Budget Constraint
A budget constraint represents the limit on the consumption choices of an individual or a firm, based on their income and the prices of goods and services. It illustrates the trade-offs between different goods and services that can be purchased within the constraints of a given budget. The budget constraint is typically depicted graphically as a budget line showing the combinations of goods that can be afforded.
7 Key excerpts on "Budget Constraint"
eBook - ePubIntermediate Microeconomics
A Tool-Building Approach
- Samiran Banerjee(Author)
- 2014(Publication Date)
- Routledge(Publisher)
...If the consumer were to spend all of her income of $10 on good 1, she can purchase m/p 1 = 10/2 = 5 units which yields the bundle (5, 0) on the horizontal axis; similarly if she spent all of her $10 on good 2, she can purchase m/p 2 = 10/1 = 10 units which yields the bundle (0, 10) on the vertical axis. Joining these two endpoints yields the budget line showing other combinations of x 1 and x 2 that can be purchased at the current prices while spending the consumer’s entire income. The Budget Constraint or budget set then consists of all bundles on the budget line or inside the shaded triangle in Figure 2.2. If a bundle lies in the interior of the budget set — say, (2, 2) — the consumer’s income is not spent in its entirety and she has some savings. Likewise, a bundle that lies on the budget line, such as (2, 6), uses up all of the consumer’s income, while a bundle like (5, 4), which is outside the budget set, is unaffordable. By rearranging the terms in equation (2.2), we may write which is the equation of a straight line with vertical intercept m/p 2 and slope – p 1 /p 2. So a competitive budget line (in the case of two goods) will always be a straight line with a slope given by the negative of the ratio of the two prices, 4 while a competitive budget set will comprise a triangle that includes the budget line and all the points to its southwest bounded by the axes (since goods cannot be consumed in negative amounts). 2.2.1 Three goods or more It is easy to extend the idea of a budget to three or more goods...
eBook - ePubEconomics for Investment Decision Makers
Micro, Macro, and International Economics
- Christopher D. Piros, Jerald E. Pinto(Authors)
- 2013(Publication Date)
- Wiley(Publisher)
...THE OPPORTUNITY SET: CONSUMPTION, PRODUCTION, AND INVESTMENT CHOICE So far, we have examined the trade-offs that economic actors (e.g., consumers, companies, investors) are willing to make. In this section, we recognize that circumstances almost always impose constraints on the trade-offs that these actors are able to make. In other words, we need to explore how to model the constraints on behavior that are imposed by the fact that we live in a world of scarcity: There is simply not enough of everything to satisfy the needs and desires of everyone at a given time. Consumers must generally purchase goods and services with their limited incomes and at given market prices. Companies, too, must divide their limited input resources in order to produce different products. Investors are not able to choose both high returns and low risk simultaneously. Choices must be made, and here we examine how to represent the set of choices from which to choose. 4.1. The Budget Constraint Previously, we examined what would happen if Warren and Smith were each given an endowment of bread and wine and were allowed to exchange at some predetermined ratio. Although that circumstance is possible, a more realistic situation would be if Warren or Smith had a given income with which to purchase bread and wine at fixed market prices. Let Warren’s income be given by I, the price he must pay for a slice of bread be P B, and the price he must pay for an ounce of wine be P W. Warren has freedom to spend his income any way he chooses, as long as the expenditure on bread plus the expenditure on wine does not exceed his income per time period. We can represent this income constraint (or Budget Constraint) with the following expression: (2-3) This expression simply constrains Warren to spend, in total, no more than his income. At this stage of our analysis, we are assuming a one-period model. In effect, then, Warren has no reason not to spend all of his income...
eBook - ePubIntermediate Microeconomics
Neoclassical and Factually-oriented Models
- Lester O. Bumas(Author)
- 2015(Publication Date)
- Routledge(Publisher)
...That budget is the person’s after-tax income which may be augmented by grants of money, borrowings, and past savings, and diminished by gifts, loans, and current savings. To equate budget and income assumes that inflows into income equal the outflows mentioned above. Assuming that the individual’s budget, B, is expended on n different goods and services during the budget period, the Budget Constraint is: where P i is the price of the i th good and Q i is the quantity of it purchased during the budget period. The Logic of the Condition-Defining Utility Maximization How does the individual spend his budget so that total utility is maximized? The condition which must prevail is that for all goods and services the incremental utility per dollar is equal: At this equilibrium, no change in the combination of goods purchased can increase the satisfaction of the consumer. Let us transform the utility maximization condition from the equation (4) form of incremental utility per dollar to the more common one of marginal utility per dollar. First, recall that marginal utility is the slope of the total utility curve: MU = Δ TU /Δ Q. Solve for incremental utility and we have, Δ TU = MU · Δ Q. Now substitute for Δ TU in equation (4) MU · Δ Q. Set all Δ Qs, all changes in the rate of consumption equal to one and we have: In this form it is seen that the utility maximizing consumer adjusts his purchases so that all items yield the same marginal utility per dollar. The Mathematics of Utility Maximization The logic of satisfaction being maximized when all marginal utilities per dollar are equal is handled mathematically here with the inclusion of the Budget Constraint. To simplify the problem it will be assumed that only two different goods are consumed and exhaust the individual’s budget. The utility function is: where X and Y are the rates of consumption of the two goods...
