Cambridge International as and a level Economics Ebook

Budget line: 
the combinations of
 
two products obtainable 
with given income and prices.
KEY TERM
146
Cambridge International A Level Economics

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Suppose someone has $200 to spend on two products, 
A and B. Assume the price of A is $20 and the price of B is 
$10. 
Table 7.2
shows the possible combinations that can be 
purchased. Each of the combinations would cost $200 in 
total. 
Figure 7.1a
 shows the budget line for this situation. 
Any point along this line will produce an outcome where 
consumption is maximised for this level of income.
If there is a change in the price of one good, with income 
remaining unchanged, then the budget line will pivot. For 
example, if the price of product B falls, then more of this 
product can be purchased at all levels of income. Th
e budget 
line will shift outwards, from its pivot at point A. Th
is is 
shown in 
Figure 7.1b.
So, if the price of B falls by a third, then 
30 of good B can now be purchased with an income of $200.
As the price of B has fallen relative to that of A, which 
is unchanged, consumers will substitute B for A. Th
is is 
known as the 
substitution eff ect
of a price change. It is 
always the case that the rational consumer will substitute 
towards the product which has become relatively cheaper. 
With the fall in the price of B, the consumer actually has 
more money to spend on other products, B included. Real 
income has therefore increased, which may mean that a 
consumer may now actually purchase more of product B. 
Th
is is called the 
income eff ect
of a price change.
Substitution eff ect: 
where following a price change, a 
consumer will substitute the cheaper product for the one 
that is now relatively more expensive.