Budget line

0:00What I want to do in this video

•Current transcript segment:0:01is introduce you to the idea of a budget line.
0:04Actually, probably isn't a new idea.
0:06It's a derivative idea of what you've seen
0:08and often in an introductory algebra course
0:11where A, you've gotten a certain amount of money
0:13and you can spend it on a certain combination of goods.
0:16What are all the different possibilities
0:17that you can actually buy?
0:19That's really what a budget line is.
0:21Let's say that you have an income
0:23and I'll do it both in the abstract
0:24and the concrete.
0:25I'll do it variables
0:27and then I'll also do it with actual numbers.
0:29Lets say your income, your income in a month is Y
0:35and lets say that you spend all of your money.
0:38Your income is equal to your expenditures.
0:43Assuming in our little model here
0:45that you're not going to be saving any money.
0:47To show how overly simplified we can make a model
0:51we are going to only assume
0:53that you can spend on two different goods
0:55and that's so that we can actually plot
0:56all the combinations on a two dimensional surface
0:59like the screen over here.
1:00Obviously, most people buy many more
1:02or they at least are choosing between many,
1:04many more than two goods.
1:06But let's say you can choose between 2 goods
1:08and let's just take goods that we've been doing
1:11using in recent videos.
1:12That 2 goods that you buy are either chocolate or fruit.
1:16You could buy chocolate by the bar
1:18or fruit by the pound.
1:19What are going to be your expenditures
1:20assuming you spend it all on chocolate and fruit?
1:23Well, there's going to be the amount
1:26that you spend on chocolate
1:27will be the price of chocolate
1:28times the quantity of chocolate you buy
1:30which is the number of bars.
1:31And then the amount you spent on fruit
1:34will be the price of fruit per pound
1:36times the quantity of fruit.
1:40For example, if Y = $20 a month
1:49and the price, actually we'll plot this in a second,
1:52the price of chocolate is equal to $1 per bar
1:58and the price of fruit is equal to $2 per pound.
2:04I think these were the prices I used
2:05in a per pound of fruit.
2:07Then all of a sudden, you would know what this is,
2:09you would know what this is and this is.
2:12You know what the Ps are and the Y
2:13and then you could actually graph one of these
2:16quantities relative to the other.
2:19What we can do is, and let's do that,
2:21we can graph the quantity of 1 relative to the other.
2:27Why don't we put the quantity of chocolate
2:29on this axis over here and let's put the quantity of fruit
2:32on this axis over here.
2:34First, if we wanted to graph it I like to put it,
2:37since I've put quantity of chocolate
2:38on the vertical axis here,
2:40I'd like to solve this equation for quantity of chocolate
2:43as a function of quantity fruit
2:45and it should make it pretty straight forward to graph.
2:47Let's try that out.
2:48First, I'm just going to rewrite this
2:49without expenditures in between.
2:51We have our income,
2:53our income Y = price of chocolate
2:57times the quantity of chocolate
3:00plus the price of fruit times the quantity of fruit.
3:05Now, I want to solve for the quantity of chocolate.
3:09Let me make that orange
3:10so we know that this is this one right over here.
3:13If I want to solve for that,
3:15the best way I could isolate it one side of this equation.
3:19Let me get rid of this this yellow part right over here
3:22and the best way to do that
3:23is to subtract it from both sides.
3:25Let's subtract the price of fruit
3:27times the quantity of fruit
3:29and I could substitute the numbers in first
3:31and that might actually make it a little bit
3:32easier to understand
3:33but I like to keep it general first.
3:35You see, you don't have to just use with these numbers
3:38you could just see the general result here.
3:40I'm going to subtract it from the left hand side
3:42and the right hand side
3:43and the whole point is to get rid of it
3:45from the right hand side.
3:47This cancels out, the left hand side
3:49becomes your income minus the price of fruit
3:54times the quantity of fruit.
3:56This is going to be equal to your right hand side
3:59which is just the price of chocolate
4:00times the quantity of chocolate.
4:02Now if we want to solve for the quantity of chocolate
4:04we just divide both sides by the price of chocolate
4:09and then you get it, and I'll flip the sides.
4:12You get the quantity of chocolates,
4:13is going to be equal to your income,
4:16your income divided by the price of chocolate
4:22minus the price of fruit times the quantity of fruit
4:28all of that over the price of chocolate.
4:31All over that over the price of chocolate.
4:34We can actually substitute these numbers in here
4:36and then we can actually plot what essentially
4:39this budget line will look like.
4:42In our situation, 20, Y = 20,
4:47the price of chocolate is equal to 1.
4:49Price of chocolate is equal to 1.
4:51This term right over here,
4:53$20 per month divided by $1 per bar
4:57which would actually give you 20 bars per month
5:00if you work out the units.
5:01This term right over here just simplifies to 20.
5:04This is actually an interesting term,
5:05your income, your income in dollars divided by the price
5:09of an actual good or service.
