Key takeaways
- The budget line p₁x₁ + p₂x₂ = M separates affordable from unaffordable bundles; income shifts it, a price change pivots it.
- Indifference curves slope downward and are convex; higher curves mean greater satisfaction.
- At the consumer's optimum the budget line is tangent to an indifference curve, so MRS equals the price ratio.
- The demand curve usually slopes downward: the substitution and income effects work together for a normal good.
- Elasticity = %Δq ÷ %Δp; if demand is elastic, a price rise lowers total expenditure.
This page is part of the Introductory Microeconomics chapter list for Class 12 Economics. It builds on the ideas of scarcity and choice in Chapter 1.
2.1The Consumer's Budget
A consumer's budget set is every combination of goods she can afford at current prices with her income. Its boundary, the budget line, joins the combinations that use her whole income. A change in income shifts the line in parallel; a change in one price pivots it around the intercept of the other good.
Choosing what to buy depends on two things: what is available to the consumer and what she prefers. To keep diagrams simple, we assume there are only two goods. A bundle (x₁, x₂) is a particular amount of each. With income M and prices p₁ and p₂, a bundle costs p₁x₁ + p₂x₂, and the consumer can buy it only if this does not exceed M.
The budget set is the collection of all affordable bundles. If goods can be divided without limit, its upper edge is a straight line, the budget line. Written as x₂ = M÷p₂ − (p₁÷p₂)x₁, it has horizontal intercept M÷p₁ (everything spent on good 1), vertical intercept M÷p₂, and a slope of −p₁÷p₂. The slope is negative because buying more of one good means buying less of the other, and its size, the price ratio, is the rate at which the market lets her swap one good for the other.
A bundle below the line leaves money unspent. From such a point there is always a bundle on the line with more of at least one good and no less of the other, so a consumer who prefers more to less will aim for the line itself.
Changes in the budget set
| What changes | Intercepts | Slope | Effect on the line |
|---|---|---|---|
| Income rises | Both rise | Unchanged | Parallel shift outwards |
| Income falls | Both fall | Unchanged | Parallel shift inwards |
| Price of good 1 rises | Horizontal falls; vertical unchanged | Steeper | Pivots inwards around the vertical intercept |
| Price of good 1 falls | Horizontal rises; vertical unchanged | Flatter | Pivots outwards around the vertical intercept |
| Income and both prices double | Unchanged | Unchanged | Budget set does not change |
2.2Preferences of the Consumer
Among the affordable bundles, a consumer picks the one she prefers most. Preferences are assumed to be complete and ordered, and monotonic: more of a good is better. They can be shown by an indifference curve, which joins bundles she values equally, or by a utility function that gives preferred bundles higher numbers.
The consumer is assumed to compare any two bundles and either prefer one or be indifferent between them, and to rank all bundles on that basis. Two further assumptions describe typical tastes.
- Monotonic preferences: if a bundle has more of at least one good and no less of the other, it is preferred.
- Diminishing marginal rate of substitution: the more of good 1 she has, the less of good 2 she will give up for one extra unit of it. Preferences of this kind are called convex.
The marginal rate of substitution (MRS) is the amount of good 2 she will give up for one more unit of good 1 while staying equally well off. It measures her willingness to pay for good 1 in terms of good 2.
Indifference curve and indifference map
An indifference curve joins all bundles that give the consumer the same satisfaction. Because preferences are monotonic, it has three properties:
- It slopes downward: if she gets more of good 1 she must have less of good 2 to stay indifferent.
- Its slope at any point, in absolute value, is the MRS.
- Bundles above a curve are preferred to those on it; bundles below are worse. So curves further from the origin represent higher satisfaction, and a family of curves forms an indifference map.
With diminishing MRS the curve is bowed towards the origin. Preferences can also be summarised by a utility function, which gives preferred bundles higher numbers and equally preferred bundles the same number. The numbers have no meaning except for ranking, so many different functions can represent the same preferences.
2.3Optimal Choice of the Consumer
A rational consumer picks the most preferred bundle she can afford. This lies on the budget line, at the point where the line just touches the highest reachable indifference curve. At that point the marginal rate of substitution equals the price ratio: what she is willing to swap equals what the market lets her swap.
Her problem is to reach the highest indifference curve that her budget set allows. The optimum cannot be below the line (a better bundle is on it), and cannot be where the line cuts a curve, since part of the line then lies on a higher curve. So it is at a point of tangency.
