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Consumer Choice: Budget Lines

Author: Sophia
PDF Version

what's covered
In this lesson, you will learn how consumer income and product prices are represented by budget lines, which show the maximum consumption possible of two goods that a consumer can afford, given the prices of the goods, when all income is spent. Specifically, this lesson will cover:

Table of Contents

1. Consumer Income: Budget Line

Now let’s explore the role of consumer income as a constraint on consumer choices in a two-good economy model. As consumers, we face the trade-off of what quantities (how much) of goods and services to consume because our income is limited.

Our income sets a boundary on what we can afford. A budget line illustrates the range of available choices given our income. A budget line shows the maximum consumption possible of two goods that a consumer can afford, given the prices of the goods, when all income is spent. A budget line is a useful tool for thinking carefully about how scarcity, opportunity cost, and efficiency apply to a particular situation. Points above the budget line are not attainable with the current budget. Points below the budget line are inefficient and can be improved by moving to the budget line. The maximum efficiency is achieved on the budget line.

Consider this scenario. Suppose Kate sets aside $100 a month to have lunch at her two favorite places:

  • The local Mexican restaurant
  • The local Italian restaurant
Suppose further that all meals on the luncheon special menu are priced at $10 at both restaurants.

A budget line will identify all possible combinations of meals Kate can afford if she spends all $100 on going out to lunch. We can plot these combinations of meals on a graph to create a visual representation of the budget line.

The budget line graph below represents the effect of Kate's budget constraint. It shows the maximum consumption possible of two meals that Kate can afford, given the prices of the two meals, when all her income is spent.

A graph with the x-axis labeled ‘Italian Meals’ and the y-axis labeled ‘Mexican Meals’, both ranging from 0 to 10 at intervals of 2. A downward-sloping line starts from the point (0, 10), labeled ‘A’, to the point (10, 0), labeled ‘D’. The line is labeled ‘Budget Line’. A horizontal dashed line extends from y equals 6, and a vertical dashed line extends upward from x equals 4, meeting at the point (4, 6). Another horizontal dashed line extends from y equals 2, and a vertical dashed line extends from x equals 8, meeting at the point (8, 2). Both points lie on the ‘Budget Line’; (4, 6) is labeled ‘B’ while (8, 2) is labeled ‘C’.
Budget Line

Notice where the line touches each axis at Points A on the vertical axis and Point D on the horizontal axis; these are the endpoints of the budget line. The endpoints identify the maximum number of each meal Kate can afford of either good when she has fully spent her budget.

  • 10 Mexican meals (10 x $10 = $100)
  • 10 Italian meals (10 x $10 = $100)
Kate can also afford any combination of meals along the line (points B and C). We will assume that Kate does not buy fractions (¼ or ½) of any $10 meal. The area under the budget line shows combinations of the two meals that are affordable, but those choices don’t maximize her satisfaction because she will still have unspent income.

Choices beyond the budget line are not affordable given Kate’s $100 budget. Kate cannot afford 12 Mexican and 12 Italian meals per month. Kate’s choices might be different if her income changes or if the price of either or both meals change. But given her current constraints, product prices, and income, the budget line represents the maximum combinations she can afford.

key concept
Any point along the budget line represents a combination that uses all the budgeted income.

term to know
Budget Line
A line that shows the maximum consumption possible of two goods that a consumer can afford, given the prices of the goods, when all income is spent.

summary
In Consumer Income: Budget Line, you learned that budget lines are used to account for the price of products and consumer income. The budget line represents the highest attainable consumption level. Any combination of goods above the line is unattainable with current resources, while any combination of goods below the line is not an efficient choice given current resources.

Source: THIS TUTORIAL WAS AUTHORED BY SOPHIA LEARNING. PLEASE SEE OUR TERMS OF USE.

Terms to Know
Budget Line

A line that shows the maximum consumption possible of two goods that a consumer can afford, given the prices of the goods, when all income is spent.

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