The budget line is the boundary between what a household can and
cannot afford, given its income and the prices of goods.
The point at which the budget line intersects the y-axis is the household’s
real income in terms of the good measured on that axis.
The magnitude of the slope of the budget line is the relative price of the
good measured on the x-axis in terms of the good measured on the y-axis.
A change in the price of one good changes the slope of the budget line. A
change in income shifts the budget line but does not change its slope.
Preferences and Indifference Curves:
A consumer’s preferences can be represented by indifference curves. The
consumer is indifferent among all the combinations of goods that lie on an
A consumer prefers any point above an indifference curve to any point on
it and prefers any point on an indifference curve to any point below it.
The magnitude of the slope of an indifference curve is called the marginal
rate of substitution.
The marginal rate of substitution diminishes as consumption of the good
measured on the y-axis decreases and consumption of the good
measured on the x-axis increases.