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The Budget ConstraintBy Marco Giusti
1. Budget Constraint definition
Agenda/Outline
1. Budget Constraint definition
2. Budget Line
Agenda/Outline
1. Budget Constraint definition
2. Budget Line
3. Budget Set
Agenda/Outline
1. Budget Constraint definition
2. Budget Line
3. Budget Set
4. Variables Affecting Budget Constraint: Increasing Income Decreasing Income Increasing Prices of goods Decreasing Prices of goods
Agenda/Outline
1. Budget Constraint definition
2. Budget Line
3. Budget Set
4. Variables Affecting Budget Constraint: Increasing Income Decreasing Income Increasing Prices of goods Decreasing Prices of goods
5. Conclusion
Agenda/Outline
1. Budget Constraint
Define the set of baskets that a consumer can purchase with a limited amount
I = money income allocated to consumption Px = the price of a specific good
Py = the price of all other goods
x = amount purchased of a specific good y = amount purchased of all other goods
Pxx + Py y ≤ I
1. Budget Constraint
It’ s composed by:
Budget Line
8
1. Budget Constraint
It’ s composed by:
Budget Line Budget Set
9
2. Budget Line
All combinations x and y that a consumer can purchase if he spends all of his variable income on the two goods
10
Pxx + Py y = I
2. Budget Line
11
Pxx + Py y = I
How to draw graph representation of Budget Line
12
Pxx + Py y = I
How to draw graph representation of Budget Line
2. Budget Line
13
Pxx + Py y = I
Intersection with axes
How to draw graph representation of Budget Line
2. Budget Line
14
Pxx + Py y = I
Intersection with axes
How to draw graph representation of Budget Line
2. Budget Line
15
C
ƒn(x)=
B
2. Budget Line How to find the slope of ƒn:
16
C
ƒn(x)=
B
2. Budget Line How to find the slope of ƒn:
17
∆y
yC = yB - ∆y
C
ƒn(x)=
B
2. Budget Line How to find the slope of ƒn:
18
∆y
∆x
yC = yB - ∆y
xC = xB + ∆x
C
ƒn(x)=
B
2. Budget Line How to find the slope of ƒn:
19
∆y
∆x
yC = yB - ∆y
xC = xB + ∆x
C
ƒn(x)=
B
2. Budget Line How to find the slope of ƒn:
3. Budget Set
20
It’s a set of all affordable bundles
0
21
It’s a set of all affordable bundles
G point show us that a given price, a consumer purchases x units and y units, and he still has money because he has not spent it all
0
3. Budget Set
22
4. Variables Affecting Budget Constraint
We consider an U.S. Household with Income I = $ 3.000 monthly.
Suppose the consumer spends his salary just for:
Food (F)
U.S. average Price of Food in 2003 PF = 2,59 $ per units (*)
Gasoline (G)
U.S. average Price of Gasoline in Sept. 2003 PG = 1.78 $/gallon (°)
(*) US Department of Agricolture, food plans: cost of food - http://www.cnpp.usda.gov/Default.htm
(°) textbook “Microeconomics (3rd edition)”, application 4.1 page 104
23
Example of Budget Constraint
Example of Budget Constraint
24
gallons of Gasoline
0
Example of Budget Constraint
25
gallons of Gasoline
Example of Budget Constraint
26
gallons of Gasoline
Example of Budget Constraint
27
gallons of Gasoline
0
Example of Budget Constraint
28
gallons of Gasoline
0
Example of Budget Constraint
29
Suppose a Consumer has bought: GD = 900 gallons
gallons of Gasoline
0
Example of Budget Constraint
30
D
Suppose a Consumer has bought: GD = 900 gallons
gallons of Gasoline
0
Example of Budget Constraint
31
D
Suppose a Consumer has bought: GD = 900 gallons
gallons of Gasoline
How many units of food can a consumer purchase with the remaining of the Income?
0
Example of Budget Constraint
32
D
Suppose a Consumer has bought: GD = 900 gallons
gallons of Gasoline
How many units of food can a consumer purchase with the remaining of the Income?
