit of good 1? It would depend on the prices of the two goods. A unit of
good 1 costs p
1
. Therefore, she will have to reduce her expenditure on good 2 by
p
1
amount. With p
1
1
2
p
p
units of good 2. Therefore, if the consumer
wants to have an extra unit of good 1 when she is spending all her money, she will
have to give up
1
2
p
p
units of good 2. In other words, in the given market conditions,
the consumer can substitute good 1 for good 2 at the rate
1
2
p
p
. The absolute
value
6
of the slope of the budget line measures the rate at which the consumer is
able to substitute good 1 for good 2 when she spends her entire budget.
Points Below the Budget Line
Consider any point below the budget line. Such a point represents a bundle
which costs less than the consumer’s income. Thus, if the consumer buys such
a bundle, she will have some money left
over. In principle, the consumer could
spend this extra money on either of the
two goods, and thus, buy a bundle
which consists of more of, at least, one
of the goods, and no less of the other
as compared to the bundle lying below
the budget line. In other words,
compared to a point below the budget
line, there is always some bundle on
the budget line which contains more of
at least one of the goods and no less of
the other. Figure 2.2 illustrates this
fact. The point C lies below the budget
line while points A and B lie on the
budget line. Point A contains more of
good 2 and the same amount of good
Subtracting (2.4) from (2.5), we obtain
p
1
?x
1
+ p
2
?x
2
= 0 (2.6)
By rearranging terms in (2.6), we obtain
?
=-
?
2
1
12
x
p
xp
(2.7)
a
? (delta) is a Greek letter. In mathematics, ? is sometimes used to denote ‘a change’.
Thus, ?x
1
stands for a change in x
1
and ?x
2
stands for a change in x
2
.
6
The absolute value of a number x is equal to x if x = 0 and is equal to – x if x < 0. The absolute
value of x is usually denoted by |x|.
A Point below the Budget Line. Compared
to a point below the budget line, there is
always some bundle on the budget line which
contains more of at least one of the goods
and no less of the other .
not to be republished
Page 5

Chapter 2
Theor Theor Theor Theor Theory of y of y of y of y of
Consumer Behaviour Consumer Behaviour Consumer Behaviour Consumer Behaviour Consumer Behaviour
In this chapter, we will study the behaviour of an individual
consumer in a market for final goods
1
. The consumer has to decide
on how much of each of the different goods she would like to
consume. Our objective here is to study this choice problem in
some detail. As we see, the choice of the consumer depends on the
alternatives that are available to her and on her tastes and
preferences regarding those alternatives. To begin with, we will
try to figure out a precise and convenient way of describing the
available alternatives and also the tastes and preferences of the
consumer. We will then use these descriptions to find out the
consumer’s choice in the market.
Preliminary Notations and Assumptions
A consumer, in general, consumes many goods; but for simplicity,
we shall consider the consumer’s choice problem in a situation
where there are only two goods.
2
We will refer to the two goods as
good 1 and good 2. Any combination of the amount of the two
goods will be called a consumption bundle or, in short, a bundle.
In general, we shall use the variable x
1
to denote the amount of
good 1 and x
2
to denote the amount of good 2. x
1
and x
2
can be
positive or zero. (x
1
, x
2
) would mean the bundle consisting of x
1
amount of good 1 and x
2
amount of good 2. For particular values
of x
1
and x
2
, (x
1
, x
2
), would give us a particular bundle. For
example, the bundle (5,10) consists of 5 units of good 1 and 10
units of good 2; the bundle (10, 5) consists of 10 units of good 1
and 5 units of good 2.
2.1 THE CONSUMER’S BUDGET
Let us consider a consumer who has only a fixed amount of money
(income) to spend on two goods the prices of which are given in the
market. The consumer cannot buy any and every combination of
the two goods that she may want to consume. The consumption
bundles that are available to the consumer depend on the prices of
the two goods and the income of the consumer. Given her fixed
1
We shall use the term goods to mean goods as well as services.
2
The assumption that there are only two goods simplifies the analysis considerably and allows us
to understand some important concepts by using simple diagrams.
not to be republished
income and the prices of the two goods, the consumer can afford to buy only
those bundles which cost her less than or equal to her income.
2.1.1 Budget Set
Suppose the income of the consumer is M and the prices of the two goods are p
1
and p
2
respectively.
