32 PA R T I INTRODUCTION AND BACKGROUND

FIGURE 2-5

Quantity of
CDs, QC
(price, PC, = $16)

A Budget constraint
6
(Y = $96)

Slope = 8/16 = 1/2

B
0 12 Quantity of
movies, QM
(price, PM, = $8)

Budget Constraint With an income, Y, of $96, a price of $16 per CD, and a price of $8 per
movie, Andrea can trade off 1 CD for 2 movies, up to a total of either 6 CDs or 12 movies. The
slope of the budget constraint is therefore 12, indicating the ratio of movie-to-CD prices.

Graphically, the budget constraint is represented by the line AB in Figure 2-5.

The horizontal intercept is the number of movies that Andrea can buy if she
purchases no CDs, and the vertical intercept is the number of CDs she can
buy if she goes to no movies, and the slope of the budget constraint is the rate
at which the market allows her to trade off CDs for movies. This rate is the
negative of the price ratio PM /PC : each extra movie that she buys, holding
income constant, must lower the number of CDs that she can buy by PM /PC.
Figure 2-5 illustrates the budget constraint for the case when Y $96,
PC $16, and PM $8. At this income and these prices, Andrea can purchase
12 movies or 6 CDs, and each CD she buys means that she can buy 2 fewer
movies. The slope of the budget constraint is the rate at which she can trade
CDs for movies in the marketplace, PM /PC 816 12.

opportunity cost The cost of

any purchase is the next best
Q Q u i c k H i n t Our discussion thus far has been couched in terms of trading
CDs for movies and vice versa. In reality, however, we dont directly trade one
good for another; instead, we trade in a market economy, in which CDs and
movies are purchased using dollars. The reason we say trading CDs for movies
is because of the central economics concept of opportunity cost, which says
alternative use of that money,
that the cost of any purchase is the next best alternative use of that money.
or the forgone opportunity.
Thus, given a fixed budget, when a person buys a CD, he forgoes the opportunity