0
Example of Budget Constraint
33
D
Suppose a Consumer has bought: GD = 900 gallons
gallons of Gasoline
How many units of food can a consumer purchase with the remaining of the Income?
0
Example of Budget Constraint
34
D
Suppose a Consumer has bought: GD = 900 gallons
gallons of Gasoline
How many units of food can a consumer purchase with the remaining of the Income?
0
Example of Budget Constraint
35
D
Suppose a Consumer has bought: GD = 900 gallons
gallons of Gasoline
How many units of food can a consumer purchase with the remaining of the Income?
0
Example of Budget Constraint
36
D
Suppose a Consumer has bought: GD = 900 gallons
gallons of Gasoline
Budget LINE:
All combinations of F and G that a consumer can purchase if he spends all of his Income on the two goods
How many units of food can a consumer purchase with the remaining of the Income?
0
Example of Budget Constraint
37
D
Suppose a Consumer has bought: GD = 900 gallons
gallons of Gasoline
Budget LINE:
All combinations of F and G that a consumer can purchase if he spends all of his Income on the two goods
Budget set, all points in this area are the affordable possibilities that a consumer can purchase without spend all the limited amount
How many units of food can a consumer purchase with the remaining of the Income?
0
Properties of Budget Constraint
What happens if INCOME Increase / Decrease?
38
Properties of Budget Constraint
What happens if INCOME Increase / Decrease?
What happens if PRICE Increase / Decrease?
39
4040
Suppose the income increase from I = $3.000 to I2 = $ 4.500
Units of Food F
gallon of Gasoline
0
Increase in Income
4141
Suppose the income increase from I = $3.000 to I2 = $ 4.500
Units of Food F
gallon of Gasoline
0
Increase in Income
4242
Suppose the income increase from I = $3.000 to I2 = $ 4.500
Units of Food F
gallon of Gasoline
0
Increase in Income
4343
Suppose the income increase from I = $3.000 to I2 = $ 4.500
SLOPE REMAIN EQUAL
Units of Food F
gallon of Gasoline
0
Increase in Income
4444
Suppose the income increase from I = $3.000 to I2 = $ 4.500
SLOPE REMAIN EQUAL
Units of Food F
gallon of Gasoline
0
Increase in Income
4545
Suppose the income increase from I = $3.000 to I2 = $ 4.500
BUDGET LINE SHIFS RIGHTWARD
SLOPE REMAIN EQUAL
Units of Food F
gallon of Gasoline
0
Increase in Income
4646
Suppose the income increase from I = $3.000 to I2 = $ 4.500
BUDGET LINE SHIFS RIGHTWARD
SLOPE REMAIN EQUAL
Budget Set whenI = $ 3.000
Units of Food F
gallon of Gasoline
0
Increase in Income
4747
Suppose the income increase from I = $3.000 to I2 = $ 4.500
BUDGET LINE SHIFS RIGHTWARD
SLOPE REMAIN EQUAL
Budget Set whenI = $ 3.000
Units of Food F
gallon of Gasoline
0
Increase in Income
4848
Suppose the income increase from I = $3.000 to I2 = $ 4.500
BUDGET LINE SHIFS RIGHTWARD
SLOPE REMAIN EQUAL
Budget Set whenI = $ 3.000
Units of Food F
I = $ 4.500
Budget Set gets BIGGER
gallon of Gasoline
0
Increase in Income
4949
Suppose the income decrease from I = $3.000 to I3 = $ 1.500
Units of Food F
gallon of Gasoline
0
Decrease in Income
5050
Suppose the income decrease from I = $3.000 to I3 = $ 1.500
Units of Food F
gallon of Gasoline
0
Decrease in Income
5151
Suppose the income decrease from I = $3.000 to I3 = $ 1.500
Units of Food F
gallon of Gasoline
0
