The Budget Line
Rose Bole has only $100 to spend on her two passions in
life: buying books and attending movies. If all books cost
$5.00 and all movies cost $2.50 (these are simply
assumptions to make the problem easier--as is the assumption
that only two items are involved in the problem), the graph
below shows the options open to Rose. The budget line is a
frontier showing what Rose can attain. The budget line
limits choices; it is due to
scarcity. The cost of a book is $5.00 or two movies.
Spending money on a product means that money cannot be used
to purchase another product. In the case of books versus
movies, the tradeoff is a straight line because one more
book always costs two movies, regardless of how many books
Rose has already.
You should be able to see that the slope of the budget
line depends only on the price of books relative to the
price of movies. If either books get cheaper or movies
get more expensive, the budget line in the graph above will
get steeper. If this is not immediately obvious, compute the
possibilities open to a person with $100 to spend if books
and movies both cost $5.00 (a case of more expensive
movies), and the possibilities open to a person with $100 to
spend if books and movies both cost $2.50 (a case of cheaper
books). Graphing the possibilities open to a person with
only $50 to spend but with books costing $5.00 and movies
costing $2.50 gives you a line that is to the left of the
line in the graph above, but parallel to it, which means
that it has the same slope. The amount of money available to
spend does not determine the slope of the budget line; only
the ratio of prices does that.
A famous example of a budget constraint is the case of
guns versus butter. During the Second World War, the United
States decided it needed to produce large amounts of
armaments (guns). It shifted factories that previously
produced goods for civilian use (butter) to the production
of guns. This tradeoff could be represented as a move from a
point such as a to a point such as b in the
graph below, except that at the start of the war there was
still a high level of unemployment left over from the
recessions of 1929-33 and 1937-8 (a period better known as
the Great
Depression). Hence, the United States was not at the
limit of what it could produce, but rather at a point such
as c, which indicates that more of all goods could
have been produced given the amount of resources and
technology.
Though point d was a more desirable position than
points a or b, it was unattainable given
technology and resources. The limit to what is possible to
produce is called the production-possibilities
frontier. Its existence, which is a result of scarcity,
indicates that there are costs to producing all goods and
services. During World War II, the cost of producing
thousands of tanks and jeeps was the virtual elimination of
production of autos for civilian use. The cost of feeding
millions of troops in the field was a less attractive diet
for the civilian population.
The major idea in this section has been that all economic
activity takes place within limitations or constraints.
Because of these constraints, choosing results in sacrificed
options. The options that are not taken, which sometimes can
be measured in monetary terms, are costs.
Next, we combine the
utility function and budget line.
Copyright
Robert Schenk
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