{"id":5054,"date":"2016-07-20T21:05:56","date_gmt":"2016-07-20T21:05:56","guid":{"rendered":"https:\/\/courses.lumenlearning.com\/microeconomics\/?post_type=chapter&p=5054"},"modified":"2016-07-20T21:05:56","modified_gmt":"2016-07-20T21:05:56","slug":"reading-budget-constraints-and-choices","status":"publish","type":"chapter","link":"https:\/\/courses.lumenlearning.com\/atd-herkimer-microeconomics\/chapter\/reading-budget-constraints-and-choices\/","title":{"raw":"Reading: Budget Constraints and Choices","rendered":"Reading: Budget Constraints and Choices"},"content":{"raw":"

Budget Constraint Framework<\/h2>\n\"Photo<\/a>\n\nFor most of us, the idea of scarcity and trade-offs is something we experience\u00a0in a very real way when it comes to our\u00a0own budget constraints. Most of us have a limited amount of money to spend on the things we need and want. Another kind of budget constraint is time. For instance, as a student, you only\u00a0have\u00a0twenty-four hours in the day to study, eat, sleep, and check Facebook. An hour spent studying economics is an hour that can't be used for sleep or play (or something else). As a result, you have\u00a0to make choices and trade-offs.\n\nIn economics, a budget constraint<\/strong> refers to\u00a0all possible combinations of goods that someone can afford, given the prices of goods, when all income (or time) is spent.\n\nTake\u00a0the following example of someone who must choose between two different\u00a0goods:\u00a0Charlie\u00a0has $10 in spending money each week that he can allocate between bus tickets for getting to work and the burgers he eats for lunch. Burgers cost $2 each, and bus tickets are 50 cents each. Figure 1, below, shows Charlie's\u00a0budget constraint ($10) and all the possible combinations of burgers and bus tickets he\u00a0can afford if he spends all his money.\u00a0<\/span>\n\n[caption id=\"\" align=\"aligncenter\" width=\"451\"]\"GraphFigure 1.<\/strong>\u00a0Charlie's budget constraint[\/caption]\n\nThe vertical axis in the figure shows burger purchases, and the horizontal axis shows bus ticket purchases. If Charlie\u00a0spends all his money on burgers, he can afford five per week. ($10 per week\/$2 per burger = 5 burgers per week.) But if he does this, he won't\u00a0be able to afford any bus tickets. This choice (zero\u00a0bus tickets and 5\u00a0burgers) is shown by point A in the figure. Alternatively, if Charlie\u00a0spends all his money on bus tickets, he can afford 20 per week. ($10 per week\/$0.50 per bus ticket = 20 bus tickets per week.) Then, however, he will not be able to afford any burgers. This alternative choice (20 bus tickets and zero burgers) is shown by point F. The slope of the budget constraint is determined by the relative price of burgers and bus tickets.\n\nIf Charlie\u00a0is like most people, he will choose some combination that includes both bus tickets and burgers\u2014that is, he will choose one of the points along the budget-constraint line that connects points A and F. Each point inside or on the budget constraint shows a combination of burgers and bus tickets that Charlie\u00a0can afford. (A point inside the curve is definitely\u00a0an option\u2014it just means that Charlie isn't spending all his money.) Keep in mind that\u00a0the\u00a0curve represents the maximum<\/em> number of burgers and bus tickets he can buy.\u00a0Any point outside the constraint is not affordable, because it would cost more money than Charlie\u00a0has in his budget.\n\nThe budget constraint clearly shows the trade-off Charlie\u00a0faces in choosing between burgers and bus tickets. Suppose he is currently at point D, where he can afford 12 bus tickets and 2\u00a0burgers. What would it cost Charlie\u00a0for one more burger? It would be natural to answer $2, but that's not the way economists think. Instead, they ask: How many bus tickets would Charlie\u00a0have to give up to get one more burger, while staying within his budget? The answer is four bus tickets. That is the true cost to Charlie\u00a0of one more burger.\n\nA budget-constraint diagram\u00a0like the one above, with just\u00a0two goods\u2014burgers and bus tickets\u2014is simple and not very realistic. After all, in an economy like ours (and Charlie's), people choose from thousands of goods. However, economists use graphs and models to illustrate\u00a0that every\u00a0choice has an opportunity cost<\/strong>, which is the point that carries over to the real world.\n

Sunk Costs<\/h3>\nIn the budget constraint framework, all decisions involve what will happen next: What quantities of goods will you consume? How many hours will you work? How much will you save? \u00a0Choices made or costs in the past are not taken into account. The budget constraint framework assumes that sunk<\/strong> costs<\/strong>\u2014costs incurred in the past that\u00a0can't be recovered\u2014should not affect the current decision.\n\nSuppose you pay $8 to see a movie, but after watching the first thirty minutes, you decide that it's awful. Should you\u00a0stick it out and watch the rest because you paid for\u00a0the ticket, or should you\u00a0leave? The money you spent\u00a0on the ticket is a sunk cost, and unless the theater manager is feeling generous, you won't\u00a0get a refund. But staying for the rest of the movie means paying an opportunity cost in time. Your\u00a0choice is whether to spend the next ninety minutes suffering through a rotten movie\u00a0or do something\u2014anything\u2014else. The lesson of sunk costs is to forget about the money and time that is irretrievably gone and to focus, instead, on the\u00a0<\/span>costs and benefits of current and future options. A sunk cost is water under the bridge, so to speak.\n\nFor people and organizations\u00a0alike, dealing with sunk costs can be frustrating and difficult. For one thing, it often means admitting an earlier error of judgment. Many companies find it hard to give up on a new product that's doing poorly because they've invested so much time and money in the product development and launch. But the lesson of sunk costs is to ignore them and make decisions based on what will happen in the future.\n\n\"Photo<\/a>","rendered":"

