BUDGETARY CONSTRAINT AND THE

BUDGET LINE (PART III)

DR. Nagma Shadab
Assistant Professor
Department of Economics
Gautam Buddha Mahila College
Magadh University
Introduction
 The indifference curve, as a tool of analysis, is not
sufficient to determine the utility-maximizing basket of
the consumer. Given the indifference map, a utility
maximizing consumer would like to reach the highest
possible indifference curve on the indifference map.
However, the consumer is assumed to have a limited
income. It follows that unless the the consumer’s income
and the prices of the goods are known, the consumer’s
utility-maximizing consumption basket cannot be
determined. The reasons is that a consumer’s limited
income and the
Contd…
 Price of goods act as constraints on the utility-maximizing behavior
of the consumer. This is known as budgetary Constraint. The
budget constraint faced by a consumer is depicted as:
Px X Qx+Py X Qy <= 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 bundles.
Budget line:
A budget line is a straight line that slope downwards and consists of
all the possible combination 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 indifferent concept from
that of an indifference curve, though both of them are essential for
consumer equilibrium.
Contd…

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 line

The concept of the budget line is precisely explained
through the following equation:
Px X Qx+Py X Qy………(1)
Where, Px is the price of Goods X;
Qx is the quantity of Goods X;
Contd…

Py is the price of GoodsY;

Qy is the quantity of GoodsY;
M is the income of the Consumer.
Equation 1 is called the budget equation. The budget
equation indicates that a consumer, given a specific
income and the market prices of X and Y, can buy
only a limited quantity of the two goods (i.e., Qx
and Qy). From Eq 1 Qx and Qy can be worked out
as follows:
Qx = M/Px – Py/Px*Qy
Contd…

Qy = M/Py- Px/Py*Qx
Equation 2 and 3 show how Qx and Qy can be
estimated, given the numerical value of M, Px,Py and
Qx (or Qy). Given these equation, the values of Qx and
Qy can be calculated as shown below:
If Qy =0, then Qx= M/Px and
if Qx=0,thenQy=M/Py
Similarly Qx (or Qy) may be alternatively assigned any
positive numerical value and the corresponding values
of Qy( or Qx) may be obtained. In this way, a schedule
showing different combination can be prepared.
Contd……
This concept can be understood clearly by the
followingexample:
A person have Rs.100/ for buying pens. He/she
has the following options for allocating his/her
amount such that he/she derives the maximum
utility from limited income:
Contd….

Budget Schedule
Combination Gel Pens (@ 20/-Per Ball Pens (@ 10/- Budget Allocation
Pen) Qx Per Pen) Qy
A 0 10 20*0+10*10= 100

B 1 8 20*1+ 10*8= 100

C 2 6 20*2+10*6= 100

D 3 4 20*3+ 10*4= 100

E 4 2 20*4+10*2= 100

F 5 0 20*5 +10* 0=100

 Contd…
12

M/Py
10 A
B*
8
B Non-Feasibility Area
Quantity
Of Ball
6 C
Pen Quantity of Ball Pen

4 D Budget Line M=PxQx+PyQy

A*
Feasibility Area
2

0 F
0 1 2 3 4 5 M/Px 6

Quantity of Gel Pen

Contd…
The above budget schedule can be plotted on a graph to obtain
the appropriate budget line in this instance.

Suppose our consumer has got Income Rs.100 to spend on

two goods X and Y. let price of good X in the market be Rs.20
per unit and that Price of Y in the ,market be Rs.10 per unit. If
the consumer spend whole income of Rs .100 on good X, he
would buy 5 units of X (or 5 Gel pens); if he spends his whole
income of Rs.100 on good Y he would buy 10 units of Y (10
Bal pens). When value of X (Gel Pen) and Y (Ball Pen) are
plotted on the X- and Y axes respectively, it gives a line,
which called the budget line, as shown in fig 1.
Contd…
Note that the budget line has negative slope, it means that
the if more of X is purchased, then less of Y can be
purchased.

