Download - The budget constraint
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The budget constraint
Consumers need income to buy goods and they must pay prices. These features limit
what the consumer can have.
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Budget constraint or budget line
The budget constraint for an individual shows combinations of two goods, say goods x and y, that can be attained given a certain income and assuming prices must be paid for the goods.
The constraint will be a line, like in the graph below.
x
y
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Budget constraint or budget line
If I = the consumer income in dollars Px = the price per unit of x Py = the price per unit of y x = the amount of x the consumer buys y = the amount of y the consumer buys, then the amount the consumer buys is
I = (Px)(x) + (Py)(y) or y = (I)/(Py) - [Px/Py](x)
Note if x = 0, y = I/Py and if
y = 0, x = I/Px and the slope of the line is - (Px)/(Py).
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Budget constraint
y
x
(0, I/PY)
(I/Px, 0)
-Px/Py This is the slope – a negative number.
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Budget constraint
y
x
The slope of the budget line is - Px/Py. Say x = a bag of chips and y = a can of pop. If Px = $1/bag and Py = .50/can, then
- Px/Py = -($1/bag)
($.50/can)
= - 2 cans/bag
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The slope of the budget line indicates that if one bag of chips is given up, 2 cans of pop can be obtained in the market. This occurs at every point on the budget line when prices remain constant in relation to the amount bought.
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slope
Note on the previous screen that the slope of the budget line is telling us about how much good x is valued in the market in relation to good y.
This implies that the slope of the budget is indicating the market rate of substitution of good x for good y.