Budget constraint

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A budget constraint represents all the combinations of goods

and services that a consumer may purchase given current prices
within his or her given income. Consumer theory uses the
concepts of a budget constraint and a preference map to analyze
consumer choices. Both concepts have a ready graphical
representation in the two-good case.

Contents
1 Uses
1.1 Individual choice
1.2 International economics
2 Many goods
3 Notes
4 See also
5 References

Budget constraint, where

and

Uses
Individual choice
Consumer behaviour is a maximisation problem. It means making the
most of our limited resources to maximise our utility. As consumers
are insatiable, and utility functions grow with quantity, the only thing
that limits our consumption is our own budget.[1]
An individual consumer should choose to consume goods at the point
where the most preferred available indifference curve on their
preference map is tangent to their budget constraint. That is, the
indifference curve tangent to the budget constraint represents the
maximum utility obtained utilizing the entire budget of the consumer.
The tangent point (the xy coordinate) represents the amount of goods
x and y the consumer should purchase to fully utilize their budget to
obtain maximum utility.[2] A line connecting all points of tangency
between the indifference curve and the budget constraint is called the
expansion path.[3]
All two dimensional budget constraints are generalized into the equation:

Where:

An individual should consume at (Qx,

Qy).

money income allocated to consumption (after saving and borrowing)

the price of a specific good
the price of all other goods
amount purchased of a specific good
amount purchased of all other goods
The equation can be rearranged to represent the shape of the curve on a graph:
, where
representing a downward sloping budget line.

is the y-intercept and

is the slope,

The factors that can shift the budget line are a change in income (m), a change in the price of a specific good (
), or a change in the price of all other goods ( ).

International economics
A production-possibility frontier is a constraint in some ways
analogous to a budget constraint, showing limitations on a country's
production of multiple goods based on the limitation of available
factors of production. Under autarky this is also the limitation of
consumption by individuals in the country. However, the benefits of
international trade are generally demonstrated through allowance of a
shift in the consumption-possibility frontiers of each trade partner
which allows access to a more appealing indifference curve. In the
"toolbox" Hecksher-Ohlin and Krugman models of international trade,
the budget constraint of the economy (its CPF) is determined by the
terms-of-trade (TOT) as a downward-sloped line with slope equal to
those TOTs of the economy. (The TOTs are given by the price ratio
Px/Py, where x is the exportable commodity and y is the importable).

Many goods

Point X is unobtainable given the

current "budget" constraints on
production.

While low level demonstrations of budget constraints are often limited

to two good situations which provide easy graphical representation, it is possible to demonstrate the relationship
between multiple goods through a budget constraint.
In such a case, assuming there are goods, called for
, that the price of good
by , and if
is the total amount that may be spent, then the budget constraint is:

is denoted

Further, if the consumer spends his income entirely, the budget constraint binds:

In this case, the consumer cannot obtain an additional unit of good

without giving up some other good. For
example, he could purchase an additional unit of good
by giving up
units of good

Notes
1. http://www.policonomics.com/budget-constraint/
2. Lipsey (1975). p 182.
3. Salvatore, Dominick (1989). Schaum's outline of theory and problems of managerial economics, McGraw-Hill,
ISBN 978-0-07-054513-7

See also
Choice modelling
Contingent valuation
Guns versus butter model
HeckscherOhlin theorem on country level budget constraints called resource endowments
Intertemporal budget constraint
Opportunity cost
Scarcity
Trade-off

References
Lipsey, Richard G. (1975). An introduction to positive economics (fourth ed.). Weidenfeld &
Nicolson. pp. 2147. ISBN 0-297-76899-9.
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Categories: Consumer theory Budgets Economics curves
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