Budget Constraint

Important Ideas and Vocabulary p1 x 1 + p2 x 2 ≤m

Exogenous Variables: p1, p2, m
Endogenous Variables: x1, x2

How does the budget line change given changes in p1, p2, or m?

Budget lines can be composed of line segments of various slopes

if the consumer faces additional complications such as taxes or rationing.

Understanding the budget constraint and how it changes is crucial

because after we discuss the consumer's tastes and preferences,
we will combine the budget constraint and consumer's desires in
order to find the optimal solution.
The Basic Budget Constraint
Use the scoll bars next to the chart below to alter the quantities of x1 and x2 purchased.

Quantities of goods, x1 and x2, purchased by consumer

x1 20
x2 10 25
p1 x 1 + p2 x 2 ≤m
Prices of goods, x1 and x2
p1 2
2 x 1 + 3 x 2 =100
p2 3 3 x2 =100−2 x1
Consumer's income 2
x 2=33. 3− x 1
m 100 3
Two ways to compute the slope. Click on the cells to see the formulas.
x1 x2 rise/run - p1/p2 is the slope
0 33.33 m/p2 is the y intercept -0.67
5 30.00 -0.67 -0.67 Consumption Possibilties
10 26.67 -0.67 -0.67 35
15 23.33 -0.67 -0.67 30
20 20.00 -0.67 -0.67 25
unaffordable
combinations
25 16.67 -0.67 -0.67

x2
20
30 13.33 -0.67 -0.67
35 10.00 -0.67 -0.67 15
40 6.67 -0.67 -0.67 10 1; 10
45 3.33 -0.67 -0.67 5 feasible
50 0.00 m/p1 is the x intercept -0.67 -0.67 combinations
0
x1
0 10 20 30 40 50 60
e cells to see the formulas.

nsumption Possibilties 0

unaffordable
combinations

1; 10

tions
x1
20 30 40 50 60
Changes in the Budget Constraint

Quantities of goods, x1 and x2, purchased by consumer

x1 10
x2 10

Initial New
Prices of goods, x1 and x2 Change p1, p2, or m b
p1 2 p1
p2 3 p2

Consumer's income
m 100 m

x1 x2 new x1
0 33.33333 How the Budget Line Changes 0
5 30 35 5
10 26.66667 30 10
15 23.33333 15
20 20 25 20
x2

initi
25 16.66667 20 al 25
30 13.33333 15 new 30
35 10 35
40 6.666667
10 40
45 3.333333 5 45
50 0 0 x1
50
0 10 20 30 40 50 60
In Excel 2007, right click on the x or y axis, select Format Axis, then set the scale in the Axis
In older versions, double click on the x or y axis and click the Scale tab to unlock the axis.
 Change p1, p2, or m below to see how the budget line changes
2 Try 1, 5, and 10
3

100 Try 150 and 50.

new x2
33.33333
30
26.66667
23.33333
20
16.66667
13.33333
10
6.666667
3.333333
0

n set the scale in the Axis Options tab.

e tab to unlock the axis.
The Budget Constraint with Rationing

Quantities of goods, x1 and x2, purchased by consumer

x1 10
x2 10
p1 x 1 + p2 x 2 ≤m
Prices of goods, x1 and x2
p1 2
x 1≤ x̄
p2 3

Consumer's income Rationed Amount of x1

m 100 xbar 25 try 10, 40, and 60

x1 x2
0 33.33333 Budget Constraint with Rationing
5 30 40
10 26.66667 35
unaffordable
15 23.33333 30 combinations
20 20 25
x2

25 16.66667
20
25 16.66667
25 16.66667 15 feasible
combinations
25 16.66667 10
25 16.66667 5
25 0 0 x1
0 10 20 30 40 50 60
The Budget Constraint with a Subsidy

Quantities of goods, x1 and x2, purchased by consumer

x1 10
x2 10 p1 x 1 + p2 x 2 ≤m+ p1 x̄ 1
x 1≥ x̄ 1
Prices of goods, x1 and x2
p1 2 Notice the second constraint that forces the consumer to buy at leas
p2 3 Like the rationing example, we can model complicated budget sets b

Consumer's income Subsidized Amount of x1

m 100 xbar 10 try 10, 40, and 60

0 33.33333
x1 x2
10 33.33333 In-kind Subsidy
15 30 40
20 26.66667 35
unaffordable
25 23.33333 30 combinations
30 20
x2

25
35 16.66667 20
40 13.33333
15 feasible
45 10 combinations
10
50 6.666667
5
55 3.333333
60 0 0
0 10 20 30 x1 40 50 60 70
t forces the consumer to buy at least the subsidized amount of x1.
an model complicated budget sets by adding constraints.
Questions

Open Word and answer the following questions. Save the document and print it when you are done.

1) In the Changes sheet, click the Reset button, then make p2 = 5.

Take a picture of the graph and paste it into your Word document.
(Hint: Select the graph (by clicking on it), hold down the Shift key, and execute Edit: Copy Picture. Note that when you hold do
Shift key, the Edit: Copy item changes to Edit: Copy Picture.)

2) The new budget line in Q1 shares the same x intercept with the initial budget line. A friend complains that "This doesn't mak
sense because if prices are higher, you should not be able to buy the same amount of the good." How do you explain to your
friend what's going on?

3) Suppose a budget line is drawn with music CDs on the Y axis and fast food on the x axis. You're hanging out in the mall wh
that the music store is giving away a coupon for a free music CD. Draw what happens to your budget line. Include the initial a
Use Word's Drawing tools to create your graph.
(Hint: You may have to display the Drawing tools by executing View: Toolbars: Drawing.)

4) Since 1979 the US Food Stamp Program has been an in-kind subsidy -- food stamps can only be spent on food.
While it is illegal to sell food stamps, some people do it anyway.
Suppose a food stamp seller could get 50 cents for every $1 of food stamps.
Draw the budget lines of a food stamp recipient who refused to sell food stamps versus one who was a food stamp seller.

5) The USDA runs the Food Stamp Program and it has a nice web site at
http://www.fns.usda.gov/fns/
Visit this web site and find out how many Americans participated in the food stamp program last year.
Report your answer and provide a citation of the web page (i.e., a URL).
Describe your procedure in answering this question.
ote that when you hold down the

ins that "This doesn't make

w do you explain to your

hanging out in the mall when you notice

t line. Include the initial and new budget lines.

spent on food.

a food stamp seller.