To see why, suppose MRS = 2 while the two goods cost the same. She would give up 2 units of good 2 for one more unit of good 1, but the market asks only 1 unit of good 2. Buying one more unit of good 1 therefore leaves her with more of both goods, so she moves. A similar argument holds when MRS is below the price ratio. Figure 2.1 shows tangency at E₁ for a consumer with income ₹20 facing prices ₹4 and ₹5.
2.4Demand
The demand function gives the amount of a good a consumer chooses at each price, keeping income, other prices and tastes unchanged. Its graph, the demand curve, normally slopes downward: a lower price raises quantity demanded. Changes in price move the consumer along the curve, while changes in other influences shift the curve.
Demand curve and the law of demand
If everything except a good's own price is held constant, the quantity chosen depends on the price alone: q = d(p). Economists draw it with price on the vertical axis, though price is the independent variable. A fall in the price of good 1 does two things:
- Substitution effect: good 1 becomes cheaper relative to good 2, so the consumer substitutes towards it. If her income is adjusted so she could just afford her old bundle, she would never buy less of good 1.
- Income effect: the price fall raises her purchasing power. For a normal good this raises demand further.
For a normal good both effects work together, so demand rises as price falls. This inverse relation is the law of demand: if demand for a good moves in the same direction as income, it must move in the opposite direction to price. A straight-line demand curve can be written q = a − bp: each rupee rise in price cuts demand by b units. For a rare Giffen good, the income effect is both negative and stronger than the substitution effect, so demand can rise with price.
Normal and inferior goods
A normal good is one whose demand rises with income, such as clothes. An inferior good is one whose demand falls as income rises, such as coarse cereals for a household that can now afford better food. A good may be normal at low incomes and inferior at high incomes.
Substitutes and complements
Goods consumed together are complements, such as tea and sugar: when the price of one rises, demand for the other falls. Goods that can replace each other are substitutes, such as tea and coffee: when the price of one rises, demand for the other rises.
Shifts in the demand curve, and movements along it
| Change | Normal good | Effect on the curve |
|---|---|---|
| Income rises | Demand rises at every price | Shifts right (left for an inferior good) |
| Price of a substitute rises | Demand rises | Shifts right |
| Price of a complement rises | Demand falls | Shifts left |
| Tastes move in favour of the good | Demand rises | Shifts right |
| Tastes move against the good | Demand falls | Shifts left |
| The good's own price changes | Quantity changes along the same curve | Movement along the curve, not a shift |
Ice-cream demand shifts right in summer as tastes change; a health scare about cold drinks shifts their demand curve left.
2.5Market Demand
Market demand at a price is the sum of every consumer's demand at that price. Graphically, the market demand curve is the horizontal sum of the individual demand curves. Because it adds quantities at each price, it is flatter than any single consumer's curve and lies to its right.
Suppose two consumers have demands d₁(p) = 10 − p for p ≤ 10 and d₂(p) = 15 − p for p ≤ 15, each zero at higher prices. For p ≤ 10 both buy, and market demand is 25 − 2p. For 10 < p ≤ 15 only the second consumer buys, so it is 15 − p. Above 15 it is zero. Adding along the quantity axis, price by price, is called horizontal summation.
| Price (₹) | Consumer 1 | Consumer 2 | Market demand |
|---|---|---|---|
| 2 | 8 | 13 | 21 |
| 5 | 5 | 10 | 15 |
| 10 | 0 | 5 | 5 |
| 12 | 0 | 3 | 3 |
| 15 | 0 | 0 | 0 |
2.6Elasticity of Demand
Price elasticity of demand measures how strongly quantity demanded responds to a price change: the percentage change in quantity divided by the percentage change in price. Demand is elastic if the absolute value exceeds one, inelastic if below one, and unit elastic at one. It is a pure number, unaffected by the units used.
Since price and quantity move in opposite directions, eD is negative, but we work with its absolute value. If |eD| > 1, demand is elastic; if |eD| < 1, inelastic; if |eD| = 1, unit elastic. Measuring price in rupees or paise, or quantity in kilograms or grams, gives the same answer, because the units cancel in the ratio of percentages.
Elasticity along a linear demand curve
On a straight line q = a − bp, elasticity is |eD| = bp ÷ (a − bp), so it changes from point to point: 0 where price is zero, 1 at the midpoint, and infinitely large where quantity is zero. Geometrically, it equals the lower segment of the line divided by the upper segment at that point.
