Essential Mathematics for Economics and Business, 4 th Edition

CHAPTER 2 : BUDGET AND COST CONSTRAINTS.

John Wiley and Sons 2013

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 Worked Example 2.22, Figure 2.39:How to plot a budget

constraint.

Worked Example 2.23, Figure 2.40:The effect of a price change

in good X (on the horizontal).

Worked Example 2.23, Figure 2.41:

The effect of a price change in good Y (on the vertical).

Worked Example 2.23, Figure 2.42: The effect of a change in

the budget limit

Plot an Isocost constraint

Effect of change in the price of labour.

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 How to plot any Linear Budget Constraint

M PX
xPX yPY M y x
PY PY
Rearrange the equation in the form y = mx + c (see above)
Plot y on the vertical axis, against x on the horizontal axis
Calculate and plot the vertical and horizontal intercepts
Join the points and label the graph
M
40
Quantity of good Y, PY

30

y 20

10 M
PX

0
0 30 60 90
Quantity of good X , x

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 Plot the Budget Constraint: x P y P M
X Y

Given: PX =2: PY = 6: M = 180: plot the constraint.

xPX + yPY = M
x (2) + y(6) = 180
(units of X) (price per unit) + (units of Y )(price per unit) = budget limit

This is the equation of the budget constraint.

To plot, rearrange the equation into the form y = mx + c:

Hence, 2x + 6y = 180 is rearranged as: y = 30 - 0.33x

In this form, it is easy to read off intercepts

Vertical intercept = 30 (value of y when x = 0):

Horizontal intercept = 90 (value of x when y = 0)

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Plot the Budget Constraint: 2x + 6y = 180
where PX =2: PY = 6: M = 180: x(2) + y(6) = 180

Plot the horizontal intercept: x = 90

Plot the vertical intercept: y = 30
Join these points
M
40
PY
y = 30 - 0.33 x
30
Quantity of good Y , y
PX
Slope =
20 PY

10 M
PX

0
0 30 60 90
Quantity of good X , x
Figure 2.39

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 Another Example : Plot the Budget Constraint
given PX =3: PY = 6: M = 180:
Substitute the prices and budget limit into the general equation:
xPX yPY M

x(3) + y(6) = 180.

Rearrange the equation into the form y = mx + c: y = 30 - 0.5x
Hence, vertical intercept = 30; horizontal intercept = 60.

Quantity of good Y, y Budget constraint: M = 180

30

Quantity of good X, x
60

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 Adjust the equation of the Budget Constraint
y= 30 -0.5x when the price of good X decreases.
PX decreases from 3 to 1.5

The original budget constraint, PX =3: PY = 6: M = 180,

Hence, the equation 3x + 6y = 180 (or y = 30 - 0.5x)

To find the equation of the new budget constraint

write PX = 1.5 in the original budget constraint (nothing else

changes)

Hence, the equation of the new budget constraint is: (1.5)x + 6y =

180.

Rearrange this equation (for plotting later) to the form y = mx + c:

Hence y = 30 - 0.25x is the equation of the budget constraint when P

has decreased from 3 to 1.5
The intercept (30) is the same: slope has changed from -0.5 to -
0.25
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Original Budget Constraint: y=30 - 0.5x
Plot the new budget constraint when price of good X decreases from 3
to 1.5
When PX decreases from 3 to 1.5
Equation of new budget constraint becomes: y = 30 - 0.25x
Plot the vertical intercept = 30 (this is the same as the original)
Plot the horizontal intercept = 120 (this is different from the
original) y

30

20

10

0 x
0 20 40 60 80 100 120

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 Plot the original budget constraint: y = 30 - 0.5x and the new
budget constraint when PX decreases from 3 to 1.5.
New budget constraint is y = 30 0.25x
For the new budget constraint: y = 30 0.25x:
(i) vertical intercept = 30 (ii) horizontal intercept = 120.
Join the vertical intercept = 30 and the horizontal intercept = 120

30

Original Constraint
20
y
Constraint with PX
10 decreases from 3 to 1.5

0
0 20 40 60 80 100 120
x

Figure 2.40

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 Summary: Change in the equation and graph of the Budget
Constraint: y = 30 - 0.5x when the price of good X decreases from
3 to 1.5
When PX decreases from 3 to 1.5 the new constraint is y = 30 0.25x
The new budget constraint pivots out from the unchanged vertical intercept (see
Figure 2.40)
(note: as X decreases in price, more units of X are affordable, so x increases)

40
y

30

Original: y = 30 - 0.5x
20

New: y = 30 - 0.25x

10

0
0 20 40 60 80 100 120
x

Figure 2.40 PX and its effect on the budget constraint

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 Adjust the equation of the original Budget Constraint:
y = 30 - 0.5x,
when the price of good Y decreases from 6 to 3
The equation of original budget constraint, where PX =3: PY = 6:
and M = 180 is 3x + 6y = 180 (or y = 30 - 0.5x)
Find the equation of the new constraint when PY changes from 6 to 3.

