Sunk costs are costs already received in the past that can’t be changed in the present. The concept of budget constraint doesn’t account for sunk costs. Sunk costs aren’t Factored into Budget Constraint Meanwhile, all the points beyond the budget constraint line on the graph above are the amounts of purchases that the consumer can’t afford. All points from the origin (0,0) to the budget constraint line are those at which the consumer doesn’t spend their entire income. Budget Constraint Graph Step 1: Determine where the budget constraint touches each axisīudget constraint is represented by all the points on the graph at which the consumer uses the entirety of their available income on purchases of these goods. With this, keep in mind that slope is typically defined as the change in y over (divided by) the change in x, but it’s actually a bit different than that. It’s saying that the price of the good on the x-axis multiplied by that same good’s quantity, plus the price of the good on the y-axis multiplied by its own quantity, is equal to income.Īdditionally, the budget constraint’s slope is the negative of the of the x-axis good’s price divided by the y-axis good’s price. This formula might seem confusing at first glance, but it’s actually pretty straightforward once you get the hang of it. rebates, volume discounts, and so forth). This equation applies to most budget constraint calculations, assuming there are no extra factors (e.g. See below for a simpler representation of this example.īudget constraint: 4B + 3J = $36 The Budget Constraint Equation Budget constraint is represented by the combined amount of both juice and bread that one can spend within that total available income limit of $36. Additionally, the amount spent on juice is noted as 3J (J being the number of bottles of juice purchased), while the amount spent on bread is noted as 4B (B being the number of loaves of bread purchased). Meanwhile, the consumer has a total of $36 to spend (Income) on these two products. Juice (PJuice) is $3 and bread (PBread) is $4. We’ll say the first is juice and the second is bread. Similar Posts: Calculating Budget ConstraintĮconomists will often reduce mathematical representations of budget constraint to a discussion of two goods at a time, so that the concept can be represented clearly on a graph with x-and y-axes. Meanwhile, “happiness” is linked to indifference curves.Ī notable practical application of this concept is its use in the field of consumer theory, as a tool to examine the parameters of consumer choices. This concept can be summed up in the following question: “What affordable set of goods/services will maximize my happiness?” The word “affordable,” here, is linked to budget constraint. In the short term, budget constraints can be reduced through the use of loans however, analyzing budget constraint, in the long run, reveals that it is primarily governed by income, rent, and other more long-term factors.īudget constraint constitutes the primary part of the concept of utility maximization. In other words, it’s all of the many combinations of goods/services that consumers are able to purchase in light of their particular income as well as the current prices of these particular goods/services. When consumers’ income limits their consumption behaviors, this is known as a budget constraint.
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