How Individuals Make Choices Based on Their Budget Constraints
Read this section to understand the concept of a budget constraint and how people make decisions when faced with this type of constraint. In economics, a budget constraint is a model that represents two possible things to choose from when spending some income. For example, suppose that you are a store manager and you have $100 to spend on two things for decorations for the store: flower arrangements at $10 each and posters at $5 each. A budget constraint for $100 will then be the different combinations with different number of flower arrangements and posters.
From a Model with Two Goods to One of Many Goods
The budget constraint diagram containing just two goods, like most models used in this book, is not realistic. After all, in a modern economy people choose from thousands of goods. However, thinking about a model with many goods is a straightforward extension of what we discussed here. Instead of drawing just one budget constraint, showing the tradeoff between two goods, you can draw multiple budget constraints, showing the possible tradeoffs between many different pairs of goods. Or in more advanced classes in economics, you would use mathematical equations that include many possible goods and services that can be purchased, together with their quantities and prices, and show how the total spending on all goods and services is limited to the overall budget available. The graph with two goods that was presented here clearly illustrates that every choice has an opportunity cost, which is the point that does carry over to the real world.