In this article, we will look closer at the concept of ‘Budget Constraint’ in economy. We will look at the so-called budget line and how it is influenced by different factors.
The Budget Constraint
So, let us start by defining the ‘budget constraint’. To start with, we want to consider the set of goods from which the consumer can choose In real life, of course, there are thousands of such goods — but because we want to keep it simple, we will assume that it is only two. We can then denote the consumer’s consumption bundle by:
What exactly is this? It is nothing more than two numbers, which tells us how much the consumer is choosing to consume of good 1 (x_1) and of good 2 (x_2). At times you might see this bundle denoted as X, which is simply an abbreviation of this set of two numbers.
Now, it will come as no surprise, but goods have a price. So, of course, we will also have to give a price for our two goods. Let us assume that they are given by (p_1, p_2) — in other words, x_1 costs p_1 and x_2 costs p_2. We then also want to give our consumer a budget, m. Then the budget constraint of the consumer can be written as:
Here p_1x_1 is the amount of money the consumer is spending on good 1, while p_2x_2 is the amount of money the consumer is spending on good 2. The consumer’s budget constraint then requires that the amount of money spent on these two goods should be no more than the total…
