Budget Line Example 2
The CFO has some bad news for you. Sammy's wage has now been increased to $20 an hour, but your budget hasn't been increased any. What should you do now? First, you jot down the following information:
Budget: $40
Chris's Wage: $10/hr
Sammy's Wage: $20/hr
Now if you give the entire budget to Sammy you can only hire him for 2 hours, while you can still hire Chris for four hours using the entire budget if you wish. Thus you now mark down the points (4,0) and (0,2) and draw a line between them.
I've drawn a brown line between them, which you can see on Indifference Curve vs. Budget Line Graph 2.
Now the area beneath our budget curve has shrunk. Also notice the shape of the triangle has changed. It's much flatter, since the attributes for Chris (X-axis) hasn't changed any, while Sammy (Y-axis) has become much more expensive.
As we can see now the purple, light green, and yellow curves are all above the budget curves, thus they are all infeasible. Only the blue (90 skates) and purple (150 skates) have portions that are not above the budget line. Thus we choose the purple indifference curve as being optimal. Only points on the line between (0,2) and (2,1) are feasible, thus we must either hire Chris for 0 hours and Sammy for 2 hours, or Chris for 2 hours and Sammy for 1 hour, or some combination of those two things which is on the purple indifference curve.
Budget Line Example 3
Since Sammy has become relatively more expensive to hire, the CFO has decided to increase your budget from $40 to $50. How does this impact your decision? Using the following information:
Budget: $50
Chris's Wage: $10/hr
Sammy's Wage: $20/hr
We see that if you give the entire budget to Sammy you can only hire him for 2.5 hours, while you can hire Chris for five hours using the entire budget if you wish. Thus you now mark down the points (5,0) and (0,2.5) and draw a line between them.
I've drawn a brown line between them, which you can see on Indifference Curve vs. Budget Line Graph 3.
Note that the budget line has moved upward. It has also moved parallel to the last budget line, which happens whenever we increase our budget. A decrease in budget would be represented by a parallel shift downward in the budget line.
We see that the yellow (150) indifference curve is our highest feasible curve. We must select a point on that curve on the line between (1,2), where we hire Chris for 1 hour and Sammy for 2, and (3,1) where we hire Chris for 3 hours and Sammy for 1.
By now you should have a good feel for indifference curves and budget lines. If you have any questions on this or any other topic please contact me by using the use the feedback form.