•A consumer with fixed income can only buy things that are within her income.
•Assume a consumer who has only a fixed amount of money (income) to spend on two goods.
•The consumption bundles that are available to the consumer depend on the prices of the two goods and the income of the consumer.
•The prices of the goods are given in the market.
•Price of a good is the amount of money that the consumer has to pay per unit of the good she wants to buy.
•Her planning of income and expenditure is called budget.
•Suppose the income of the consumer is M and the prices of bananas and mangoes are p1 and p2 respectively.
•If the consumer wants to buy x1 quantities of bananas and x2 quantities of mangoes, she will have to spend amount = p1x1 + p2x2
•The consumer can buy any bundle (x1, x2) such that
•p1x1 + p2x2 ≤ M
•The inequality is called the consumer’s budget constraint.
•The set of bundles available to the consumer is called the budget set.
•The budget set is thus the collection of all bundles that the consumer can buy with her income at the prevailing market prices.
Example of Budget Set
•Assume that a consumer has Rs 20, and suppose,
•Assume both the goods are priced at Rs 5 and are available only in integral units.
•The bundles that this amount of money and price that the consumer can afford to buy are:
•(0, 0), (0, 1), (0, 2), (0, 3), (0, 4), (1, 0), (1, 1), (1, 2), (1, 3), (2, 0), (2, 1), (2, 2), (3, 0), (3, 1) and (4, 0).
•The consumer’s budget set would consist of all bundles (x1, x2) such that
•x1 and x2 are any numbers greater than or equal to 0 and
•p1x1 + p2x2 ≤ M
•The budget set consists of all points on or below the straight line having the equation
•The line consists of all bundles which cost exactly equal to M. This line is called the budget line.
•The equation p1x1 + p2x2 = M is a straight line.
•This line has horizontal intercept (M/p1) and vertical intercept (M/p2)
•The slope of the budget line is (-p1/p2)