WHAT IS BUDGET LINE?
A budget line is a straight line that slopes downwards and consists of all the possible combinations of the two goods which a consumer can buy at a given market price by allocating all his/her income. It is an entirely different concept from that of an indifference curve, though they are both are essential for consumer equilibrium
The two essential components of a budget line are:
- The purchasing power of a consumer, i.e. his/her income;
- The market price of both commodities.
EQUATION OF BUDGET
The concept of the budget line is precisely explained through the following equation:
Px/Py = Qx/Qy
Px is the price of goods X;
Qx is the quantity of goods X;
Py is the price of goods Y;
Qy is the quantity of goods Y;
M is the income of the consumer.
ASSUMPTIONS OF A BUDGET LINE
As we know that economics is mostly based on assumptions, so goes for the budget line. To make the results and analysis more clear and easy to understand, the economist assumes the following in respect of a budget line:
- Two Commodities: It is believed that the consumer will spend all his/her income on purchasing only two goods.
- Income of the Consumer is Known: The consumer’s income is limited and is known, even the revenue is wholly allocated for buying only two commodities
- Market Price is Known: The market price of both the goods are known to the consumer.
- Expenditure is equal to the Income: We assume that the consumer spends all his/her income.