Two special curves have the same elasticity at every point: a vertical line (perfectly inelastic, |eD| = 0) and a rectangular hyperbola pq = constant (|eD| = 1 throughout, so expenditure never changes).
What decides elasticity
Demand tends to be inelastic for necessities, such as food in general, and elastic for luxuries. It is more elastic for a specific item with close substitutes: demand for one variety of pulses is more elastic than demand for pulses as a whole, because buyers can switch.
Elasticity and expenditure
Spending on a good is price times quantity. When price rises, quantity falls, so spending can rise or fall depending on which effect wins.
| Demand is | Quantity falls by | Total expenditure |
|---|---|---|
| Elastic (|e| > 1) | A larger percentage than the price rise | Falls |
| Unit elastic (|e| = 1) | The same percentage | Unchanged |
| Inelastic (|e| < 1) | A smaller percentage | Rises |
The opposite holds when price falls: spending rises if demand is elastic and falls if it is inelastic.
Worked Examples
Example 1: A budget line
- Given
- Income M = ₹20; price of good 1 = ₹4; price of good 2 = ₹5.
- Formula
- p₁x₁ + p₂x₂ = M; intercepts M÷p₁ and M÷p₂; slope = −p₁÷p₂
- Steps
- Equation: 4x₁ + 5x₂ = 20. Horizontal intercept = 20÷4 = 5. Vertical intercept = 20÷5 = 4. Slope = −4÷5 = −0.8. If the price of good 1 falls to ₹2, the horizontal intercept becomes 20÷2 = 10 and the vertical stays at 4. If income doubles to ₹40, both intercepts double (10 and 8) and the slope is unchanged.
- Answer
- 5 units of good 1 or 4 units of good 2 at most; slope −0.8. A price fall pivots the line outwards; an income rise shifts it out in parallel.
Example 2: Market demand
- Given
- d₁(p) = 10 − p for p ≤ 10; d₂(p) = 15 − p for p ≤ 15.
- Formula
- Market demand = d₁(p) + d₂(p) at each price
- Steps
- At p = 4: 6 + 11 = 17, which matches 25 − 2(4) = 17. At p = 12: consumer 1 buys 0 and consumer 2 buys 3, so market demand is 3.
- Answer
- Market demand is 17 units at ₹4 and 3 units at ₹12.
Example 3: Elasticity and expenditure
- Given
- The price of a good rises from ₹40 to ₹44 and quantity demanded falls from 500 to 400 units.
- Formula
- eD = %Δq ÷ %Δp; expenditure = p × q
- Steps
- %Δp = 4 ÷ 40 × 100 = +10. %Δq = −100 ÷ 500 × 100 = −20. eD = −20 ÷ 10 = −2. Expenditure before: 40 × 500 = 20,000; after: 44 × 400 = 17,600.
- Answer
- |eD| = 2, so demand is elastic, and expenditure falls by ₹2,400.
Common Mistakes
- Drawing a budget line with a positive slope. More of one good always means less of the other, so the slope is negative.
- Writing the slope as p₂÷p₁. The slope of the budget line is −p₁÷p₂ when good 1 is on the horizontal axis.
- Showing a change in the good's own price as a shift of the demand curve. It is a movement along the curve.
- Saying elasticity is the slope of the demand curve. Elasticity uses percentage changes, not absolute ones.
- Treating a straight-line demand curve as having constant elasticity. It varies from 0 to infinity along the line.
10 Important Questions for Class 12 Board and School Examinations
Questions are written in original words. Marks are shown beside each question.
Q1A consumer with income ₹60 faces a price of ₹12 for good 1 and ₹15 for good 2. The horizontal intercept of her budget line is: (A) 4 (B) 5 (C) 6 (D) 12 1 mark · MCQ
(B) 5.
Horizontal intercept = M ÷ p₁ = 60 ÷ 12 = 5.
Q2Assertion (A): If the price of good 1 rises, the budget line becomes steeper. Reason (R): The slope of the budget line in absolute value is p₁÷p₂. Choose: (a) both true, R explains A; (b) both true, R does not explain A; (c) A true, R false; (d) A false, R true. 1 mark · Assertion-reason
(a) Both are true and R correctly explains A.
A higher p₁ raises the price ratio, which is the steepness of the line.
