Consumer Budget

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What is Consumer Budget?

The real purchasing power of a consumer with which he can buy a combination of two goods is known as the consumer budget. To prepare or learn about the consumer budget, the prices of the two commodities must be available. The consumer budget shows the various combination of commodities a consumer can purchase with his limited income.

Every consumer usually has a fixed limit of purchasing power with which he can buy two commodities. The prices are taken to be fixed in the market. In other words, the price of the commodities does not fluctuate in the market. Therefore, the consumer will choose the best combination of the two goods that provides him the utmost satisfaction. For a given budget and fixed prices of commodities, the consumer can manage to buy the combination of goods that provides more utility than the price paid by the consumer.

The two most prominent factors of a consumer budget are −

  • Budget Set
  • Budget Line.

Budget Set

The budget set shows the probable sets or combinations of two commodities the consumer can purchase for the given income of the consumer and the prices of the commodities.

The budget set equation can be written as −

P1X1 + P2X2 ≤ Y

Here,

P1 refers to the price of commodity: 1

P2 refers to the price of commodity: 2

X1 refers to the quantity of commodity: 1

X2 refers to the quantity of commodity: 2

Y refers to total expenditure or total budget.

It must be noted that the budget sets also represent the constraints up to which a consumer can buy two commodities in maximum quantities. That is why a budget set is also known as a budget constraint.

Example of Budget Set

Let’s assume that a person has Rs 400 in his hand and he has to buy pulses and rice. The price of pulses is Rs 100 per unit while the price of rice is Rs 50 per unit. With the given income and prices of commodities, the various combinations of rice and pulses the consumer can buy are

Income Pulses (Rs 100/unit) Rice (Rs 25/unit)
400 0 16
400 1 12
400 2 8
400 3 4
400 4 0

The table shows that if the consumer wants to buy only rice he can get a maximum of 16 units with his income of Rs 400. On the other hand, if he wants to get only pulses he can get a maximum of 4 units with his total income of Rs 400. The other combinations or sets of budget are 1 unit of pulse and 12 units of rice, 2 units of pulse and 8 units of rice, and 3 units of pulse and 4 units of rice.

Budget Line

Budget line is a line on the graph that shows various possible combinations of good 1 and good 2 which a consumer can buy with his budget and given the market prices of commodities.

The key components of the budget line are −

  • Consumer Purchasing Power
  • Price or market value of goods

The budget line equation can be written as −

P1X1+P2X2 = Y

Here,

P1 refers to the price of Good:1

X1 is the quantity of Good: 1

X2 is the quantity of Good: 2

P2 is the price of Good: 2

Y is total expenditure or total budget.

Graphical Representation

Images Coming soon

Image 1: Budget Line

In the given graph, X-axis represents Pulse while Y-axis represents rice. The budget line or price line represents various combinations of Pulses and Rice. Beyond the line, the consumer cannot buy any quantity of the given two commodities. While drawing the graph, it is assumed that the consumer spends the entire amount of his income on purchasing the two commodities. Therefore, the budget line represents the limit line of the consumer.

Properties of Budget Line

Following are the main properties of a budget line −

  • The budget line is a straight line

As the budget line represents a linear equation, the line is straight. The intercepts of the budget line represent the maximum quantity of commodities one can buy with limited income.

  • The budget line has a negative downward slope

The slope of the budget line is from left to right. The slope of this line is usually expressed as Px/Py. As the consumption of one commodity limits the consumption of the other, it is a straight line with a negative slope.

  • Parallel Budget Lines

If the commodities have the same proportion of price, the slope of the budget line will also be the same. So, for an equal price ratio of prices, parallel budget lines can be obtained.

  • Non-attainable points

Any point beyond the budget line is unattainable for the given income and prices of commodities. Therefore, for a given income and fixed prices of two commodities, there is no attainable point for the given budget sets.

  • Forward shift

If the prices of the commodities remain constant, an increase in income would shift the budget line forward. In other words, the price line is moved toward the left when the income increases but prices stay intact.

  • Backward shift

When the prices of commodities decrease but income remains constant, the price line gets a backward shift.

  • Fall in the price of one commodity

If the price of only one commodity falls, the price line shift to the right. The straight line that represents the commodity the price of which has fallen shifts toward the right.

  • Rise in price of one commodity

The price line shift to the left when the price of one commodity rises. In this case, the straight line representing the commodity shifts toward the left.

Conclusion

Consumer budget is an invaluable tool for individuals as well as economists. On one hand, it helps consumers to prepare for the expenses while on the other hand, it helps economists find a common ground to describe the effects of price rises and income changes.

The consumer budget is also important because it helps individuals estimate their real purchasing power. When used conscientiously, it can help minimize the waste of money and resources. By comparing expenses made on two commodities, a real and palpable understanding of the needs of the consumers can be made. By understanding this need, consumers can stay ready for expected expenses.

By utilizing budget sets and budget lines, consumers can get a handy idea of the probable combination of two goods they can buy with a limited budget. This helps them to maximize the satisfaction and utility derived from the consumption of two items. It also lets the consumers decide on an optimal budget expenditure based on their incomes.

In simple words, a consumer budget is a valuable tool that helps both individuals and economists because it offers a real comparison of two commodities both of which are necessary.

FAQs

Q1. What are the main components of a consumer budget?

Ans. The two main components of a consumer budget are budget set and budget line.

Q2. What is the condition regarding the income that is assumed while talking about a consumer budget?

Ans. In the case of a consumer budget, the income of the consumer is taken to be constant, and the entire amount of income is considered to be spent only on two commodities.

Q3. Are budget sets and budget lines interlinked?

Yes. The budget line represents the budget set when the equation equals the total expenditure. In the case of a budget set, the equation can equal or be less than the total income.

raja
Updated on 13-Oct-2022 11:19:47

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