Discuss in brief the factors that affect budget line.
Since the budget li is based on consumer income and prices of commodities, hence shifts in the budget line may occur due to change in income or change in price or both so there are two types of effects or shits in the budget line:
- Effect of change in income
- Effect of change in price
Effect of Change in Income
Effect of change in income is shown in the following graph
L1, M1 is the original budget line where Y intercept is M1/Py and X intercept is M1/Px slope of the budget line is –Px/Py.
Now if prices of x and y remain unchanged and income increases from M1 to M2 the budget line shifts upward from L1M1 to L2M2. It is parallel to the original budget line. Its slope is the same. Now the consumer can purchase more of both commodities.
But if income decreases from M1 to M0 and prices remain the same the budget line shifts downward from L1M1 to L0M0. It is also parallel to original line with the same slope. Now the consumer can purchase less of both commodities.
Effect of Change in Prices
Effect of change in prices can be observed in the following diagram
L1M1 is the original budget line with the given income M1 and prices of goods Px1 and Py. Its slope is “-Px1/Py”. If the consumer spends the whole on the purchase of x only he can buy OM1 units of X. Now let price of x fells from Px1 to Px2. Price of commodity Y and consumer income M1 remain unchanged. If the consumer spends the entire budget M1 on the purchase of X, now he can buy OM2 unit of X. Therefore, the budget line rotates from L1M1 to L1M2. Slope of this newline is –Px2/Py (It is flatter than the previous one). With the fall in Px now the consumer can purchase more of X and the some quantity of Y. Similarly with the rise in Px the budget line may rotates from L1M1 to L1MO.