THE BUDGET CONSTRAINT WHAT THE CONSUMER CAN AFFORD
Most people would like to increase the quantity or quality of the goods they consume-to take longer vacations, drive fancier cars, or eat at better restaurants. People consume less than they desire because their spending is constrained, or limited, by their income. We begin our study of consumer choice by examining this link between income and spending.
To keep things simple, we examine the decision facing a consumer who buys only two goods: Pepsi and pizza. Of course, real people buy thousands of different kinds of goods. Yet assuming there are only two goods greatly simplifies the problem without altering the basic insights about consumer choice. We first consider how the consumer’s income constrains the amount he spends on Pepsi and pizza. Suppose that the consumer has an income of $1,000 per month and that he spends his entire income each month on Pepsi and pizza. The price of a pint of Pepsi is $2, and the price of a pizza is $10. The table in Figure 1 shows some of the many combinations of Pepsi arid pizza that the consumer can
buy. The first line in the table shows that if the consumer spends all his income on pizza, he can eat 100 pizzas during the month, but he would not be able to buy any Pepsi at all. The second line shows another possible consumption bundle: 90 pizzas and 50 pints of Pepsi. And so on. Each consumption bundle in the table costs exactly $1,000 The graph in Figure 1 illustrates the consumption bundles that the consumer can choose. The vertical axis measures the number of pints of Pepsi, and the horizontal axis measures the number of pizzas. Three points are marked on this figure. At point A, the consumer buys no Pepsi and consumes 100 pizzas. At point B, the consumer buys no pizza and consumes 500 pints of Pepsi. At point C, the consumer buys 50 pizzas and 250 pints of Pepsi. Point C, which is exactly at the middle of the line from A to B, is the point at which the consumer spends an equal amount ($500) on Pepsi and pizza. These are only three of the many combinations
of Pepsi and pizza that the consumer can choose. All the points on the line from A to B are possible. This line, called the budget constraint, shows the consumption bundles that the consumer can afford. In this case, it shows the trade-off between Pepsi and pizza that the consumer faces.
The slope of the budget constraint measures the rate at which the consumer can trade one good for the other. Recall that the slope between two points is calculated as the change in the vertical distance divided by the change in the horizontal distance .c’rise over run”). From point A to point B, the vertical distance is 500 pints, and the horizontal distance is 100 pizzas: Thus, the slope is 5 pints per pizza. (Actually, ‘because the budget constraint slopes downward, the slope is a negative number. But for our purposes, we can ignore the minus sign.) Notice that the slope of the budget constraint equals the relative price of the two goods-the price of one good compared to the price of the other, A pizza costs 5 times. as much as a pint of Pepsi, so the opportunity cost of a pizza is 5 pints of Pepsi. The budget constraint’s slope of 5 reflects’ the trade-off the market is offering the consumer: I pizza for 5 pints of Pepsi.
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