Budget Lines & the Rate of Transformation in Economics

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  • 0:02 Budget Constraints
  • 1:02 Rate of Transformation
  • 2:39 Impact
  • 3:51 Lesson Summary
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Lesson Transcript
Instructor: Kevin Newton

Kevin has edited encyclopedias, taught middle and high school history, and has a master's degree in Islamic law.

Ever wonder why combo deals at pizza places appeal to us so much? They save us money, right? This lesson explains how economists measure the power of one's budget, as well as how businesses can use that information to their advantage.

What Are Budget Constraints?

It's a fact - everyone has a limited supply of money. From the high school kid working at a fast food place to Bill Gates, no one has truly limitless money. As a result, everyone is forced to work within budget constraints, or the limits that our money places on our purchasing. Depressing as it sounds, budgeting is not just something that your parents or your financial advisor are constantly talking about; it is a very real part of economics.

Let's assume for a second that you have budgeted a specific amount of money, perhaps $40, for purchasing soft drinks and pizza for your movie night. Each case of soft drinks costs $5, while each pizza costs $10. You could purchase eight cases of soft drinks and no pizza, or four pizzas and no soft drinks. Note that you cannot do both, because that would cost $80, and you only have $40. What should you do?

The Rate of Transformation Curve

In true economics style, we have a model for that. Known as the rate of transformation, the model measures the amount of two goods you can get for a specific amount of money. Think about it as the rate at which the purchase of one good is transformed into the purchase of another good. The line created by the measurement is called the budget line. Sometimes, you'll see it referred to as the rate of transformation curve.

For our above example, here is a graph that shows the rate of transformation between pizza and soft drinks:

Rate of Transformation Curve
rate of transformation curve for pizza and drinks

From this chart, we can see that there are points at which we can have both soft drinks and pizza. Depending on our utility for each, we could purchase someplace towards one axis or the other or square in the middle. Only have one friend that drinks soft drinks? Then chances are you'd only buy one or two cases and maximize on pizza.

What about if your friends are all the type to eat only two slices each, but will drink soft drinks all night long? Then, you may get six cases of soft drinks, but only one pizza. As long as the point chosen is on the line, then in theory you can buy it. Of course, for this example, whole numbers are necessary, but if you were buying produce at a grocery store, you could actually buy half or even quarter pound increments. Additionally, you could choose a point inside the budget line curve and save some of your money. On the other hand, you could not choose a point to the right of the curve, because you don't have enough money to make that purchase. Of course, you could always ask your friends to chip in some money.

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