Economics
Budget Constraint Graph
A budget constraint graph illustrates the different combinations of goods or services that an individual or a firm can afford given a limited budget and the prices of the goods or services. It typically shows a downward-sloping line representing the various combinations of two goods that can be purchased, given a fixed income and the prices of the goods.
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7 Key excerpts on "Budget Constraint Graph"
eBook - ePub- Stanley Bober(Author)
- 2016(Publication Date)
- Routledge(Publisher)
Now that we have the foundation of this indifference–ordinal ranking approach, we move to arrive at the rule for utility maximization based on this, and then to derive the consumer demand curve. The construction of this curve is merely a reflection of a consumer adjusting to an external event so as to maintain one’s maximizing position, and the event is a change in the price of the good for which we want to derive the curve. Before the event occurs, the consumer has chosen a particular basket of goods that presumably mirrors the highest attainable level of utility, and the basic elements of this choice are obviously the individual’s set of preferences as represented by an indifference map, the prices of the individual goods composing the basket, and the individual’s money income. Before setting out the solution to this choice problem, it should be reiterated and emphasized that the solution here (and in the context of the marginal utility cardinal analysis as well) is based on what we can consider as “independence of preferences.” Each consumer is concerned only with one’s own consumption pattern; the utility or satisfaction derived from a particular purchase is attributable to the individual’s own experience. In the solution to the choice problem the consumer is presumed not to be concerned or indeed influenced by what is going on elsewhere, that is, by the choices being made by other consumers. In Principles texts the student is shown an aggregate or market demand curve adjacent to individual demand curves and is told that points on the aggregate curve are found by summing horizontally the individual demand curves. The individual consumers behind the individual curves are considered to be in their own box, making their own decisions, and not at all being influenced by the behavior of the others. Certainly in an understanding of consumer demand this is one perception that we will want to question. But let us get back to the mainstream indifference model.Figure 4.8The consumer faces a host of combinations of goods that one may want to purchase and that we see as being reflected in the indifference map. What one would like to do is but one half the problem. The other and more telling half is what the consumer can do at the time of making the choice. The essence of the consumption choice is to narrow down the choices from all possible choices to those that are economically attainable. And what is attainable is dependent on the constraints facing the consumer—those being the prices of the goods and one’s available income. Figure 4.9 illustrates such a budget constraint.We set out the constraint asFigure 4.9telling us that the amount of spending on goods A and B cannot exceed the consumer’s available income. The expenditure of less than one’s full income generates the purchase of sets of baskets that lie within the dotted-lines area under the constraint line. The use of one’s total available income (given prices) places one on the budget constraint line. This line evidences what is attainable (what the consumer can do), for it shows the set of combinations of A and B that can be purchased given the “objective” data of prices and income. The placement of the budget line is determined by finding the intercepts on the A and B axes. For example, if the consumer were to spend all income on good B , then the amount purchased would be given byM/pB; likewise, if we were to set B = 0, we determine the good A budget intercept asM/pA .There are some features of this line that we should mention. An increase in money income with unchanged prices clearly shifts the line to the right, enlarging the available set of baskets. Clearly a change in the price of one of the goods, given unchanged money income, alters the slope of the constraint line as it changes one of the intercepts. Furthermore, if we were to double income and also double price, the available set of possible purchases would not change; the intercepts remain the same and the equation of the constraint line, of course, remains unchanged as well. So the set of commodity A and B baskets available to the consumer depends on relative prices (pB /pA) and on the real value or purchasing power of money (M/pB , M/pA). We should note that the slope of our constraint line is (−pA /pB).6
eBook - PDF- Steven A. Greenlaw, Timothy Taylor, David Shapiro(Authors)
- 2017(Publication Date)
- Openstax(Publisher)
However, the lesson of sunk costs is to ignore them and make decisions based on what will happen in the future. From a Model with Two Goods to One of Many Goods The budget constraint diagram containing just two goods, like most models used in this book, is not realistic. After all, in a modern economy people choose from thousands of goods. However, thinking about a model with many goods is a straightforward extension of what we discussed here. Instead of drawing just one budget constraint, showing the tradeoff between two goods, you can draw multiple budget constraints, showing the possible tradeoffs between many different pairs of goods. In more advanced classes in economics, you would use mathematical equations that include many possible goods and services that can be purchased, together with their quantities and prices, and show how the total spending on all goods and services is limited to the overall budget available. The graph with two goods that we presented here clearly illustrates that every choice has an opportunity cost, which is the point that does carry over to the real world. 2.2 | The Production Possibilities Frontier and Social Choices By the end of this section, you will be able to: • Interpret production possibilities frontier graphs • Contrast a budget constraint and a production possibilities frontier • Explain the relationship between a production possibilities frontier and the law of diminishing returns • Contrast productive efficiency and allocative efficiency • Define comparative advantage Just as individuals cannot have everything they want and must instead make choices, society as a whole cannot have everything it might want, either. This section of the chapter will explain the constraints society faces, using a model called the production possibilities frontier (PPF). There are more similarities than differences between individual choice and social choice. As you read this section, focus on the similarities.