3
If the consumer wants to buy x
1
units of good 1, she will
have to spend p
1
x
1
amount of money. Similarly, if the consumer wants to buy x
2
units of good 2, she will have to spend p
2
x
2
amount of money. Therefore, if the
consumer wants to buy the bundle consisting of x
1
units of good 1 and x
2
units
of good 2, she will have to spend p
1
x
1
+ p
2
x
2
amount of money. She can buy this
bundle only if she has at least p
1
x
1
+ p
2
x
2
amount of money. Given the prices of
the goods and the income of a consumer, she can choose any bundle as long as
it costs less than or equal to the income she has. In other words, the consumer
1
, x
2
) such that
p
1
x
1
+ p
2
x
2
= M (2.1)
The inequality (2.1) is called the consumer’s budget constraint. The set of
bundles available to the consumer is called the budget set. The budget set is
thus the collection of all bundles that the consumer can buy with her income at
the prevailing market prices.
EXAMPLE  2.1
Consider, for example, a consumer who has Rs 20, and suppose, both the goods
are priced at Rs 5 and are available only in integral units. The bundles that this
consumer can afford to buy are: (0, 0), (0, 1), (0, 2), (0, 3), (0, 4), (1, 0), (1, 1),
(1, 2), (1, 3), (2, 0), (2, 1), (2, 2), (3, 0), (3, 1) and (4, 0). Among these bundles,
(0, 4), (1,3), (2, 2), (3, 1) and (4, 0) cost exactly Rs 20 and all the other bundles
cost less than Rs 20. The consumer cannot afford to buy bundles like (3, 3) and
(4, 5) because they cost more than Rs 20 at the prevailing prices.
3
Price of a good is the amount of money that the consumer has to pay per unit of the good she
wants to buy. If rupee is the unit of money and quantity of the good is measured in kilograms, the
price of good 1 being p
1
means the consumer has to pay p
1
rupees per kilograms of good 1 that she
Spoilt for Choice
9
Theory of Consumer Behaviour
not to be republished
10
Introductory Microeconomics
2.1.2 Budget Line
If both the goods are perfectly
divisible
4
, the consumer’s budget set
would consist of all bundles (x
1
, x
2
)
such that x
1
and x
2
are any numbers
greater than or equal to 0 and p
1
x
1
+
p
2
x
2
= M. The budget set can be
represented in a diagram as in
Figure 2.1.
All bundles in the positive
quadrant which are on or below the
line are included in the budget set.
The equation of the line is
p
1
x
1
+ p
2
x
2
= M (2.2)
The line consists of all bundles which
cost exactly equal to M. This line is
called the budget line. Points below
the budget line represent bundles which cost strictly less than M.
The equation (2.2) can also be written as
5
1
21
22
p
M
xx
pp
=-
(2.3)
The budget line is a straight line with horizontal intercept
1
M
p
and vertical
intercept
2
M
p
. The horizontal intercept represents the bundle that the consumer
can buy if she spends her entire income on good 1. Similarly, the vertical intercept
represents the bundle that the consumer can buy if she spends her entire income
on good 2. The slope of the budget line is
1
2
–
p
p
.
Budget Set. Quantity of good 1 is measured
along the horizontal axis and quantity of good 2
is measured along the vertical axis. Any point in
the diagram represents a bundle of the two
goods. The budget set consists of all points on
or below the straight line having the equation
p
1
x
1
+ p
2
x
2
= M.
4
The goods considered in Example 2.1 were not divisible and were available only in integer units.
There are many goods which are divisible in the sense that they are available in non-integer units
also. It is not possible to buy half an orange or one-fourth of a banana, but it is certainly possible to
buy half a kilogram of rice or one-fourth of a litre of milk.
5
In school mathematics, you have learnt the equation of a straight line as y = c + mx where c is the
vertical intercept and m is the  slope of the straight line. Note that equation (2.3) has the same form.