Q3What is a budget set? Why is the budget line downward sloping? 3 marks
The budget set is the collection of all bundles a consumer can afford at given prices and income.
- The budget line joins bundles costing exactly her income.
- To buy more of one good she must spend less on the other.
- So the line slopes downward, with slope −p₁÷p₂.
Example: with income ₹20 and both goods at ₹5, (4, 0), (2, 2) and (0, 4) are on the line.
Q4What are monotonic preferences? Why does an indifference curve slope downward? 3 marks
Preferences are monotonic when more of at least one good, and no less of the other, is always preferred.
- If she gets more of good 1 and keeps the same amount of good 2, she is better off.
- To stay equally well off, she must therefore have less of good 2.
- Hence the indifference curve slopes downward.
Example: (4, 3) is preferred to (3, 3), so the two cannot be on the same curve.
Q5Distinguish between normal goods and inferior goods, with one example each. 3 marks
Demand for a normal good rises with income; demand for an inferior good falls as income rises.
- Normal good: income up, demand up.
- Inferior good: income up, demand down.
- A good can be normal at low incomes and inferior at higher incomes.
Example: clothes are normal; coarse cereals can be inferior.
Whether a good is normal or inferior depends on the consumer’s income and tastes.
Q6Explain the consumer's optimum using indifference curves and the budget line. 4 marks
The consumer's optimum is the affordable bundle on the highest indifference curve, where the budget line touches a curve.
- On the budget line: a point below it can always be improved.
- Tangency: any other point on the line lies on a lower curve.
- Condition: MRS = p₁÷p₂.
- Why: otherwise she can gain by swapping at market rates.
Example: with prices ₹4 and ₹5 the optimum has MRS = 0.8.
At the optimum, her willingness to swap goods equals the rate at which the market lets her swap. A bundle where the curve crosses the line cannot be optimal.
Q7Distinguish between a movement along the demand curve and a shift of the demand curve. 4 marks
A price change moves us along the curve; a change in any other determinant shifts the whole curve.
- Movement: caused only by the good's own price; other things stay the same.
- Shift: caused by income, prices of related goods or tastes.
- Direction: a rise in demand shifts the curve right; a fall shifts it left.
- Quantity: a movement changes quantity demanded; a shift changes demand at every price.
Example: a rise in the price of tea moves along the tea curve but shifts the coffee curve right.
Q8Explain the law of demand using the substitution effect and the income effect. 6 marks
The law of demand states that, for goods whose demand rises with income, quantity demanded rises when price falls.
- A fall in the price of good 1 makes it cheaper relative to good 2.
- Substitution effect: with income adjusted to the old purchasing power, the consumer buys at least as much of good 1.
- Income effect: the price fall raises purchasing power, so she buys more of a normal good.
- Both effects increase demand for a normal good.
- So the demand curve slopes downward.
- For a Giffen good the income effect dominates and the curve can slope upward.
Hence price and quantity demanded are inversely related.
When income effects are small, the substitution effect alone ensures a downward-sloping curve. Giffen goods, with an upward-sloping curve, are extremely rare, since they need a strongly inferior good that takes a large share of the budget.
Q9Explain the relationship between price elasticity of demand and total expenditure on a good when price rises. 6 marks
The effect on spending depends on whether the percentage fall in quantity is larger or smaller than the percentage rise in price.
| Demand | Condition | Expenditure |
|---|---|---|
| Elastic | %Δq > %Δp | Falls |
| Unit elastic | %Δq = %Δp | Unchanged |
| Inelastic | %Δq < %Δp | Rises |
For a price fall, the reverse holds. Hence a seller of an inelastic good gains revenue by raising price.
Elasticity is the key reason. Where demand is elastic, consumers cut quantity sharply, so spending falls; where inelastic, they cut quantity only slightly, so spending rises. For example, if price rises 10 per cent and quantity falls 20 per cent, elasticity is 2 and expenditure falls, while a 5 per cent fall in quantity with the same price rise (elasticity 0.5) raises expenditure. This is why sellers of necessities, with inelastic demand, gain revenue by raising price, while sellers of goods with many substitutes may lose.
Q10At a price of ₹50 the demand for a good is 200 units. When the price rises to ₹55, demand falls to 160 units. Calculate the price elasticity of demand and say whether demand is elastic or inelastic. How does expenditure change? 4 marks · Numerical
The price elasticity of demand is −2, so demand is elastic, and expenditure falls from ₹10,000 to ₹8,800.
