Price Earnings Line Or Budget Line
To study customer maximisation manners or customer's equilibrium the acquaintance of price
earnings line or budget line in essential. An indifference map points out choices of the
customers only. But his actual assortment of the two commodities is based on his earnings and
their prices. According to Prof. Salvatore, "The budget line presents all the diverse permutations
of the two commodities that a customer can purchase, give his or her earnings and the price of the
two commodities.
Change in Price-Earnings Line, Change in Price and Change in Earnings
It is clear as to how many units of the two commodities A and B the customer can purchase
depends upon his budget and the price of both the commodities. Now let us see how a customer's
budget line will be affected by vary in price and earnings.
If the customer's earnings does not vary but the prices of commodities A and B vary, the inclination
of his budget line will vary. The prices of A and B staying invariable, if the customer's earnings or
budget increase or decrease his earnings or budget line will also vary. If earnings enhances the budget
line will budge outwards. Either things can occur, there might be a parallel inward or outward shift of
the budget line.
Customer's Equilibrium
A customer is in equilibrium when specified his likings and prices of two commodities, he spends a
given money earnings on the purchase of the two commodities in such a way as to get the maximum
contentment. According to Koulsayaiannis, "The customer is in equilibrium when he maximises his utility
given his earnings and the market prices."
Its Postulations
The indifference curve study of customer's equilibrium is based on the following postulations.
- The customer's indifference map for the two commodities A and B is based on his degree of choices for them which does not vary at all.
- His money earnings is given as constant. It is $10 which he expends on the two commodities in question.
- Prices of two commodities A and B are also constant. A is priced at $2 per unit and B at $1 per unit.
- The commodities A and B are homogeneous and separable.
- There is no varying in the likings and manners of the customer all through the study.
- There is a perfect rivalry in the market from where he makes the purchase of the two commodities.
- The customer is realistic and thus maximises his contentment from the purchase of the two commodities.
Its Conditions
1. The budget line ought to be Tangent to the indifference curve. Based on the postulations
the customer can buy 5 units of A by spending the entire amount $10 on commodity A or on 10
units of B. The tablet illustrates some of the possible permutations on which $10 can be allocated.
These gives us probable permutations specified by parameters X,Y,Z,M,N,O and P. The line PX shows the permutations of commodities A and B, given their prices, when he expends his earnings on them. Thus PX is the budget line. This budget equation is the equation of the line connecting the points X and P where X = I/Pa and P = I/Pb. The customer would choice permutations O and Y on a lower indifference curve I, because permutations Z and N is also available to him on a higher indifference curve I2. But here is another permutation M, which is on the highest indifference curve I3 on this budget line XP. Since all other permutations lie on lower indifference curves, they represent lower levels of contentment than permutations M which is the customer's equilibrium point. We may thus catalogue the conditions M which is the customer's equilibrium point. The customer is in equilibrium when his budget line is tangent to an indifference curve. XP is the tangent curve I3 at M. Let us construct how the curve looks with the above parameters.
Permutation |
Commodity A in units |
Commodity B in units |
X |
5 |
0 |
Y |
4 |
2 |
Z |
3 |
4 |
M |
2.5 |
5 |
N |
1.5 |
7 |
O |
1 |
8 |
P |
0 |
10 |
These gives us probable permutations specified by parameters X,Y,Z,M,N,O and P. The line PX shows the permutations of commodities A and B, given their prices, when he expends his earnings on them. Thus PX is the budget line. This budget equation is the equation of the line connecting the points X and P where X = I/Pa and P = I/Pb. The customer would choice permutations O and Y on a lower indifference curve I, because permutations Z and N is also available to him on a higher indifference curve I2. But here is another permutation M, which is on the highest indifference curve I3 on this budget line XP. Since all other permutations lie on lower indifference curves, they represent lower levels of contentment than permutations M which is the customer's equilibrium point. We may thus catalogue the conditions M which is the customer's equilibrium point. The customer is in equilibrium when his budget line is tangent to an indifference curve. XP is the tangent curve I3 at M. Let us construct how the curve looks with the above parameters.
Earnings Effect
In the above study, of the customer's equilibrium it was alleged that the earnings of the customer
stays invariable, given the prices of the commodities A and B. Given the likings and choices of the
customer and the prices of the two commodities, if the earnings of the customer varies, the effect
it will have on his purchase is known as the earnings effect. If the earnings of the customer
enhances his budget line will budge upward to the right, parallel to the original budget line.
On the contrary, a fall in his earnings will budge the budget line inward to the left. The budget
lines are parallel to each other because relative prices stay unvaried.
The Substitution Effect
The substitution effect relates to the diverge in quantity demanded resulting from a diverge in
the price of good due to the substitution of relatively cheaper good for a dearer one, while
keeping the price of the other good and real earnings and likings of the customer as invariable.
The Price Effect
Slutsky explained the substitution effect by taking the apparent real earnings of the customers
constant. With the drop in the price of good A when the real earnings of the customer improves,
it is in synch in such a way that the customer could purchase the same package of the two
commodities as prior to the price diverge if he liked, so that his real earnings stays invariable.
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Other topics under Consumption Theory:
- Cross Elasticity of Demand, Income Elasticity of Demand
- Demand and Law of Demand
- Elasticity of Demand
- Exceptions to the Law of Demand
- The Concept of Customer's Surplus
- The Indifference Curve Theory - PART I
- The Indifference Curve Theory - PART II
- Revealed Preference Theory of Demand
- Superiority of Hicks' gauge of CS over Marshall's
- Superiority of Revealed Preference Theory
- Uses or Application of Indifference Curve Study