We have come to know that higher indifference curve yields more satisfaction than a lower one. So, a rational customer, in order to maximize his utility, will always want to achieve the highest indifference curve.
But the level of satisfaction he is capable of deriving depends on his affordability, which is determined by two factors – his income and prices of the goods he intends to purchase. A combined representation of these two determining factors can be made by a budget line.
Let us try to explore the concept of budget line with the help of a hypothetical example. For the sake of simplicity, assume that Mr. X consumes only two gods- cold drink and sandwiches. Suppose, price of a bottle of cold drink is Rs. 10, a piece of sandwich costs Rs. 15 and income of Mr. X is Rs. 150 per week.
ADVERTISEMENTS:
If he spends all his income in cold drink, he can purchase at most 15 bottles of cold drink (point B in figure 7.11). If he spends his entire income in sandwiches, he can buy 10 pieces of sandwiches (point A in figure 7.11).
If he desires, he can also distribute his income on both the goods and purchase different combinations of quantities of cold drink and sandwiches. Points C and D represent this possibility. A line joining points A, B, C and D is the budget line of Mr. X.
ADVERTISEMENTS:
Thus, a budget line of a consumer can be defined as a line that connects the points showing all the possible combinations of goods and services that can be purchased with his budget at the prevailing market prices.
In diagram 7.11, AB is the budget line of Mr. X. Point A represents a situation where Mr. X spends all his income to buy 10 pieces of sandwiches. Similarly, point B represents a situation where Mr. X spends all his income to buy 15 bottles of cold drink. All intermediate points (like C, D etc.) show different combinations of both the goods that he can buy, with his earning, at the prevailing market prices.