eBook - PDF- Steven A. Greenlaw, Timothy Taylor(Authors)
- 2015(Publication Date)
- Openstax(Publisher)
If you spend your income on video games, you cannot spend it on movies. If you choose to marry one person, you give up the opportunity to marry anyone else. In short, opportunity cost is all around us and part of human existence. The following Work It Out feature shows a step-by-step analysis of a budget constraint calculation. Read through it to understand another important concept—slope—that is further explained in the appendix The Use of Mathematics in Principles of Economics. Understanding Budget Constraints Budget constraints are easy to understand if you apply a little math. The appendix The Use of Mathematics in Principles of Economics explains all the math you are likely to need in this book. So if math is not your strength, you might want to take a look at the appendix. Step 1: The equation for any budget constraint is: Budget = P 1 × Q 1 + P 2 × Q 2 where P and Q are the price and quantity of items purchased and Budget is the amount of income one has to spend. Step 2. Apply the budget constraint equation to the scenario. In Alphonso’s case, this works out to be: Budget = P 1 × Q 1 + P 2 × Q 2 $10 budget = $2 per burger × quantity of burgers + $0.50 per bus ticket × quantity of bus tickets $10 = $2 × Q burgers + $0.50 × Q bus tickets Step 3. Using a little algebra, we can turn this into the familiar equation of a line: y = b + mx For Alphonso, this is: $10 = $2 × Q burgers + $0.50 × Q bus tickets Step 4. Simplify the equation. Begin by multiplying both sides of the equation by 2: 2 × 10 = 2 × 2 × Q burgers + 2 × 0.5 × Q bus tickets 20 = 4 × Q burgers + 1 × Q bus tickets Step 5. Subtract one bus ticket from both sides: 20 – Q bus tickets = 4 × Q burgers Divide each side by 4 to yield the answer: 5 – 0.25 × Q bus tickets = Q burgers or Q burgers = 5 – 0.25 × Q bus tickets Step 6. Notice that this equation fits the budget constraint in Figure 2.2. The vertical intercept is 5 and the slope is –0.25, just as the equation says.
eBook - PDF- David Shapiro, Daniel MacDonald, Steven A. Greenlaw(Authors)
- 2022(Publication Date)
- Openstax(Publisher)
If you spend your income on video games, you cannot spend it on movies. If you choose to marry one person, you give up the opportunity to marry anyone else. In short, opportunity cost is all around us and part of human existence. The following Work It Out feature shows a step-by-step analysis of a budget constraint calculation. Read through it to understand another important concept—slope—that we further explain in the appendix The Use of Mathematics in Principles of Economics. Understanding Budget Constraints Budget constraints are easy to understand if you apply a little math. The appendix The Use of Mathematics in Principles of Economics explains all the math you are likely to need in this book. Therefore, if math is not your strength, you might want to take a look at the appendix. Step 1: The equation for any budget constraint is: where P and Q are the price and quantity of items purchased (which we assume here to be two items) and Budget is the amount of income one has to spend. Step 2. Apply the budget constraint equation to the scenario. In Alphonso’s case, this works out to be: Step 3. Using a little algebra, we can turn this into the familiar equation of a line: For Alphonso, this is: Step 4. Simplify the equation. Begin by multiplying both sides of the equation by 2: Step 5. Subtract one bus ticket from both sides: Divide each side by 4 to yield the answer: Step 6. Notice that this equation fits the budget constraint in Figure 2.2. The vertical intercept is 5 and the slope is –0.25, just as the equation says. If you plug 20 bus tickets into the equation, you get 0 burgers. If you plug other numbers of bus tickets into the equation, you get the results (see Table 2.1), which are the points on Alphonso’s budget constraint. WORK IT OUT 30 2 • Choice in a World of Scarcity Access for free at openstax.org Point Quantity of Burgers (at $2) Quantity of Bus Tickets (at 50 cents) A 5 0 B 4 4 C 3 8 D 2 12 E 1 16 F 0 20 TABLE 2.1 Step 7.