Decrease in Income
5252
Suppose the income decrease from I = $3.000 to I3 = $ 1.500
SLOPE REMAIN EQUALUnits of Food F
gallon of Gasoline
0
Decrease in Income
5353
Suppose the income decrease from I = $3.000 to I3 = $ 1.500
SLOPE REMAIN EQUALUnits of Food F
gallon of Gasoline
0
Decrease in Income
5454
Suppose the income decrease from I = $3.000 to I3 = $ 1.500
BUDGET LINE SHIFS LEFTWARD
SLOPE REMAIN EQUALUnits of Food F
gallon of Gasoline
0
Decrease in Income
5555
Suppose the income decrease from I = $3.000 to I3 = $ 1.500
BUDGET LINE SHIFS LEFTWARD
SLOPE REMAIN EQUALUnits of Food F
Budget Set whenI = $ 3.000
gallon of Gasoline
0
Decrease in Income
5656
Suppose the income decrease from I = $3.000 to I3 = $ 1.500
BUDGET LINE SHIFS LEFTWARD
SLOPE REMAIN EQUALUnits of Food F
Budget Set whenI = $ 3.000
gallon of Gasoline
0
Decrease in Income
5757
Suppose the income decrease from I = $3.000 to I3 = $ 1.500
BUDGET LINE SHIFS LEFTWARD
SLOPE REMAIN EQUALUnits of Food F
Budget Set whenI = $ 3.000
I = $ 1.500
Budget Set gets SMALLER
gallon of Gasoline
0
Decrease in Income
Change in Income
Income Variable:
– if INCREASE:
58
Change in Income
Income Variable:
– if INCREASE:
59
Slope remains Equal
Change in Income
Income Variable:
– if INCREASE:
60
Slope remains Equal
Budget Line shifts Rightward
Change in Income
Income Variable:
– if INCREASE:
61
Slope remains Equal
Budget Set Bigger (Higher purchasing power)
Budget Line shifts Rightward
Change in Income
Income Variable:
– if INCREASE:
– if DECREASE:
62
Slope remains Equal
Budget Set Bigger (Higher purchasing power)
Budget Line shifts Rightward
Change in Income
Income Variable:
– if INCREASE:
– if DECREASE:
63
Slope remains Equal
Budget Set Bigger (Higher purchasing power)
Budget Line shifts Rightward
Slope remains Equal
Change in Income
Income Variable:
– if INCREASE:
– if DECREASE:
64
Slope remains Equal
Budget Set Bigger (Higher purchasing power)
Budget Line shifts Rightward
Slope remains Equal
Budget Line shift Leftward
Change in Income
Income Variable:
– if INCREASE:
– if DECREASE:
65
Slope remains Equal
Budget Set Bigger (Higher purchasing power)
Budget Line shifts Rightward
Slope remains Equal
Budget Set Smaller (Lower purchasing power)
Budget Line shift Leftward
6666
Suppose the price of the Gasoline increase from PG= 1,78 $/gallon to PG2= 2,06 $/gallon
gallon of Gasoline
0
Increase in Price of x
6767
Suppose the price of the Gasoline increase from PG= 1,78 $/gallon to PG2= 2,06 $/gallon
gallon of Gasoline
0
Increase in Price of x
6868
Suppose the price of the Gasoline increase from PG= 1,78 $/gallon to PG2= 2,06 $/gallon
gallon of Gasoline
0
Increase in Price of x
6969
Suppose the price of the Gasoline increase from PG= 1,78 $/gallon to PG2= 2,06 $/gallon
SLOPE INCREASE
gallon of Gasoline
0
Increase in Price of x
7070
Suppose the price of the Gasoline increase from PG= 1,78 $/gallon to PG2= 2,06 $/gallon
SLOPE INCREASE
gallon of Gasoline
0
Increase in Price of x
7171
Suppose the price of the Gasoline increase from PG= 1,78 $/gallon to PG2= 2,06 $/gallon
SLOPE INCREASE
gallon of Gasoline
BUDGET LINE MOVES INWARD
0
Increase in Price of x
7272
Suppose the price of the Gasoline increase from PG= 1,78 $/gallon to PG2= 2,06 $/gallon
SLOPE INCREASE
Budget Set I = $ 3.000 PF = $2,59 PG=$1,78 /gallon
