To use this simulation, you must download and install the Mathematica Viewer from the Wolfram Demonstrations Project. Although this software is free, it is a sizable download. This activity is therefore optional.
It is difficult to map indifference curves because preferences can change from moment to moment, but budget lines are real and tangible. This simulation shows how price changes and income changes affect a budget line. Of course, we are often making purchasing decisions based on more than two goods at a time, but modelling simpler considerations is the first step to modelling more complex decisions.
Once you have downloaded the software to your desktop, open the simulation and click the "reset parameters" box. The two goods in this model are labeled A and B. At the initial settings, the person to whom this budget line belongs can purchase a maximum of four units of good B at $6 per unit. Alternately, the this person could chose to buy only good A., purchasing 6 units at a price of $4 each. Notice that, in either case the total is $24; $24 is the budget this person has to spend on goods A and B. All points on the red line is a possible combination of goods with the $24 budget. For example, purchasing 2 units of good B at $6 each and 3 units of good A at $4 each fits within the budget.
Explore the simulation. Move the income slider to, say, $36. The dotted line that appears is the new budget line. Notice how this new budget line is parallel to the previous budget line at the lower income. Does that make sense? It ought to! The slope of the budget line is determined by the respective prices of goods A and B, not income!
Next, reset the parameters and examine what happens when goods A and B are different prices. Raise and lower both prices separately.
Now, lower both prices. Change the price of good A to $2.66 and the price of good B to $4. Doesn’t the dotted line look like the previous budget line you had for $36? Why might this be? In effect, with general deflation we experience a general wage increase, as we will be able to buy more for the same total price. Yes, the lowering of prices is conceptually equivalent to an increase in income.
Try the opposite last. Reset the values, lower the budget line, and find a level of price for each good such that the budget line approximates the previous one. Take a few more moments to experiment with this simulation.