Derivation of the Slope of the Budget Line
The slope of the budget line measures
the amount of change in good 2
required per unit of change in good
1 along the budget line. Consider any
two points (x
1
, x
2
) and (x
1
+ ?x
1
, x
2
+
?x
2
) on the budget line.
a
It must be the case that
p
1
x
1
+ p
2
x
2
= M (2.4) and
p
1
(x
1
+ ?x
1
) + p
2
(x
2
+ ?x
2
) = M
(2.5)
not to be republished
11
Theory of Consumer Behaviour
Price Ratio and the Slope of the Budget Line
Think of any point on the budget line. Such a point represents a bundle which
costs the consumer her entire budget. Now suppose the consumer wants to have
one more unit of good 1. She can do it only if she gives up some amount of the
other good. How much of good 2 does she have to give up if she wants to have an
extra unit of good 1? It would depend on the prices of the two goods. A unit of
good 1 costs p
1
. Therefore, she will have to reduce her expenditure on good 2 by
p
1
amount. With p
1
1
2
p
p
units of good 2. Therefore, if the consumer
wants to have an extra unit of good 1 when she is spending all her money, she will
have to give up
1
2
p
p
units of good 2. In other words, in the given market conditions,
the consumer can substitute good 1 for good 2 at the rate
1
2
p
p
. The absolute
value
6
of the slope of the budget line measures the rate at which the consumer is
able to substitute good 1 for good 2 when she spends her entire budget.
Points Below the Budget Line
Consider any point below the budget line. Such a point represents a bundle
which costs less than the consumer’s income. Thus, if the consumer buys such
a bundle, she will have some money left
over. In principle, the consumer could
spend this extra money on either of the
two goods, and thus, buy a bundle
which consists of more of, at least, one
of the goods, and no less of the other
as compared to the bundle lying below
the budget line. In other words,
compared to a point below the budget
line, there is always some bundle on
the budget line which contains more of
at least one of the goods and no less of
the other. Figure 2.2 illustrates this
fact. The point C lies below the budget
line while points A and B lie on the
budget line. Point A contains more of
good 2 and the same amount of good
Subtracting (2.4) from (2.5), we obtain
p
1
?x
1
+ p
2
?x
2
= 0 (2.6)
By rearranging terms in (2.6), we obtain
?
=-
?
2
1
12
x
p
xp
(2.7)
a
? (delta) is a Greek letter. In mathematics, ? is sometimes used to denote ‘a change’.
Thus, ?x
1
stands for a change in x
1
and ?x
2
stands for a change in x
2
.
6
The absolute value of a number x is equal to x if x = 0 and is equal to – x if x < 0. The absolute
value of x is usually denoted by |x|.
A Point below the Budget Line. Compared
to a point below the budget line, there is
always some bundle on the budget line which
contains more of at least one of the goods
and no less of the other .
not to be republished
12
Introductory Microeconomics
Changes in the Set of Available Bundles of Goods Resulting from Changes in the
Consumer’s Income. A decrease in income causes a parallel inward shift of the budget
line as in panel (a). An increase in income causes a parallel outward shift of the budget line
as in panel (b).
1 as compared to point C. Point B contains more of good 1 and the same amount
of good 2 as compared to point C. Any other point on the line segment ‘AB’
represents a bundle which has more of both the goods compared to C.
2.1.3 Changes in the Budget Set
The set of available bundles depends on the prices of the two goods and the income
of the consumer. When the price of either of the goods or the consumer’s income
changes, the set of available bundles is also likely to change. Suppose the
consumer’s income changes from M to M
'
but the prices of the two goods remain
unchanged. With the new income, the consumer can afford to buy all bundles
(x
1
, x
2
) such that p
1
x
1
+ p
2
x
2
= M '. Now the equation of the budget line is
p
1
x
1
+ p
2
x
2
= M
'
(2.8)
Equation (2.8) can also be written as
1
21
22
–
p
M'
xx
pp
=
(2.9)
Note that the slope of the new budget line is the same as the slope of the
budget line prior to the change in the consumer’s income. However, the vertical
intercept has changed after the change in income. If there is an increase in the
income, i.e. if M' > M, the vertical intercept increases, there is a parallel outward
shift of the budget line. If the income increases, the consumer can buy more of
the goods at the prevailing market prices. Similarly, if the income goes down, i.e.
if M' < M, the vertical intercept decreases, and hence, there is a parallel inward
shift of the budget line. If income goes down, the availability of goods goes
down. Changes in the set of available bundles resulting from changes in
consumer’s income when the prices of the two goods remain unchanged are
shown in Figure 2.3.
Now suppose the price of good 1 changes from p
1
to p'
1
but the price of good
2 and the consumer’s income remain unchanged. At the new price of good 1,
the consumer can afford to buy all bundles (x
1
,x
2
) such that p'
1
x
1
+ p
2
x
2
= M. The
equation of the budget line is
p'
1
x
1
+ p
2
x
2
= M (2.10)
not to be republished
```
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## Economics Class 11

217 videos|199 docs|48 tests

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