Budget Constraint (Economics) - Explained
What does a budget constraint imply in economic analysis?
Written by Jason Gordon
Updated at March 26th, 2023
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What is a Budget Constraint?
A budget constraint indicates all the combinations that a consumer can purchase given the price of the goods and the amount of funds (budget).
In general terms, a budget constraint implies that the consumer makes a choice of the most suitable combination of goods within their budget.
The budget constraint graph shows all of the possible combinations of goods that will exhaust the budget.
Anything outside the constraint is not affordable, because it would cost more money than is in the budget.
How to Calculate the Budget Constraint?
Step 1: The equation for any budget constraint is:
Budget = P1 × Q1 + P2 × Q2
where P and Q are the price and quantity of items purchased and Budget is the amount of income one has to spend.
Step 2. Apply the budget constraint equation to the scenario.
Step 3. Using a little algebra, we can turn this into the familiar equation of a line:
y = b + mx
Step 4. Simplify the equation.
Step 5. This equation fits the budget constraint.
Related Topics
- Self Interest
- Cost-Benefit Analysis
- Enlightened Self-Interest
- Fisher's Separation Theorem
- Ratchet Effect
- Total Utility (Economics)
- Efficiency Principle
- Expected Utility
- Subjective Theory of Value
- Positional Goods
- Utilitarianism
- Indifference Curve
- Time Preference Theory of Interest
- Incentives
- Marginal Benefit
- Diminishing Marginal Utility
- Sunk Costs
- Production Possibilities Frontier
- Law of Diminishing Returns
- Economic Efficiency
- Efficiency Theory
- Productive Efficiency
- Capacity Utilization Rate
- Allocative Efficiency
- Pareto Efficient
- Comparative Advantage
- Criticisms of the Economic Approach
- Behavioral Economics
- Normative Economics
- Positive Economics
- Invisible Hand
- Sunk cost
