Q6 How does the slope of a budget l... [FREE SOLUTION]

Chapter 1: Q6 (page 17)

How does the slope of a budget line illustrate opportunity costs and trade-offs? How does a budget line illustrate scarcity and the effect of limited incomes?

Short Answer

Expert verified

The consumer has to sacrifice in order to consume one more unit of some other goods. The trade of one good to attain one more of another good is explained by the slope of the budget line. It is calculated by measuring the price ratio of one good to the other.

Any consumer cannot satisfy all the wants because of the scarcity of the required resources to attain them. A budget line shows the maximum set of goods a consumer can buy with the limited income corresponding to the prices of those goods.

Step by step solution

Graphical illustration of the budget line

Suppose the income of a person is $120. He wants to spend his income on buying books and burgers. The price of a single unit of a burger is $10, and that of a book is $20. The following diagram illustrates the maximum number of both the goods that the consumer can buy.

The quantity of burgers is shown on the x-axis, and the quantity of books is shown on the y-axis.

The slope of the budget line and illustration of the trade-off between the opportunity costs of the two goods

Opportunity cost is the lost value of the next best alternative. The price ratio of burgers to quantity will provide the value of the slope. The value of the slope (division of the price of books to the price of burgers) is 2.

It is seen from the graph that the consumer has to forgo two units of burgers to attain one additional unit of the book. It shows that the consumer has to trade off two units of burgers to obtain one additional unit of the book. Thus, the opportunity cost of one additional book is two units of burgers.

Scarcity and effect of limited income

The wants of a consumer are unlimited, but one can only satisfy his/her want for a particular set of goods because of the limited resources he/she possesses. Due to the fixed income and prices associated with each good, a consumer cannot buy an unlimited quantity of desirable goods and services.

In the provided example, the consumer can either buy a maximum of 12 burgers or a maximum of 6 books within the limited income of $120. A consumer can buy any quantity of books and burgers inside the budget line. On the other hand, if he wishes to buy a combination of both goods outside the budget line, the limited nature of the fixed income and fixed prices of both the goods will not allow him to obtain it. Thus, the budget line illustrates the scarcity and effects of limited income.