How does the budget line change if the consumer’s income increases to Rs 40 but the prices remain unchanged?
When the consumer's income increases from Rs 20 to Rs 40 while prices remain unchanged, there is a parallel outward shift of the budget line.
Since the prices of both goods remain the same, the slope of the budget line does not change. However, both the vertical and horizontal intercepts increase. The consumer can now buy more of both goods at the prevailing market prices.
For instance, if the consumer spends her entire income on good 1 (priced at Rs 4), she can now buy 10 units instead of 5 units earlier. Similarly, for good 2 (priced at Rs 5), she can buy 8 units instead of 4 units. Thus, the budget set expands, giving the consumer more consumption bundles to choose from.
Explanation
The textbook context clearly states that when income increases (M' > M), both vertical and horizontal intercepts increase, resulting in a parallel outward shift of the budget line. The prices remain unchanged, so the slope remains the same. The consumer can buy more of both goods at prevailing prices. This is a standard result in consumer theory where an increase in income expands the budget set without changing the relative prices.
Solution Steps
Step 1: Identify that income increases from Rs 20 to Rs 40 (M' > M) while prices remain unchanged.
Step 2: Apply the concept that when income increases, both intercepts increase causing a parallel outward shift.
Step 3: Calculate new intercepts - Horizontal: Rs 40/Rs 4 = 10 units; Vertical: Rs 40/Rs 5 = 8 units.
Step 4: Conclude that the budget line shifts parallel outward, expanding the budget set.