Economy and Business>>The Budget Constraint
The budget constraint is a part of the consumer behavior theory, this assumes than anybody can buy more things with a price set when has already spent all his budget. This can be completed comparing with the utility of the goods, people will buy the most useful possible but without exceeding their budget.
Let's assume that in a economy we can buy two kinds of goods: wine and glass, with a price set (Pg,Pw). The maximum amount people can afford of a good is 9 of wine (with no glass) and 20 of glass (with no wine). According the consumer behavior theory, We can draw it in a graph for a better understanding and the result will be the following:
Consumers can buy any combination of goods located in the blue area. Note that the maximum amount of wine is different than the maximum amount of glass. This is because each good has a different price, if each unit of glass cost Pg, each unit of wine cost Pw and the economy has a budget of size m, we have:
Qglasses*Pglass+Qwine*Pw≤m. This is the equation of all sets (Qg,Qw) people can buy with the budget m and the price set (Pg,Pw). if we change the ≤ for a = we have the sets of (Qg,Qw) that will spend the money in the economy, the budget constraint.
The exact amount of each depends on the preferences of people, but will be placed in the blue area.
Changes in the price set
According the consumer behavior theory, If Wine and glass change of price and the budget remains equal, the constrain will be shifted to the right if prices decrease (B1-B2), and to the left if prices increase.
If all gets more expensive by the inflation, people will lose all the possibilities placed in the yellow area as people will can buy fewer of everything. In the case of lower prices, people will can buy more and in this case people will gain a yellow area, This graph can mean the two things, but without trying to match the quantities.
A shift from B1 to B2 can also happen because of a fiscal stimulus. What done Obama decreasing the Taxes, is exactly this. If the taxes are lower, people will have more money and will and buy more of everything. In the case of a raise of taxes, the shift will be like moving from B2 to B1
Now we will see what happens when only changes the price of a good:
if while the price of glass remains steady and the wine becomes more expensive in the way that people can can only buy a maximum of 5 units, instead of 9. The constraint will be moved from B2 to B1 and economy will loose the yellow area. If the change was from B1 to B2 we understood a decrease in prices of wine.
This other Graph is the the same but in that case what change in price are glasses instead of wine.
Rationing
The consumer behavior theory regards cases of war or other catastrophes, when the government can ration goods, in this case the rationing is on wine, because of a epidemics of alcoholism, the government has limited the wine consumption in 5 units.y I cut the blue area with a red line to represent this.
The result is that the new constraint will be the following, with all the sets containing more than five units of wine removed.
Tax on consumption
Now Imagine that the government wants to charge a tax t when consuming more than 5 units of wine, this will mean that the 6th unit will cost Pw+t . The maximum consumption of wine will be decreased and the constraint will have 2 slopes. The constraint of the blue area will continue being Qglasses*Pglass +Qwine*Pw≤m but the yellow area will be limited with the constraint caused by the new priceof wine: Qglasses*Pglass +Qwine*(Pw+t)≤m
