Economics, 3rd Edition

104  PART 2  SUPPLY AND DEMAND: HOW MARKETS WORK

THE BUDGET CONSTRAINT: WHAT THE CONSUMER CAN AFFORD

One of the assumptions the SEM makes is that more is preferred to less. Most people would like to 

increase the quantity or quality of the goods they consume – to take longer holidays, drive fancier cars 

or buy a bigger house. People consume less than they desire because their spending is constrained, or 

limited, by their income.

To keep things simple, let us use a model which examines the decisions facing a consumer who buys 

only two goods: cola and pizza. Of course, real people buy thousands of different kinds of goods. Yet using 

this model greatly simplifies the problem without altering the basic insights about consumer choice.

Suppose that the consumer has an income of 

€1,000 per month and that he spends his entire income 

each month on cola and pizza. The price of a litre of cola is 

€2 and the price of a pizza is €10.

The table in Figure 5.1 shows some of the many combinations of cola and pizza that the consumer 

can buy. The first row in the table shows that if the consumer spends all his income on pizza, he can 

eat 100 pizzas during the month, but he would not be able to buy any cola at all. The second line shows 

another possible consumption bundle: 90 pizzas and 50 litres of cola. And so on. Each consumption bundle 

in the table uses up the consumer’s income – exactly 

€1,000.