eBook - ePubA Fiscal Cliff
New Perspectives on the U.S. Federal Debt Crisis
- John Merrifield, Barry Poulson(Authors)
- 2020(Publication Date)
- Cato Institute(Publisher)
...This is the essence of budgeting. Recognizing that the function of budgeting is constrained optimization also reveals its essential information requirements: budget makers must know the resource constraint (how much is available), the opportunity cost (value of scarce resources consumed) for each considered alternative use, and the expected social benefit from each. Although this observation may seem utterly unexceptional and commonplace, the current federal budget process fails to provide this requisite information in salient form to elected policymakers. Just as oddly, proposals to provide this information in recent years have aimed almost exclusively at improving the measurement of benefits, as though the requirements for a well-defined constraint and relevant cost measures had already been addressed fully. This chapter aims to rebalance reform efforts toward adding a salient resource constraint and improving cost measurement by demonstrating their absence from and inadequacy in the current federal budget process. It also suggests how those essential features might be added to the existing process. NO CONSTRAINT Advancing the claim that the current federal budget process lacks an effective Budget Constraint risks running afoul of the admonition to “avoid statements with which no one would disagree.” Nonetheless, the failure of most budget reform proposals to include this feature implies either that such a constraint already exists or—more baffling—that it is unneeded. One bit of evidence on this issue is the Congressional Budget Office’s (CBO) annual long-term (30-year) projection of budget revenues, outlays, deficits, and debt, which assumes the indefinite continuation of current law and budget policy...
eBook - ePub- Gary S. Becker(Author)
- 1993(Publication Date)
- Harvard University Press(Publisher)
...The utility function, Eq. (1.1), then is extended to where t h j. is the time spent at the j th activity. A time-Budget Constraint joins the money-income constraint: where t is the total time available during some period, such as 24 hours a day or 168 hours a week, and t w is the time spent working for pay. 1 One important implication of this extension is that money income is no longer “given” but is determined by the allocation of time, inasmuch as earnings are determined by the time allocated to work. Therefore, the goods and time-Budget Constraints are not independent and can be combined into one overall constraint: or where w is the earnings per hour of work, v is property income, and S is “full” or potential income (or the money income when all time is allocated to the market sector). The terms on the left show that full income is spent in part directly on market goods and in part indirectly on the time used to produce utility rather than earnings. 2 The equilibrium conditions from maximizing the utility function (Eq. 1.4) subject to the full-income constraint, Eq. (1.7), include The marginal utility from all uses of time are equal in equilibrium because they have the same price (w), and the marginal rate of substitution between time and each good equals the “real” wage rate, where the price deflator is the price of that good. 3 The main implications of these equilibrium conditions are generalizations of the negatively sloped demand curves derived with the simpler model. A compensated rise in the price of any good—a rise offset by a sufficient rise in property income to keep real income constant—reduces the demand for that good and increases the demand for “most” other goods. It also reduces the time spent at work and increases the time spent at most nonmarket (or household) activities, because a rise in the price of a good reduces the real wage rate in units of that good...
eBook - ePub- Bradley T. Ewing, John M. Barron, Gerald J. Lynch(Authors)
- 2006(Publication Date)
- Routledge(Publisher)
...The key reason for this is that the actual constraint faced by households will differ from that anticipated. In particular, using the actual firm distribution constraint, we replace anticipated real income from wages, dividends, and interest payments from firms with the actual real income net of depreciation. The resulting realized household Budget Constraint after time t is then If anticipations by households were incorrect at time t concerning prices or dividends during the period, then revisions in plans for consumption and saving will be made in light of the actual Budget Constraint faced. In this case, the actual household demand functions for output and money are written as follows: consumption demand during period t is money demand during period t is and we replace with Note that the term is referred to as the “marginal propensity to consume.” 12 Similarly, we replace with Money illusion and the real balance effect Let us consider (sufficient) assumptions under which demands and supplies are homogeneous of degree 0 in current wages, prices, and the nominal stock of money – that is, there is the absence of money illusion. Note that in considering whether or not there exists money illusion, we must now look at the behavior not only of households but also of firms. Consider firms first. Assuming perfect foresight on the part of firms, it is clear that current labor demand is homogeneous of degree 0 in current prices (the wage rate w t and the price level p t). Thus, so also current output supply...
eBook - ePub- Enrico Colombatto(Author)
- 2016(Publication Date)
- Routledge(Publisher)
...For example, one could decide to spend all the money one earns immediately, day after day, month after month. Most frequently, however, current expenditure differs from current income. In particular, it might happen that one wants to consume in excess of his current income and thus plans to cover the difference by borrowing or by drawing on past savings. The opposite might also apply, especially during working years: ‘savings’ is the name assigned to the positive difference between current income and current expenditure. It is obvious that many variables influence one's decision to borrow or to save. Yet, although trying to find the exact relation among such variables might be tempting, it is not a very useful exercise: each individual presents different features, and those features are likely to change frequently, not merely because preferences change, but also as a consequence of the external environment. For example, a crisis or a boom significantly affects our expectations and, therefore, our decisions to consume, even when our current income remains constant. Despite the analytical difficulties involved, however, in this section we shall see that the fundamental elements that drive economic action – value and opportunity costs – also apply to people's decisions about how to distribute their consumption budgets over time. The mechanics is straightforward. Ceteris paribus, the more we consume today, the less we can consume in the future. By contrast, the more we want to consume in the future, the less we can afford today. Choosing when to consume is thus a matter of opportunity cost of consumption. In the economics jargon, the sacrifice one incurs when one opts to consume in the future what could be consumed today is called the ‘rate of time preference’...