gallon of Gasoline
BUDGET LINE MOVES INWARD
0
Increase in Price of x
7373
Suppose the price of the Gasoline increase from PG= 1,78 $/gallon to PG2= 2,06 $/gallon
SLOPE INCREASE
Budget Set I = $ 3.000 PF = $2,59 PG=$1,78 /gallon
gallon of Gasoline
BUDGET LINE MOVES INWARD
0
Increase in Price of x
7474
Suppose the price of the Gasoline increase from PG= 1,78 $/gallon to PG2= 2,06 $/gallon
SLOPE INCREASE
Budget Set I = $ 3.000 PF = $2,59 PG=$1,78 /gallon
Budget Set gets SMALLER
gallon of Gasoline
BUDGET LINE MOVES INWARD
0
Increase in Price of x
7575
Suppose the price of the Gasoline decrease from PG= 1,78 $/gallon to PG3= 1,34 $/gallon
gallon of Gasoline
0
Decrease in Price of x
7676
Suppose the price of the Gasoline decrease from PG= 1,78 $/gallon to PG3= 1,34 $/gallon
gallon of Gasoline
0
Decrease in Price of x
7777
Suppose the price of the Gasoline decrease from PG= 1,78 $/gallon to PG3= 1,34 $/gallon
gallon of Gasoline
0
Decrease in Price of x
7878
Suppose the price of the Gasoline decrease from PG= 1,78 $/gallon to PG3= 1,34 $/gallon
SLOPE DECREASE
gallon of Gasoline
0
Decrease in Price of x
7979
Suppose the price of the Gasoline decrease from PG= 1,78 $/gallon to PG3= 1,34 $/gallon
SLOPE DECREASE
gallon of Gasoline
0
Decrease in Price of x
8080
Suppose the price of the Gasoline decrease from PG= 1,78 $/gallon to PG3= 1,34 $/gallon
SLOPE DECREASE
gallon of Gasoline
BUDGET LINE MOVES OUTWARD
0
Decrease in Price of x
8181
Suppose the price of the Gasoline decrease from PG= 1,78 $/gallon to PG3= 1,34 $/gallon
SLOPE DECREASE
Budget Set I = $ 3.000 PF = $2,59 PG=$1,78 /gallon
gallon of Gasoline
BUDGET LINE MOVES OUTWARD
0
Decrease in Price of x
8282
Suppose the price of the Gasoline decrease from PG= 1,78 $/gallon to PG3= 1,34 $/gallon
SLOPE DECREASE
Budget Set I = $ 3.000 PF = $2,59 PG=$1,78 /gallon
gallon of Gasoline
BUDGET LINE MOVES OUTWARD
0
Decrease in Price of x
8383
Suppose the price of the Gasoline decrease from PG= 1,78 $/gallon to PG3= 1,34 $/gallon
SLOPE DECREASE
Budget Set I = $ 3.000 PF = $2,59 PG=$1,78 /gallon
The Budget Set
gets BIGGER
gallon of Gasoline
BUDGET LINE MOVES OUTWARD
0
Decrease in Price of x
Change in Price
Price of x variable:
– if INCREASE:
84
Change in Price
Price of x variable:
– if INCREASE:
85
Slope Rises Up
Change in Price
Price of x variable:
– if INCREASE:
86
Slope Rises Up
Budget Line shifts Inward
Change in Price
Price of x variable:
– if INCREASE:
87
Slope Rises Up
Budget Set Smaller (Lower purchasing power)
Budget Line shifts Inward
Change in Price
Price of x variable:
– if INCREASE:
– if DECREASE:
88
Slope Rises Up
Budget Set Smaller (Lower purchasing power)
Budget Line shifts Inward
Change in Price
Price of x variable:
– if INCREASE:
– if DECREASE:
89
Slope Rises Up
Budget Set Smaller (Lower purchasing power)
Budget Line shifts Inward
Slope Goes Down
Change in Price
Price of x variable:
– if INCREASE:
– if DECREASE:
90
Slope Rises Up
Budget Set Smaller (Lower purchasing power)
Budget Line shifts Inward
Slope Goes Down
Budget Line shift Outward
Change in Price
Price of x variable:
– if INCREASE:
– if DECREASE:
91
Slope Rises Up
Budget Set Smaller (Lower purchasing power)
Budget Line shifts Inward
Slope Goes Down
Budget Set Bigger (Higher purchasing power)
Budget Line shift Outward
