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6.b The Budget Constraint
In the previous section we looked at indifference curves, which showed what the consumer
would like
to
have with respect to two goods X and Y.
In this section we will look at what the consumer can actually
afford.
A budget constraint is an equation, graph, or table that shows the bundles
available
to the
consumer. If we again assume there are only two goods available X and Y, a budget constraint has the
equation
I = P
x
·X + P
y
·Y.
In this equation I is the total money income, P
x
is the price of good X, and P
y
is the price of good Y.
Since
there are only two goods, the left side of this equation represents total expenditure.
Let's go over an
example of a budget constraint. Let total income I = $100, price of good X P
x
= $10 and price of good Y
P
y
= $5.
Table 6.b.1 shows the bundles that can be acquired under this budget constraint.
X
Y
0
20
1
18
2
16
10
0
If the consumer buys none of good X, then the budget allows for 20 units of good Y to be bought.
If the
consumer buys one unit of good X, then what is left in the budget is enough to buy 18 units of good Y.
As
the consumer buys more of X, less of Y can be bought all the way until the consumer buys 10 units of good
X when nothing is left in the budget to by good Y.
Plotting
these bundles on a graph gives us
the budget
line
.
Diagram 6.b.1 shows the budget line corresponding to table 6.b.1.
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 Spring '07
 Cheng

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