The Consumer’s Budget
In this section, we elaborate on the consumer's decision-making regarding the expenditure on two goods with a fixed income. The central idea revolves around the concept of the budget constraint, which reflects all possible consumption bundles of goods a consumer can afford. The section introduces the budget line, which is the graphical representation of the budget constraint, showing combinations of goods that cost exactly the consumer's income. The slope of the budget line is significant because it reflects the rate at which one good must be sacrificed to purchase another—in other words, the price ratio.
Key Points:
- The budget set represents all combinations of goods that can be purchased within the consumer's income.
- The budget line is represented mathematically as: \( p_1x_1 + p_2x_2 = M \), where \(p_1\) and \(p_2\) are prices of goods 1 and 2, and \(M\) is income.
- An increase in income shifts the budget line outward (parallel shift), while an increase in the price of one good pivots the budget line, changing its slope.
- Knowledge of how income and prices interact within this framework helps economists and consumers forecast changes in consumption behavior.