What is a Budget Constraint?: What is a Budget Constraint?
A budget constraint shows the consumer’s purchase opportunities as every combination of two goods that can be bought at given prices using a given amount of income. The budget constraint measures the combinations of purchases that a person can afford to make with a given amount of monetary income. Li’s Demand for Wheat and Rice: Li’s Demand for Wheat and Rice Illustration of consumer theory Li’s demand for wheat and rice depends upon the prices for these goods, her income, and her preferences. Suppose we look first at her budget constraint: Wheat costs $4/lb. Rice costs $2/lb. Li has $40 of income. Li’s Budget Constraint: Li’s Budget Constraint The mathematical expression for Li’s budget constraint is: I = PW W + PR R R = I/PR – (PW / PR)W I like to refer to the |slope| of the budget line as the ERS=Economic Rate of Substitution In this case it is PW / PR For Li: PW=$4 PR=$2 I=$40 ERS=2 Graph of Li’s Budget Constraint: Graph of Li’s Budget Constraint The graph to the right shows a pict
