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Economic Theory

b) the consumer has a fixed amount of money to spend on the two
goods. It is assumed that he will spend the amount on both the goods and
not save any part of it;
c) the prices of these goods are given in the market and are assumed to

be constant.
d) the consumer is assumed to act rationally and maximize his

satisfaction.

5. Budget Line
A consumer’s indifference map for good X and good Y represents

four scales of preferences of a consumer for the two goods. Indifference
curves to the right represent higher satisfaction. The consumer would like
to choose a combination of good X and good Y, which will be on the

highest indifference curve. But his choice will depend upon his income
and the price of the two goods. To understand the extent of purchase of the
goods with the given prices and income of the consumer, budget line is
important.

The budget line can be written algebraically as follows:

PxX + PyY = M, (6.3)

where Px and Py denote prices of goods X and Y respectively and M stands
for money income. The above budget-line equation implies that, given the
money income of the consumer and prices of the two goods, every

combination lying on the budget line will cost the same amount of money
and can therefore be purchased with the given income. The budget line can

be defined as a set of combinations of two commodities that can be
purchased if whole of a given income is spent on them
Suppose that the consumer has Rs.20 to spend on tea and biscuits,
which cost 50 paise and 40 paise respectively. The consumer has three

alternative possibilities before him:
a) he may decide to buy tea only, in which case he can buy 40 cups of
tea;

b) he may decide to buy biscuits only, in which case he can buy 50
biscuits;
c) he may decide to buy some quantity of both the goods, say 20 cups
of tea (Rs.10) and 25 biscuits (Rs.10) or 12 cups of tea (Rs.6) and 35

biscuits (Rs.14), and so on. (Total amount = Rs.20).

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