To obtain the equation of the new budget constraint

Replace 6 (the value of PY ) by 3 in the original equation (nothing else
changes)
The equation of new budget constraint is:
3x + (3) y = 180
Rearrange the equation into the form y = mx + c (for plotting):
Hence, the equation of the new budget constraint is y = 60 x.

Horizontal intercept is the same: slope has changed from -0.5 to -1

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 Adjust the graph of the Budget Constraint: y = 30 - 0.5x when
the price of good Y decreases
When PY changes from 6 to 3
The equation of the budget constraint becomes: y = 60 - x
Read off the intercepts;
Plot the vertical intercept = 60
Plot the horizontal intercept = 60
Join the intercepts

70

60

50

40

30

20

10

x
0
0 20 40 60

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 Compare the graphs of the original budget constraint and new
budget constraint following a decrease in the price of good Y
The new constraint pivots upwards from the unchanged horizontal
intercept (see Figure 2.41)
Comment: When Y decreases in price, more units of Y are
affordable
y
70

60
y = 60 - x
50

40

30

y = 30 - 0.5 x
20

10

x
0
0 20 40 60

Figure 2.41 PY and its effect on the budget constraint

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 Adjust the equation of the Budget Constraint:
y = 30 - 0.5x when the budget limit increases
M changes from 180 to 240
The original budget constraint, where PX =3: PY = 6: M =
180,
was given by the equation was: 3x + 6y = 180 ( or y = 30 - 0.5x)

To obtain the equation of the new budget constraint

replace M by 240 (nothing else changes)
The equation of the new budget constraint becomes: 3x + 6y =
240:
Rearrange this equation into the form y = mx + c (for plotting
later):
The equation of the budget constraint
is y = 40 - 0.5x.

Slope is the same: vertical intercept has changed from 30

to 40

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 Change in the graph of the Budget Constraint:
y = 30 - 0.5x when the budget limit increases

M changes from 180 to 240

Equation of budget constraint becomes: y = 40 - 0.5x
Plot the vertical intercept = 40
Plot the horizontal intercept = 80

y 50

40

30

20

10

0 x
0 20 40 60 80

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 Change in the graph of the Budget Constraint:
y = 30 - 0.5x when the budget limit increases

The adjusted budget constraint is: y = 40 - 0.5x

Join the vertical intercept = 40 and the horizontal intercept = 80

y 50

40
New budget limit = 240
30

20

10
Original budget limit = 180

0 x
0 20 40 60 80

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 Summary: Change in the graph of the Budget Constraint:
y = 30 - 0.5x when the budget limit increases

When the budget limit increases, the constraint moves upwards,

parallel to the original constraint
Comment: When the budget limit increases, more units of both X
and Y are affordable
y 50

40
Budget = 240
30

20

10
Budget = 180

0 x
0 20 40 60 80

Figure 2.42 Y and its effect on the Budget constraint

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 Plot the Isocost line:4K + 5L = 8000 as K = f(L).
Method:
Rearrange the equation to K = f(L):
Hence K = 2000 - 1.25L
Plot K on the vertical axis, L on the horizontal axis.
Calculate and plot the horizontal and vertical intercepts.
A and B are simply two extra points.
It is a safeguard (against arithmetic errors) to plot at least one extra point
when plotting lines
Join the points K
2500
C
r
2000

A
1500
K = 2000 - 1.25L
B
1000

500 C
w
0 L
0 400 800 1200 1600

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 Isocost line:4K + 5L = 8000, hence K = 2000 - 1.25L
Labour increases from 5 to 8 per hour:
The equation of the new isocost line is K = 2000 -2L
Plot the horizontal and vertical intercepts : draw the isocost line
The horizontal intercept moves towards the origin, along the
horizontal axis
Comment: when the price of labour increases, fewer units are
affordable

Figure 2.48 K
2500

2000

1500 K = 2000 - 1.25L

1000
K = 2000 2L

500

0 L
200

400

600

800

1000

1200

1400

1600
0

Effect of change in price of labour on the isocost line

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