Economics, 3rd Edition

270

0

50

15

100

B

C

E

D

A

Consumer’s

budget constraint

Quantity

of pizza

Litres 

of cola

Spending 

on cola (

€)

Number 

of pizzas

Spending 

on pizza (

€)

Total  

spending (

€)

0

0

100

1,000

1,000

50

100

90

900

1,000

100

200

80

800

1,000

150

300

70

700

1,000

200

400

60

600

1,000

250

500

50

500

1,000

300

600

40

400

1,000

350

700

30

300

1,000

400

800

20

200

1,000

450

900

10

100

1,000

500

1,000

0

0

1,000

---

CHAPTER 5  BACKGROUND TO DEMAND: THE THEORY OF CONSUMER CHOICE  105

the many combinations of cola and pizza that the consumer can choose given a specified income. All the 

points on and inside the line from A to B are possible. In this case, it shows the trade-off between cola 

and pizza that the consumer faces.

For example, assume the consumer is at point A, consuming 100 pizzas and zero cola. If the consumer 

wants to purchase a drink to go with his pizza he must give up some pizza in order to buy some cola – he 

has to trade-off the benefits of consuming cola against the benefits foregone of reducing consumption of 

pizza. We can quantify this trade-off. If the consumer moves to point C then he has to forego the benefits 

that 50 pizzas would provide to gain the benefits that 250 litres of cola would bring. The consumer would 

have to make a decision about whether it is worth giving up those 50 pizzas to get the benefits of the cola.

The slope of the budget constraint measures the rate at which the consumer can trade one good for 

the other. Remember, the slope between two points is calculated as the change in the vertical distance 

divided by the change in the horizontal distance (‘rise over run’). From point A to point B, the vertical dis-

tance is 500 litres, and the horizontal distance is 100 pizzas. Because the budget constraint slopes down-

wards, the slope is a negative number – this reflects the fact that to get one extra pizza, the consumer has  

to reduce his consumption of cola by five litres. In fact, the slope of the budget constraint (ignoring the 

minus sign) equals the relative price of the two goods – the price of one good compared to the price of 

the other. A pizza costs 5 times as much as a litre of cola, so the opportunity cost of a pizza is 5 litres of 

cola. The budget constraint’s slope of 5 reflects the trade-off the market is offering the consumer: 1 pizza 

for 5 litres of cola.

The opportunity cost of buying one extra pizza is five litres of cola. It is useful to use a rule of thumb 

(a heuristic) here; the opportunity cost of a good on the horizontal axis (pizza in our example) is the slope 

of the budget constraint (5 in this example). What is the opportunity cost of 1 extra litre of cola in our 

example? The opportunity cost of the good on the vertical axis is the inverse of the slope of the budget 

constraint which in this case is 

1

5

 or 0.2. To acquire 1 extra litre of cola the consumer has to sacrifice one-

fifth of a pizza. In some examples of budget constraints you may encounter, you might find the opportunity 

cost calculation does not make much sense. If the two goods being considered were cola and tins of soup 

you could not ask the shop to chop up the tin of soup into five! What is important to remember is that 

the slope is related to the ratio of prices of the goods being considered (the relative prices), 

P

    

x

P

    

y

 where P

 

y 

is the price of the good on the vertical axis and P

 

x is the price of the good on the horizontal axis. In our 

example the ratio of the prices is 

10

2

 which when simplified becomes 5.

SELF TEST 

Draw a budget constraint for a person with income of 

€5,000 if the price of food is €10 per unit 

and the price of leisure is 

€15 (per hour). What is the slope of this budget constraint? What is the opportunity 

cost of an extra hour of leisure in terms of food?