The Budget Set - B Com PDF Download

Budget Set

There are two factors that affect a consumer’s choice of quantities to purchase between two goods: prices and money income. Price times quantity for each good gives us the expenditure incurred on purchasing a good. In our analysis, there are two goods. So, the expenditure on both goods must be less than or equal to the money income of the consumer. This is the budget constraint faced by a consumer. It is depicted as:

P1.X1 + P2.X2 <= M

All those bundles that satisfy this criterion are set to form a part of what is called the budget set. The consumer can choose to consume out of any of these bundles.

Budget Line

In consumer budget, the graphical representation of all such bundles which cost the consumer exactly his money income is called the budget line. The equation of the budget line is, therefore:

P1.X1 + P2.X2 = M

We measure the quantity of good 1 on the horizontal axis and that of good 2 on the vertical axis. We can depict the budget line by calculating the horizontal and vertical intercept. The intercepts are the maximum of each good the consumer can afford to buy.

So, horizontal intercept = M/P1 (the consumer buys only good 1, X2 = 0)

And, vertical intercept = M/P2 ­(the consumer buys only good 2, X1 = 0)

Fig. 1: Budget Line

The figure assumes good 1 to be ‘X’ and good 2 to be ‘Y’. Note that a bundle such as ‘K’ forms a part of the budget set and costs less than the total money income. A bundle such as ‘H’ on the other hand lies outside the budget line and is hence not affordable.

Slope of the Budget Line

Why does the budget line slope downward? We must understand that the quantities of goods 1 and 2 are limited (as in the real world) and the consumer has a fixed money income. So, to have more of good 1, he has to ‘give up’ some amount of good 2. This negative relation between consumption quantities of two goods causes the budget line to slope downwards.

The slope of the budget line is the amount of good 2 given up to have one more unit of good 1. The price of one unit of good 1 is P1. To have one more unit of good 1, therefore, consumption of good 2 must be reduced by P1 amount. Now, with the P2amount, one unit of good 2 could have been bought. So, with the P1 amount,  of good 2 could have been bought.

Thus, the consumer must give up units of good 2 to obtain one extra unit of good 1, i.e. the slope of the budget line is.