Category: Budget

The iso-cost line is the counterpart of the budget line or the price line of consumer theory. It shows all the combinations of the two factors (say, labour and capital) that the firm can buy with a given outlay for a given set of prices of the two factors.It plays an important part to determine the combinations of factors, the firm will choose for production ultimately to minimise cost.Fig. 7.9 shows the way iso-cost line is drawn. We measure the units of factor ‘X’ on the ADVERTISEMENTS: X-axis and those of factor ‘Y’ on the Y-axis. Suppose, the firm has at its disposal Rs. 200 for the two factors. The price of the factor ‘X’ is Rs. 10 per unit and that of factor ‘Y’ is Rs. 5 per unit.…

The revealed preference theory is based on the following assumptions: 1. Rationality: The consumer is assumed to behave rationally in the sense that he prefers bundle of goods that contains more quantities of the commodities. This assumption of rationality underlies all logical explanations of consumer’s behaviour. 2. Consistency: The revealed preference theory sets upon this basic assumption, which has been called as consistency postulate. It can thus be stated, “no two observations of choice behaviour are made which provide conflicting evidence to the individual’s preference”. ADVERTISEMENTS: In other words, if an individual chooses combination (or bundle) ‘A’ in one situation (given by his budget constraint) in which bundle ‘B’ was also available to him, he will not choose combination ‘B’ in any other situation (given by his new budget constraint)…

The consumer purchases such a combination of commodities on the budget line from which there is no tendency for change or rearrangement. However, if the price of only one commodity (say, ‘X’) changes, with everything else including consumer’s income remaining unchanged, the consumer equilibrium will shift to a new budget line.The point of equilibrium corresponding to each price change will be given by the point at which the corresponding budget line touches the highest possible indifference curve. With every change in the price of commodity ‘X’, the budget line changes its slope, but its starting point on the Y-axis remains the same, as the price of commodity ‘Y’ is assumed to be constant.In other words, the purchasing power of the consumer in terms of commodity ‘Y’ remains unchanged, equal to…

(i) Since budget line is derived from a linear budget equation M = XPx + YPy, so it is a straight line. The intercepts of this line with the axes show the maximum amount of one commodity that can be purchased, if none of the other is bought.(ii) Budget line has a negative slope, i.e., slopes downward from left to right. The negative slope of the budget line is mathematically established by noticing coefficient of ‘X’, i.e., – PX/PY when the budget equation is rearranged as(iii) Mathematically, the slope of the budget line is derivative ?Y/?X or coefficient of ‘X’ in the above equation. Thus, the slope of the budget line is negative of the price ratio, i.e., – Px/ Py. If prices of commodity ‘X’ and commodity ‘Y’ are…