Budget Constraint Framework<\/h2>\n

\"Photo<\/a><\/p>\n

For most of us, the idea of scarcity and trade-offs is something we experience\u00a0in a very real way when it comes to our\u00a0own budget constraints. Most of us have a limited amount of money to spend on the things we need and want. Another kind of budget constraint is time. For instance, as a student, you only\u00a0have\u00a0twenty-four hours in the day to study, eat, sleep, and check Facebook. An hour spent studying economics is an hour that can’t be used for sleep or play (or something else). As a result, you have\u00a0to make choices and trade-offs.<\/p>\n

In economics, a budget constraint<\/strong> refers to\u00a0all possible combinations of goods that someone can afford, given the prices of goods, when all income (or time) is spent.<\/p>\n

Take\u00a0the following example of someone who must choose between two different\u00a0goods:\u00a0Charlie\u00a0has $10 in spending money each week that he can allocate between bus tickets for getting to work and the burgers he eats for lunch. Burgers cost $2 each, and bus tickets are 50 cents each. Figure 1, below, shows Charlie’s\u00a0budget constraint ($10) and all the possible combinations of burgers and bus tickets he\u00a0can afford if he spends all his money.\u00a0<\/span><\/p>\n

\"Graph<\/p>\n

Figure 1.<\/strong>\u00a0Charlie’s budget constraint<\/p>\n<\/div>\n

The vertical axis in the figure shows burger purchases, and the horizontal axis shows bus ticket purchases. If Charlie\u00a0spends all his money on burgers, he can afford five per week. ($10 per week\/$2 per burger = 5 burgers per week.) But if he does this, he won’t\u00a0be able to afford any bus tickets. This choice (zero\u00a0bus tickets and 5\u00a0burgers) is shown by point A in the figure. Alternatively, if Charlie\u00a0spends all his money on bus tickets, he can afford 20 per week. ($10 per week\/$0.50 per bus ticket = 20 bus tickets per week.) Then, however, he will not be able to afford any burgers. This alternative choice (20 bus tickets and zero burgers) is shown by point F. The slope of the budget constraint is determined by the relative price of burgers and bus tickets.<\/p>\n

If Charlie\u00a0is like most people, he will choose some combination that includes both bus tickets and burgers\u2014that is, he will choose one of the points along the budget-constraint line that connects points A and F. Each point inside or on the budget constraint shows a combination of burgers and bus tickets that Charlie\u00a0can afford. (A point inside the curve is definitely\u00a0an option\u2014it just means that Charlie isn’t spending all his money.) Keep in mind that\u00a0the\u00a0curve represents the maximum<\/em> number of burgers and bus tickets he can buy.\u00a0Any point outside the constraint is not affordable, because it would cost more money than Charlie\u00a0has in his budget.<\/p>\n

The budget constraint clearly shows the trade-off Charlie\u00a0faces in choosing between burgers and bus tickets. Suppose he is currently at point D, where he can afford 12 bus tickets and 2\u00a0burgers. What would it cost Charlie\u00a0for one more burger? It would be natural to answer $2, but that’s not the way economists think. Instead, they ask: How many bus tickets would Charlie\u00a0have to give up to get one more burger, while staying within his budget? The answer is four bus tickets. That is the true cost to Charlie\u00a0of one more burger.<\/p>\n

A budget-constraint diagram\u00a0like the one above, with just\u00a0two goods\u2014burgers and bus tickets\u2014is simple and not very realistic. After all, in an economy like ours (and Charlie’s), people choose from thousands of goods. However, economists use graphs and models to illustrate\u00a0that every\u00a0choice has an opportunity cost<\/strong>, which is the point that carries over to the real world.<\/p>\n

Sunk Costs<\/h3>\n

In the budget constraint framework, all decisions involve what will happen next: What quantities of goods will you consume? How many hours will you work? How much will you save? \u00a0Choices made or costs in the past are not taken into account. The budget constraint framework assumes that sunk<\/strong> costs<\/strong>\u2014costs incurred in the past that\u00a0can’t be recovered\u2014should not affect the current decision.<\/p>\n

Suppose you pay $8 to see a movie, but after watching the first thirty minutes, you decide that it’s awful. Should you\u00a0stick it out and watch the rest because you paid for\u00a0the ticket, or should you\u00a0leave? The money you spent\u00a0on the ticket is a sunk cost, and unless the theater manager is feeling generous, you won’t\u00a0get a refund. But staying for the rest of the movie means paying an opportunity cost in time. Your\u00a0choice is whether to spend the next ninety minutes suffering through a rotten movie\u00a0or do something\u2014anything\u2014else. The lesson of sunk costs is to forget about the money and time that is irretrievably gone and to focus, instead, on the\u00a0<\/span>costs and benefits of current and future options. A sunk cost is water under the bridge, so to speak.<\/p>\n

For people and organizations\u00a0alike, dealing with sunk costs can be frustrating and difficult. For one thing, it often means admitting an earlier error of judgment. Many companies find it hard to give up on a new product that’s doing poorly because they’ve invested so much time and money in the product development and launch. But the lesson of sunk costs is to ignore them and make decisions based on what will happen in the future.<\/p>\n

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Candela Citations<\/h3>\n\t\t\t\t\t
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CC licensed content, Original<\/div>