Note that budget line the divides commodity space into two
parts, which may be termed the feasibility and non-
feasibility areas. The area lying below the budget line is the
feasibility area (fig 1). Any combination of goods X(Gel
Pen) and Y (Bal Pen), which represented by a point in this
area (e.g; point A*) or on the boundary line(i.e., the budget
line) is a feasible combination given M, Px and Py. The
area above the budget line is the non-feasibility area
because any point falling in this area for example, point B,
is unattainable (given M, Px and Py).
Contd…
Slope of the budget line:- Another aspect of the budget line,
which is of great importance in determining consumer’s
equilibrium, is its slope.
Market Rate of Exchange (MRE):- The market rate of
exchange refers to the ratio of units sacrificed of goods Y(Ball
pen) to acquired specifics units of goods X (Gel Pen) at a
given market price. It indicates slope of a budget line.
We know that the slope of a curve is calculated as a change in
vertical or Y-axis divided by change in variable on the
horizontal or X-axis. In the above example slope of the
budget line will be number of units of Ball pen, that the
consumer is willing to sacrifices for an additional unit of Gel
pen.
Contd….

Slope of Budget Line = Units of Ball Pens(Y) willing to Sacrifice

Unit of Gel Pens (X) willing to Gain

Slope of the budget line = Δ Qy/ Δ Qx = OA/OF =M/Py/M/Px

= Px/Py =Price Of Gel Pen(X)/ Price Of Ball
Pen(Y)
= Price Ratio
Then we can say that
Market Rate Of Exchange(MRE) = Price Ratio
= Slope of the Budget line
Shifts in Budget line (Change in Income)

In the indifference curve theory, it is assumed that the

consumer purchases and consume only two goods
(here X and Y). If the price of goods X and Y, and the
money income of the consumer is given, then the
equation of the budget line of the consumer would be
M= PxQx +PyQy ….(1)
Qy= M/Py- Px/Py*Qx ….(2)
Then slope of budget line= - Px/Py
And x and y intercept of the line are M/Px and M/Py
respectively.
Contd…
Now suppose, initially the values of M, Px and Py are
such that the budget line of the consumer has been
A change in Income
A2 An increase in
income shifts the
A budget line outwards

An decrease in
income shifts the
budget line inward

F F2
Fig-2
Contd…

Obtained to be a line like AF in fig 2 . If now the money

income (M) of the consumer rises, Px and Py remaining
unchanged, then, the slope (-Px/Py) of his/her budget line
remaining constant, the intercept of the line (M/Px and M/Py)
would increase.
As a result, the budget line would have a rightward parallel
shift from AF to a new position like A2F2.
Conversely, if the money income of the consumer decreases,
prices remaining constant, the budget line would shift parallel
to the left A1F1. This rightward or leftward parallel shift of the
budget line is known as “ shift” of the budget line.
Rotation of the budget line (Change in
Price)
On the other hand, if the money income of the consumer remaining
constant, the price of one goods changes, then

A decrease in the price of

good X(Gel Pen) changes the
slope of the budget line and
A intercept -X rotates it outward.

An increase in the price of

Quantity of Ball good X (Gel Pen) changes the
Pen slope of the line and
intercept-X rotates it inward

0 F1 F F2
Fig 3 Quantity of Gel pen
Contd…
It is known as the “ rotation of the budget line”. For
example suppose, initially, the consumer’s budget line is
AF in fig 3. now if the money income (M) of the
consumer and the Price of good X diminishes, then the
y- intercept of the budget line (M/Py) remains constant
at OA,but the X- intercept (M/Px) increases from OF to
OF2. As a result, now the budget line of the consumer
would be AF2. Here the budget line while changing its
position from AF to AF2 rotates anticlockwise about the
point F. This is known as the “rotation” of the budget line.
Similarly , if M and Px remaining constant, Py fall, then
also a rotation of the budget line remaining constant,
 Contd…
Py falls, then also a rotation of the budget line from
Q A decrease in the price of good
Y(Ball Pen) changes the slope of
A2 the budget line and intercept –
Y (M/Py) rotates it outward.

A
Quantity of Ball Pen
An increase in the price of
good Y (Bal Pen) changes the
A1 slope of the line and
intercept-Y(M/Py) rotates it
inward

0 F
Quantity of Gel Pen
Fig 4
Contd…
the initial AF position to a Position like A2F. Now the
X intercept of the budget line remaining constant,
the Y-intercept increase and the rotation of the
budget line would be clockwise about the point F.
References:
1).-Dwivedi, D.N (2012) . Microeconomices, Dorling
Kindersley (India) Pvt, Ltd
2). Koutsoyiannis. A (2004) , Modern
Microeconomices ,Macmillan press(London), Ltd
3). https://theinvestorsbook.com/budget-line.html
4).http://www.economicsdiscussion.net/consumer/shift-
and-rotation-of-the-budget-line-with-
diagram/22511
5).https://pressbooks.bccampus.ca/uvicecon103/cha
pter/6-1-consumption-choices/