BUDGET CONSTRAINT

Consumption choices are limited by income and prices. We summarize these influences on buying plans in a budget line or constraint. Given his or her tastes or preferences, along with the assumption of rationality of consumers, he or she tries to get on the highest possible indifference curve. To do so, the consumer must consider factors other than his or her own tastes or preferences or choices. These factors, such as prices of commodities and the level of the consumer’s income, can limit or constrain the nature and size of the market basket that he or she can buy.

Let’s consider the budget constraint facing an individual who has a fixed level of income (I) that can be used to buy two goods (X and Y) at fixed prices (PX and Py). The budget constraint facing this individual can be expressed as:

Px.X + Py.Y = I