Consumer Budget: Meaning and Practical Analysis

Consumer’s real purchasing power with which he can buy a combination of two goods, given their prices is known as the Consumer’s Budget. A consumer has limited income therefore the consumer’s budget shows the number of goods and services he can afford.

Let’s take an example, suppose, the income of a consumer is fixed and with that income, he can afford only two things. The prices for both the things in the market are fixed, therefore the consumer will try to choose the best combination of the goods that he wants to buy. He would look for the things that would yield him utility more than the price he has paid, this would give him maximum satisfaction. 

The consumer budget includes two things: a budget set and a budget line.

Budget Set

The attainable combination of a set of products when the consumer has a fixed income, given the prices of products. Therefore, the two utmost factors that affect the choice of the consumer while purchasing a quantity are the consumer’s income and the price of the quantity. The total expenditure that is incurred while purchasing a good or service is the price times quantity for each. Therefore, if the consumer is buying two goods, the expenditure spent on them must be less than or equal to the income of the consumer. This is known as the budget constraint that a customer faces. The mathematical equation for a budget set it-

where P₁ = Price of good 1

P₂ = Price of good 2

X₁ = Quantity of good 1

X₂ = Quantity of good 2

M = total budget or total expenditure

The bundles satisfying the criterion set to form a part of the budget set and the consumer can choose out of any of these bundles which one to consume.

Provided a fixed income, the consumer budget leaves customers with the only choice of deciding the quantity of their purchase. Given they can purchase only two commodities, two aspects influence a customer’s inclination towards the number of units to purchase from both commodities: his/her money income and price of each item.

The total cost incurred in purchasing a commodity is known by multiplying the price (P_n) of each unit with their quantity of purchase (Q_n). For two commodities, the total expenditure can be calculated by adding the aforementioned products for both goods. This sum must be less than or equal to the consumer’s money income (M). This is referred to as the budget restraint that a consumer faces and is represented as:

P₁.X₁ + P₂.X₂ <= M – equation (i)

[Where, 

P₁ represents the price of product 1

X₁ stands for the quantity of product 1

P₂ represents the price of product 2

X₂ stands for the quantity of product 2

M is the total monetary earning of a consumer]

These combinations of bundles that a consumer can afford to purchase according to his/her income and item prices, collectively constitute the budget set.

What is the Budget Line in Economics?

Now if we slightly modify the equation mentioned earlier to make total expenses equivalent to total income, and plot the same on a graph, it will present us with a budget line.

The budget line is a graphical representation of all such combinations of two commodities that a customer can afford according to his/her earnings and given market prices in such a manner that the total expenditure on these combinations is exactly equal to the money income of the consumer.

• Budget Line Equation

Following is a representation of a budget line in the equation.

P₁.X₁ + P₂.X₂ = M

Where the letters represent the same values as that in equation (i).

• Graph of Budget Line

Refer to the image provided below for a graphical representation of a budget line.

(Image will be uploaded soon)

Here, the quantity of product 1 (X) has been represented on the x-axis, while the quantity of product 2 (Y) has been represented on the y-axis.

The horizontal intercept of the graph represents the ratio of consumer’s income to cost of product 1 at Y = 0, that is the customer does not buy product 2. It can be calculated as:

x-intercept = M / P₁

Vertical intercept of the graph represents the ratio of consumer’s income to cost of product 2 at X = 0, that is the customer does not buy product 1. It can be calculated as:

y-intercept = M / P₂

Point K inside the budget line stands for a feasible bundle which is a part of a given budget set and forms expenses less than total money earnings of the consumer. Point H, on the other hand, represents a bundle that is not included in the provided budget set and is, therefore, more expensive than total income.

Example of Budget Line

Look at a practical example in order to understand the function of the budget set and budget line better.

Shalini wants to buy T-shirts and go to the movies. Movie tickets cost Rs. 7 per piece and each T-shirt comes at Rs. 14. She can spend a total of Rs. 56 on them. She has to plan her expenditure in a way that she can avail maximum benefit from a limited income.

Following is a table planning out all possible combinations of bundles within given income.

Refer to the graph provided below to understand how a budget line can be plotted with the prepared table of budget sets.

(Image will be uploaded soon)

Here, the horizontal axis represents the quantity of T-shirts and the vertical axis represents the quantity of movie tickets. This budget line denotes the affordability margin of a consumer and all points inside and on this line represent budget sets of two items less than and equal to total money income respectively.

When all the bundles which mean the combinations of good 1 and good 2 cost the consumer exactly his income, this line is known as the budget line, sometimes, price line.

P₁X₁ + P₂X₂ = M

where P₁ = Price of good 1

P₂ = Price of good 2

X₁ = Quantity of good 1

X₂ = Quantity of good 2

M = total budget or total expenditure

John has Rs. 50 to buy chocolate. He only has a few options to allocate his income so that he can receive maximum utility from the limited salary. 

The idea of a budget is extremely crucial while managing expenses, be it in a large economy or a simple household. It gives a clear picture of what to buy and how much to buy within a given income.

In this section, you will study about consumer budget, what is budget set, and budget line in Economics. Read on to find detailed explanations on these topics with examples.

Properties of the Budget Line

Some salient features of a budget line have been listed below.

• Straight Line: Budget line comes with a straight line which implies the sustained rate of market exchange for each set of bundles.

• Real Income Line: This line is representative of the total income and expenditure power of a consumer.

• Negative or Downward Slope: Graphs of budget lines have a downward slope which points to an inverse proportionality between purchases of two given commodities.

• Tangent to Indifference Curve: Budget line acts as a tangent to the indifference curve at a point which can be referred to as consumer’s equilibrium.

Requirements of a Budget Line

The theory of the budget line is mostly based on assumptions, like a majority of economic theories, in order to bring out simpler and clearer analytic results. Some of them are mentioned below:

• Revenue of a consumer is spent on the purchase of two commodities only.

• Total money earning of a consumer is limited and known.

• The consumer knows the market prices of both products.

• The entire income of a consumer is equal to his/her total expenditure.

Consumer budget and Budget Line is a crucial topic in CBSE Class 12 Commerce and comes with multiple complex concepts from which students may need to attempt questions in their board exams. Stay ahead of the crowd with a Budget Line in Economics PDF available on Vedantu’s website. For more information on such topics, download our app today.