- Walter Nicholson, Christopher Snyder(Authors)
- 2021(Publication Date)
- Cengage Learning EMEA(Publisher)
This situation is illustrated in Figure 4.3 . Initially, the person maximizes utility by choosing the combination X * , Y * at point A . When the price of X falls, the budget line shifts outward to the new budget constraint, as shown in the figure. Remember that the budget constraint meets the Y -axis at the point where all available income is spent on good Y. Because neither the person’s income nor the price of good Y has changed here, this Y -intercept is the same for both constraints. The new X -intercept is to the right of the old one because the lower price of X means that, with the lower price, this person could buy more X if they devoted all income to that purpose. The flatter slope of the budget con-straint shows us that the relative price of X to Y (that is, P X y P Y ) has fallen. substitution effect (in consumption) The part of the change in quantity demanded that is caused by substitution of one good for another. A movement along an indifference curve. income effect The part of the change in quantity demanded that is caused by a change in real income. A movement to a new indifference curve. Quantity of Y per week Y 3 Y 2 Y 1 U 3 U 2 U 1 I 1 I 2 I 3 Quantity of Z per week Z 3 Z 2 Z 1 0 Good Z is inferior because the quantity purchased declines as income increases. Y is a normal good (as it must be if only two goods are available), and purchases of it increase as total expenditures increase. Figure 4.2 Indifference Curve Map Showing Inferiority Copyright 2022 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
eBook - PDF- Martha L. Olney(Author)
- 2015(Publication Date)
- Wiley(Publisher)
Any combi- nation of apples and beef that falls on or to the left of the line is affordable. Any combination that is on the line uses the entire budget. Economists call this line the budget line. The slope of the budget line is the ratio of the prices. Remember that slope is rise over run. Use the two intercepts to determine the slope. The rise, the vertical intercept, is the total budget divided by the price of apples: budget/P A . The run, the negative (or, opposite) of the horizontal intercept, is the negative of the total Budget Constraint 67 Budget Line when Budget = $1,000 Budget Line when Budget = $1,000 Quantity of A Quantity of A Slope = rise run Quantity of B Budget Line when Budget = $2,000 1,000 2,000 200 400 Quantity of B (a) (c) (b) Quantity of A Budget Line when P B = $5 Budget Line when P B = $2 1,000 Quantity of B 200 500 Budget P A = 1,000 rise run −P B P A = Budget P B = 200 Figure 5.2 Budget lines. The budget line shows the combinations of goods A and B that the consumer can afford to purchase. The slope of the budget line is −P B /P A . In Figure 5.2b, the budget line shifts out as the total budget increases from $1,000 to $2,000. In Figure 5.2c, the budget line pivots as the price of good B changes from $5 to $2. budget divided by the price of beef: − budget P B . The slope of the budget line is slope of budget line = rise run = budget P A − budget P B = − P B P A The slope of the budget line is the negative of the ratio of the price of the item measured on the horizontal axis to the price of the item measured on the vertical axis. TIP Don’t lose that minus sign! The budget line slopes down. So its slope is negative. 68 Chapter 5 Consumer Theory When the total budget increases, the entire budget line shifts but the slope stays the same. The budget line shifts because the intercepts change. The slope stays the same because the prices have not changed.
eBook - PDF- John Gowdy(Author)
- 2020(Publication Date)
- CRC Press(Publisher)
Input Costs Money to Buy Goods FIRMS HOUSEHOLDS $ $ Figure 5.1 Monetary Flows within the Economy. Now let us go back and see how we arrive at these new con-cepts of marginal cost and product prices that allow us to establish the Pareto conditions for general equilibrium in a market instead of a barter society. PRICES IN CONSUMPTION: THE BUDGET CONSTRAINT Prices are incorporated into the framework of consumer deci-sion-making by means of the consumer’s budget constraint . If M is the total amount of money a consumer has to spend on beef (good X) and Brazil nuts (good Y), and if the prices of these goods are P X and P Y , respectively, then the budget constraint can be written as M = P X X + P Y Y. Suppose the total amount of money for food available to one of the consumers, say Bertha, is $1000. The price of Copyright © 1995 St. Lucie Press beef is $10 per pound, and the price of Brazil nuts is $5 per pound. It follows that Bertha can buy a maximum of 100 pounds of beef or 200 pounds of Brazil nuts or some combination of the two. In Figure 5.2, the intercepts of the budget line with the X (beef) and Y (Brazil nuts) axes of the graph show the amount of each good that could be purchased if the entire budget was spent on only one good (M/P X = 100 pounds and M/P Y = 200 pounds). Connecting these points gives all the possible combinations of beef and Brazil nuts one could buy with $1000. The slope of the budget line ( be increased (a move to a higher indifference curve) by purchasing the combination of beef and Brazil nuts indicated by point 2. A move to point 3 would give her an even higher level of utility but it exceeds her budget. The higher level of utility represented by point 3 could only be reached if her budget increased. A propor-tionate increase in the price of both goods, on the other hand, would force Bertha to a lower utility level, since fewer goods can be purchased as prices increase (point 4 in Figure 5.2 ).
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