A budget line shows the combinations of two goods that an individual can afford given their income and the prices of those goods. A shift in the budget line indicates a change in either income or the prices of the goods. This section will detail the various causes of such shifts.
1. Change in Income
A change in income has a direct impact on the consumer's purchasing power, leading to a shift in the budget line.
Increase in Income: If an individual's income increases, they can afford to purchase more of both goods. This results in the budget line shifting outwards along both the x and y axes, indicating a higher level of affordability for any combination of the two goods.
Decrease in Income: Conversely, a decrease in income reduces the consumer's purchasing power. The budget line shifts inwards along both axes, indicating a lower level of affordability.
2. Change in the Price of a Good
A change in the price of either good will cause the budget line to pivot. The direction of the pivot depends on whether the price increases or decreases.
Increase in the Price of a Good: If the price of one good increases, the consumer can afford less of the other good for any given level of income. The budget line will pivot inwards along the axis corresponding to the good whose price increased.
Decrease in the Price of a Good: If the price of one good decreases, the consumer can afford more of the other good for any given level of income. The budget line will pivot outwards along the axis corresponding to the good whose price decreased.
3. Change in the Price Ratio of Two Goods
A change in the relative prices of two goods also leads to a pivot in the budget line.
Increase in the Price of One Good Relative to the Other: If the price of one good increases more than the other, the consumer can afford less of the good with the higher price for any given level of income. The budget line pivots inwards.
Decrease in the Price of One Good Relative to the Other: If the price of one good decreases more than the other, the consumer can afford more of the good with the lower price for any given level of income. The budget line pivots outwards.
Summary Table
Cause of Shift
Direction of Shift
Explanation
Change in Income
Outwards (Increase) / Inwards (Decrease)
More or less purchasing power for any combination of goods.
Increase in Price of a Good
Inwards
Less of the good with the higher price can be afforded.
Decrease in Price of a Good
Outwards
More of the good with the lower price can be afforded.
Understanding the causes of shifts in the budget line is fundamental to analyzing consumer behavior and the impact of economic changes on purchasing decisions.
Suggested diagram: A budget line showing the trade-off between two goods. A change in income would show a shift outwards. An increase in the price of one good would show a pivot inwards.