9292
Suppose the price of the Food increase from PG= $ 2,59 to PF2= $ 3,26
gallon of Gasoline
0
Increase in Price of y
9393
Suppose the price of the Food increase from PG= $ 2,59 to PF2= $ 3,26
gallon of Gasoline
0
Increase in Price of y
9494
Suppose the price of the Food increase from PG= $ 2,59 to PF2= $ 3,26
gallon of Gasoline
0
Increase in Price of y
9595
Suppose the price of the Food increase from PG= $ 2,59 to PF2= $ 3,26
SLOPE DECREASE
gallon of Gasoline
0
Increase in Price of y
9696
Suppose the price of the Food increase from PG= $ 2,59 to PF2= $ 3,26
SLOPE DECREASE
gallon of Gasoline
0
Increase in Price of y
9797
Suppose the price of the Food increase from PG= $ 2,59 to PF2= $ 3,26
SLOPE DECREASE
gallon of Gasoline
0
BUGET LINE MOVES INWARD
Increase in Price of y
9898
Suppose the price of the Food increase from PG= $ 2,59 to PF2= $ 3,26
SLOPE DECREASE
Budget Set I = $ 3.000 PF = $2,59PG=$1,78 /gallon
gallon of Gasoline
0
BUGET LINE MOVES INWARD
Increase in Price of y
9999
Suppose the price of the Food increase from PG= $ 2,59 to PF2= $ 3,26
SLOPE DECREASE
Budget Set I = $ 3.000 PF = $2,59PG=$1,78 /gallon
gallon of Gasoline
0
BUGET LINE MOVES INWARD
Increase in Price of y
100100
Suppose the price of the Food increase from PG= $ 2,59 to PF2= $ 3,26
SLOPE DECREASE
Budget Set I = $ 3.000 PF = $2,59PG=$1,78 /gallon
Budget Set gets SMALLER
gallon of Gasoline
0
BUGET LINE MOVES INWARD
Increase in Price of y
101101
Suppose the price of the Food decrease from PG= $ 2,59 to PF3= $ 1,98
gallon of Gasoline
0
Decrease in Price of y
102102
Suppose the price of the Food decrease from PG= $ 2,59 to PF3= $ 1,98
gallon of Gasoline
0
Decrease in Price of y
103103
Suppose the price of the Food decrease from PG= $ 2,59 to PF3= $ 1,98
gallon of Gasoline
0
Decrease in Price of y
104104
Suppose the price of the Food decrease from PG= $ 2,59 to PF3= $ 1,98
SLOPE INCREASE
gallon of Gasoline
0
Decrease in Price of y
105105
Suppose the price of the Food decrease from PG= $ 2,59 to PF3= $ 1,98
SLOPE INCREASE
gallon of Gasoline
0
Decrease in Price of y
106106
Suppose the price of the Food decrease from PG= $ 2,59 to PF3= $ 1,98
SLOPE INCREASE
gallon of Gasoline
0
BUGET LINE MOVES OUTWARD
Decrease in Price of y
107107
Suppose the price of the Food decrease from PG= $ 2,59 to PF3= $ 1,98
SLOPE INCREASE
Budget Set I = $ 3.000 PF = $2,59PG=$1,78 /gallon
gallon of Gasoline
0
BUGET LINE MOVES OUTWARD
Decrease in Price of y
108108
Suppose the price of the Food decrease from PG= $ 2,59 to PF3= $ 1,98
SLOPE INCREASE
Budget Set I = $ 3.000 PF = $2,59PG=$1,78 /gallon
gallon of Gasoline
0
BUGET LINE MOVES OUTWARD
Decrease in Price of y
109109
Suppose the price of the Food decrease from PG= $ 2,59 to PF3= $ 1,98
SLOPE INCREASE
Budget Set I = $ 3.000 PF = $2,59PG=$1,78 /gallon
gallon of Gasoline
0
BUGET LINE MOVES OUTWARD
Decrease in Price of y
110110
Suppose the price of the Food decrease from PG= $ 2,59 to PF3= $ 1,98
SLOPE INCREASE
Budget Set I = $ 3.000 PF = $2,59PG=$1,78 /gallon
Budget Set gets BIGGER
gallon of Gasoline
0
BUGET LINE MOVES OUTWARD
Decrease in Price of y
Change in Price
Price of y variable:
– if INCREASE:
111
Change in Price
Price of y variable:
– if INCREASE:
112
Slope Goes Down
Change in Price
Price of y variable:
– if INCREASE:
