Microeconomics. Chapter 4.3. Budget constraint

1.

Microeconomics
Eighth Edition
Chapter 4.3
Budget constraint
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2.

Learning Objectives
4.3 Budget Constraint.
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3.

Budget Constraint (1 of 4)
• Budget line (or budget constraint) - the bundles of
goods that can be bought if the entire budget is spent
on those goods at given prices.
• Opportunity set - all the bundles a consumer can
buy, including all the bundles inside the budget
constraint and on the budget constraint.
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4.

Budget Constraint (2 of 4)
• If Lisa spends all her budget, Y, on pizza and burritos,
then
pB B pZ Z Y
– where pB B is the amount she spends on burritos and
pZ Z is the amount she spends on pizzas.
• This equation is her budget constraint.
– It shows that her expenditures on burritos and pizza
use up her entire budget.
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5.

Budget Constraint (3 of 4)
• How many burritos can Lisa buy?
– To answer solve budget constraint for B (quantity of
burritos):
PB B PZ Z Y
PB B Y PZ Z
Y PZ
B
Z
PB PB
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6.

Budget Constraint (4 of 4)
• From previous slide we have:
Y PZ
B
Z
PB PB
– Lisa can buy more burritos with a higher income, a
lower price of burritos or pizza, or if she buys fewer
pizzas.
– If pZ = $1, pB = $2, and Y = $50, then:
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7.

Allocations of a $50 Budget Between
Burritos and Pizza
Table 4.1 Allocations of a $50 Budget Between
Burritos and Pizza
Bundle
Burritos
Pizza
a
25
0
b
20
10
c
10
30
d
0
50
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8.

B, Burritos per semester
Figure 4.7 Budget Constraint
Amount of Burritos
consumed if all income
is allocated for Burritos.
25 = Y/pB
20
From previous slide we have
that if:
pZ = $1, pB = $2, and Y = $50,
then the budget constraint, L1,
is:
a
b
B
L1
c
10
Opportunity set
$50 ($1 Z )
25 0.5Z
$2
Amount of Pizza
consumed if all income
is allocated for Pizza.
d
0
10
30
50 = Y/pZ
Z, Pizzas per semester
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9.

Slope of the Budget Constraint
• We have seen that the budget constraint for Lisa is
given by the following equation:
Y PZ
B= - Z
PB PB
Slope = D B/D Z = MRT
– The slope of the budget line is also called the marginal
rate of transformation (MRT).
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10.

Solved Problem 4.2
• Suppose that a government rations water by setting a
quota on how much a consumer can purchase. If a
consumer can afford to buy 12 thousand gallons a
month but the government restricts purchases to no
more than 10 thousand gallons a month, how does
the consumer’s opportunity set change?
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11.

Solved Problem 4.2: Answer
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12.

B, Burritos per semester
Figure 4.8(a) Changes in the Budget
Constraint: Price of Pizza Doubles
Slope = -$1/$2 = -0.5
25
L1 (pZ = $1)
$2
Y - PZ = $1
Z
PB
PB
B=
If the price of pizza
doubles, (increases from
$1 to $2) the slope of the
budget line increases
Loss
L2 (pZ = $2)
0
Slope = -$2/$2 = -1
25
50
Z, Pizzas per semester
This area represents
the bundles she can no
longer afford
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13.

Figure 4.8(b) Changes in the Budget
Constraint: Income Doubles
B, Burritos per semester
$50 B = $100
PB
50
L3 (Y = $100)
PZ
Z
PB
If Lisa’s income increases
by $50 the budget line
shifts to the right (with the
same slope!)
25
Gain
L1 (Y = $50)
0
This area represents the
new consumption
bundles she can now
afford!!!
50
100
Z, Pizzas per semester
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14.

Solved Problem 4.3
Is Lisa better off if her income doubles or if the prices of
both the goods she buys fall by half?
Answer: Her budget line and her opportunity set are
the same with either change.
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