Understand the Economic Concept of a Budget Line

Understand the Economic Concept of a Budget Line The term budget line has several related meanings, including a couple that are self-evident and a third that is not. The Budget Line as an Informal Consumer Understanding   The budget line is an elementary concept that most consumers understand intuitively without a need for graphs and equations its the household budget, for example. Taken informally, the budget line describes the boundary of affordability for a given budget and specific goods. Given a limited amount of money, a consumer can only spend that same amount buying goods. If the consumer has X amount of money and wants to buy two goods A and B, she can only purchase goods totaling X. If the consumer needs an amount of A costing 0.75 X, she can then spend only .25 X, the amount remaining, on her purchase of B.   This seems almost too obvious to bother writing or reading about. As it turns out, however, this same concept one that most consumers make many times each day with reflecting on it is the basis of the more formal budget line concept in economics, which is explained below.   Lines in a Budget Before turning to the economics definition of budget line, consider another concept: the line-item budget. This is effectively a map of future expenditures, with all the constituent expenditures individually noted and quantified. Theres nothing very complicated about this; in this usage, a budget line is one of the lines in the budget, with the service or good to be purchased named and the cost quantified. The Budget Line as an Economics Concept   One of the interesting ways the study of economics relates to human behavior generally is that a lot of economic theory is the formalization of the kind of simple concept outlined above a consumers informal understanding of the amount she has to spend and what that amount will buy. In the process of formalization, the concept can be expressed as a mathematical equation that can be applied generally. A Simple Budget Line Graph To understand this, think of a graph where the vertical lines quantify how many movie tickets you can buy and where the horizontal lines do the same for crime novels. You like going to the movies and reading crime novels and you have $150 to spend. In the example below, assume that each movie costs $10 and each crime novel costs $15. The more formal economics term for these two items is budget set. If movies cost $10 each, then the maximum number of movies you can see with the money available is 15. To note this you make a dot at the number 15 (for total movie tickets) at the extreme left-hand side of the chart. This same dot appears at the extreme left above 0 on the horizontal axis because you have no money left for books the number of books available in this example is 0. You can also graph the other extreme all crime novels and no movies. Since crime novels in the example cost $15 and you have $150 available, if you spend all the available money crime novels, you can buy 10. So you put a dot on the horizontal axis at the number 10. Youll place the dot at the bottom of the vertical axis because in this instance you have $0 available for movie tickets. If you now draw a line from the highest, leftmost dot to the lowest, rightmost dot youll have created a budget line. Any combination of movies and crime novels that falls below the budget line is affordable. Any combination above it is not.