THE BUDGET CONSTRAINT

The budget set consists of all bundles of goods that the consumer can afford at given prices and
income. We will typically assume that there are only two goods.

The budget line is written as p1x1+p2x2 = m. It has a slope of −p1/p2, a vertical intercept of
m/p2, and a horizontal intercept of m/p1.

 p1x1= the amount of money spent on good one.

 p2x2= the amount of money spent of good two.
 m = money income of the consumer.
The budget constraint requires that the amount on money spent on x1 x2 should not exeed m.

The slope of budget line shows market rate of substitution.

The vertical intercept shows that; if all money is spent on good 2 the consumer can buy m/p2 of
good 2. The horizontal intercept shows that if all money is spent on good one then m/p1 of good
one can be purchased.

Change in the budget line.

Budget line change; due to changes in income and prices

Increasing income shifts the budget line outward. Both the intercepts m/p2 and m/p1will change
how ever the slope of budget line does not change.

Due to change in prices slope as well as intercept will change. Increasing the price of good 1
makes the budget line steeper. Increasing the price of good 2 makes the budget line flatter.

When the price of good one and good 2 will change at the same time; both the intercepts will
change. The change in slope depends; if both prices will change in same proportion then the
slope doesn’t change. suppose For example that we double the prices of both goods. In this case
both the horizontal intercepts will shifts inwords by one half. And therefore the budget line shifts
inward by half. Multiplying both prices by 2 is just like dividing income by 2.

It follows that if we multiply both prices and income by 2 then, the budget line does not change
at all.

If the price of good 2 change (increase) proportionally more than good 1 then the budget line
will be flatter.

Implications
If all prices and income increases at the same rate then it doesn’t change the optimal choice of
the consumer, as this doesn’t change the budget line.

If income of the consumer increases, then the consumer must be at least as well of as at the lower
income.