Given: p₀ = 50, q₀ = 200; p₁ = 55, q₁ = 160.
Formula: eD = %Δq ÷ %Δp.
Steps: %Δp = 5÷50 × 100 = 10. %Δq = −40÷200 × 100 = −20. eD = −20÷10 = −2. Expenditure: 50 × 200 = 10,000; 55 × 160 = 8,800.
Final answer: |eD| = 2 (elastic); expenditure falls by ₹1,200.
10 Points for State PSC and UPSC Aspirants
- The Consumer Protection Act, 2019 replaced the 1986 Act and set up the Central Consumer Protection Authority (2020).Why it matters: the consumer's rights and redress are standard polity-economy crossover questions.Source: India Code; Department of Consumer Affairs
- National Consumer Day is observed on 24 December and World Consumer Rights Day on 15 March.Why it matters: a common static fact.Source: Department of Consumer Affairs
- The NSO conducted the Household Consumption Expenditure Survey in 2022–23 and 2023–24 after a gap since 2011–12.Why it matters: the main official source on consumer budgets in India.Source: MoSPI, HCES
- Engel's law: as incomes rise, the share of income spent on food falls; the HCES data show this pattern.Why it matters: links consumer theory to household data.Source: MoSPI, HCES
- Governments raise revenue by taxing goods with inelastic demand, such as petroleum products and tobacco, because quantity falls little when price rises.Why it matters: applies elasticity to taxation questions.Source: Union Budget, Ministry of Finance
- Direct Benefit Transfer (from 1 January 2013) gives cash to beneficiaries, which shifts the budget line in parallel; a price subsidy instead changes its slope.Why it matters: a policy illustration of budget-line analysis.Source: Union Budget documents
- A Giffen good (after Robert Giffen) and a Veblen good are the two classic exceptions to the law of demand.Why it matters: a standard theory question.Source: NCERT Introductory Microeconomics
- The United Nations declared 2023 the International Year of Millets on India's proposal, reviving a once-inferior staple.Why it matters: a current-affairs link to normal and inferior goods.Source: Ministry of Agriculture and Farmers Welfare; PIB
- Utility analysis has two versions: cardinal (Marshall) and ordinal (Hicks and Allen, indifference curves).Why it matters: static theory frequently asked in optional papers.Source: NCERT Introductory Microeconomics
- Because the price of petrol and diesel is outside GST and demand is inelastic, excise duty on them is a stable source of revenue.Why it matters: an elasticity application to fiscal policy.Source: Union Budget, Ministry of Finance
These are revision notes, not official predictions of exam content.
Quick Revision
- Budget line: p₁x₁ + p₂x₂ = M; slope −p₁÷p₂.
- Income change: parallel shift; price change: pivot.
- Indifference curve: downward sloping, convex; higher curve preferred.
- Optimum: tangency, MRS = p₁÷p₂.
- Law of demand: price up, quantity down (normal goods).
- Own price: movement along; other factors: shift.
- Market demand: horizontal sum of individual demands.
- eD = %Δq ÷ %Δp; elastic > 1; expenditure moves opposite to price if elastic.
Related Glossary Terms and Chapters
Glossary:
Budget lineIndifference curvePrice elasticity of demandOpportunity costMarginal rate of substitution
Related chapters: Introduction, for scarcity and choice; Market Equilibrium, where this demand curve meets supply; Class 11 Statistics for Economics, Chapter 7, Index Numbers, for the CPI basket that reflects consumer spending (page coming soon). From Class 11: Correlation, Presentation of Data.
Sources
- NCERT textbooks: Introductory Microeconomics, Class 12, National Council of Educational Research and Training. Syllabus reference. Accessed 23 October 2026.
- India Code: Central Acts, Legislative Department, Government of India. Accessed 23 October 2026.
- MyGov, Government of India (Consumer Protection Act, 2019 awareness). Accessed 23 October 2026.
- Economic Survey, Ministry of Finance, Government of India. Accessed 23 October 2026.
- Ministry of Statistics and Programme Implementation (Household Consumption Expenditure Survey). Official statistics.
About this page
Drafted with AI assistance from the NCERT chapter structure, in original words. Content is checked and approved by Dr. Anamika Shrivastava, PhD Economics, before publication. Read how this site works or send a correction.
Syllabus year 2026-27 · Last updated