1 The budget constraint Consumers need income to buy goods and they must pay prices. These features limit what the consumer can have.

2 Budget constraint or budget line u The budget constraint for an individual shows combinations of x and y that can be attained given a certain income and assuming prices must be paid for the goods. u The constraint will be a line in the graph we saw before – you know the one, the one where the amount of x is measured horizontally and the amount of y is measured vertically.

3 Budget constraint or budget line If I = the consumer income in dollars Px = the price per unit of x Py = the price per unit of y x = the amount of x the consumer buys y = the amount of y the consumer buys, then the amount the consumer buys is I = (Px)(x) + (Py)(y) or y = (I)/(Py) - [Px/Py](x) Note if x = 0, y = I/Py and if y = 0, x = I/Px and the slope of the line is - (Px)/(Py).

4 Budget constraint y x (0, I/PY) (I/Px, 0) -Px/Py This is the slope – a negative number.

5 Budget constraint y x The slope of the budget line is - Px/Py. Say x = a bag of chips and y = a can of pop. If Px = $1/bag and Py =.50/can, then - Px/Py = -($1/bag) ($.50/can) = - 2 cans/bag 2 1 The slope of the budget line indicates that if one bag of chips is given up, 2 cans of pop can be obtained in the market. This occurs at every point on the budget line when prices remain constant in relation to the amount bought.

6 slope Note on the previous screen that the slope of the budget line is telling us about how much good x is valued in the market in relation to good y. This implies that the slope of the budget is indicating the market rate of substitution of good x for good y. Remember the indifference curve slope was indicating how much of good x a person was willing to give up to get more of good y. The slope of the budget is the relative price of x.