Question

Answer the following question.
What can cause a change in the budget line? Explain.

Answer 1

There are two factors which can cause a change in the budget line:

a. If the money income of the consumer changes
When there is a rise in the money income, this implies that the consumer can purchase more of both the goods with the same prices. With such a change the budget line shifts parallely. outwards. 

On the other hand, if the money income decreases, this implies that the consumer will now be able to purchase less of both the goods with the same prices. With such a change the budget line shifts parallely inwards.  

b. If price of any of the goods (P₁, P₂) changes
Suppose, the price of good 1 increases from P₁ to P₁´ with money income and price of good 2 remaining constant. Since P₁ has increased, the consumer will now be able to purchase a lesser amount of good 1 with his given income. In other words, if the consumer spends his entire income on good 1 then, he will now be able to purchase a lesser amount of good 1. This implies that the horizontal intercept falls. Also, with the increase in the price of good 1, the price ratio i.e. the slope of the budget line increases.

On the other hand, when the price of good 2 increases, the budget line pivots inwards around the same horizontal intercept. The slope of the new budget line will fall and it will become flattered.