113
Slope Goes Down
Budget Line shifts Inward
Change in Price
Price of y variable:
– if INCREASE:
114
Slope Goes Down
Budget Set Smaller (Lower purchasing power)
Budget Line shifts Inward
Change in Price
Price of y variable:
– if INCREASE:
– if DECREASE:
115
Slope Goes Down
Budget Set Smaller (Lower purchasing power)
Budget Line shifts Inward
Change in Price
Price of y variable:
– if INCREASE:
– if DECREASE:
116
Slope Goes Down
Budget Set Smaller (Lower purchasing power)
Budget Line shifts Inward
Slope Rises Up
Change in Price
Price of y variable:
– if INCREASE:
– if DECREASE:
117
Slope Goes Down
Budget Set Smaller (Lower purchasing power)
Budget Line shifts Inward
Slope Rises Up
Budget Line shift Outward
Change in Price
Price of y variable:
– if INCREASE:
– if DECREASE:
118
Slope Goes Down
Budget Set Smaller (Lower purchasing power)
Budget Line shifts Inward
Slope Rises Up
Budget Set Bigger (Higher purchasing power)
Budget Line shift Outward
The Budget Constraint is useful to:
– Find the best solution to satisfy a need to purchase two different goods with a limited amount
119
5. Conclusion
The Budget Constraint is useful to:
– Find the best solution to satisfy a need to purchase two different goods with a limited amount
– Understand the purchasing power and how it can be affected by:
120
5. Conclusion
The Budget Constraint is useful to:
– Find the best solution to satisfy a need to purchase two different goods with a limited amount
– Understand the purchasing power and how it can be affected by:
INCOME CHANGES
121
5. Conclusion
The Budget Constraint is useful to:
– Find the best solution to satisfy a need to purchase two different goods with a limited amount
– Understand the purchasing power and how it can be affected by:
INCOME CHANGES PRICE CHANGES
122
5. Conclusion
1) Income Variable
– if INCREASE:
123
5. Conclusion
1) Income Variable
– if INCREASE:
- Slope remains Equal
- Budget Line shifts Rightward
- Budget Set Bigger (Higher purchasing power)
124
5. Conclusion
1) Income Variable
– if INCREASE:
- Slope remains Equal
- Budget Line shifts Rightward
- Budget Set Bigger (Higher purchasing power)
– if DECREASE:
125
5. Conclusion
1) Income Variable
– if INCREASE:
- Slope remains Equal
- Budget Line shifts Rightward
- Budget Set Bigger (Higher purchasing power)
– if DECREASE:
- Slope remains Equal
- Budget Line shift Leftward
- Budget Set Smaller (Lower purchasing power)
126
5. Conclusion
2) Price Variable– if INCREASE:
127
5. Conclusion
2) Price Variable– if INCREASE:
- Slope: Rises Up (x - axis) / Goes Down (y - axis)
- Budget Line shifts Inward
- Budget Set Smaller (Lower purchasing power)
128
5. Conclusion
2) Price Variable– if INCREASE:
- Slope: Rises Up (x - axis) / Goes Down (y - axis)
- Budget Line shifts Inward
- Budget Set Smaller (Lower purchasing power)
– if DECREASE:
129
5. Conclusion
5. Conclusion
2) Price Variable– if INCREASE:
- Slope: Rises Up (x - axis) / Goes Down (y - axis)
- Budget Line shifts Inward
- Budget Set Smaller (Lower purchasing power)
– if DECREASE:
- Slope: Goes Down (x - axis) / Rises Up (y - axis)
- Budget Line shift Outward
- Budget Set Bigger (Higher purchasing power)
130
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131
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