5:10You could view this term right over here
5:12as your real income.
5:17The reason why it's called real income
5:18is it's actually pegging what your earnings
5:20to what you can buy.
5:22It's pegging it to a certain real goods,
5:24it's not tied to some abstract quantity like money
5:26which always has a changing buying power.
5:29What you could buy for $20 in 2010 is very different
5:32than what you could buy for $20 in 1940.
5:34Here, when you divide your income,
5:38divide it a by a price of some good
5:40it's really telling you your income in terms of that good.
5:43You could view your income as $20 per month
5:46or you could view your income
5:47if you wanted your income in chocolate bars.
5:49You could say my income is,
5:50I could buy 20 chocolate bars each month.
5:53So I could say, my income 20 chocolate bars per month.
5:56They would be equivalent to you
5:57assuming that you could sell the chocolate bars
5:58for the same price you could buy it
6:00and that's somewhat of an assumption.
6:02But you could say I have the equivalent income
6:03of 20 bars a month.
6:05You could have also done it in fruit.
6:06I have the equivalent income of 20 divided by 2,
6:0910 pounds of fruit a month.
6:12It's trying your income to real things,
6:14not the abstract quantity like money.
6:16Anyway, this is going to be equal to,
6:18let me write it over here.
6:20My quantity of chocolate
6:22is going to be equal to this term right over here as 20.
6:27If you wanted to do the units,
6:28it would be 20 bars per month
6:30and you could do a little bit of dimensional analysis
6:32to come up with that.
6:33You could treat the units just like numbers
6:34and see how the cancel out.
6:3620 bars per month minus the price of fruit
6:40divided by the price of chocolate.
6:42$2 per pound of fruit.
6:46The price of fruit is going to be $2
6:48and I actually want to look at the units
6:50because that's interesting.
6:53Let me write it here.
6:55The price of fruit is equal to $2 per pound.
7:01Let me write it this way.
7:03$2 per pound of fruit,
7:09I'll show you how the units cancel out.
7:10Then we're dividing that by the price of chocolate.
7:13Dividing it by the price of chocolate
7:16which is equal to $1 per bar of chocolate.
7:23Now, obviously the math is fairly straight forward.
7:24We just get 2, but the units are a little bit interesting.
7:27You have a dollar and the numerator of the numerator
7:30and a dollar, the numerator of the denominator,
7:32those will cancel out.
7:33You could actually view this as,
7:35this is going to be the same thing
7:36just to look at the units.
7:37This is going to be,
7:39this is the same thing as the numerator times the inverse
7:42times the reciprocal of the denominator right over here.
7:47You could say $2 per pound times,
7:52the reciprocal of 1 is just 1,
7:55times 1 bar per dollar.
7:59Then the dollars cancel out
8:01and you are left with 2 bars per pound of fruit.
8:11What we've actually done over here,
8:12this term right over here,
8:14it gives us bars of chocolate per pound of fruit.
8:18It simplifies to 2 bars of chocolate per pound of fruit.
8:21It's actually giving you the opportunity cost
8:24of a pound of fruit.
8:25It's saying hey, you could buy a pound of fruit
8:27but you'd be giving up 2 bars of chocolate.
8:29Because the price, you could get 2 bars of chocolate
8:32for every pound of fruit.
8:34You could view this as the relative price,
8:36this right over here is the relative price
8:44of fruit in this example.
8:46It's telling you the opportunity cost,
8:47it's telling you how much fruit cost
8:49in terms of chocolate bars.
8:51Regardless, that number is fairly straight forward,
8:53it was just a 2.
8:55Minus 2 times the quantity of fruit.
9:01This is fairly straight forward to plot.
9:03If the quantity of fruit it 0,
9:06our quantity of chocolate is 20.
9:09This is going to be 20 over here.
9:11This is 20 and this is going to be 10.
9:14This is 15, this is 5.
9:17This is a point on our budget line right over there.
9:20There is multiple ways that you could think about this.
9:22One way you could say is if you buy no chocolate,
9:26if the quantity of chocolate is 0,
9:28what is going to be the quantity of fruit?
9:30Then you could solve this or you could just say,
9:33"Look, if I have $20 a month
9:34"then I'm going to spend it all on fruit.
9:35"I can buy 10 pounds of fruit."
9:36So to say that this right over here is 10.
9:40Let's say this right over here is 10, this is 5,
9:43so this is also on our budget line
9:46and every point in between
9:48is going to be on our budget line.
9:50Every point in between is going to be on our budget line.
9:53Another way you could have done this
9:54and this comes straight out of kind of your typical
9:56algebra 1 course.
9:57You could say, in this case,
10:01if you view this as the Y axis,
10:02you say your Y interceptor,
10:03you say, "My chocolate quantity interceptor is 20
10:06"and then my slop is negative 2.
10:09"My slope is negative 2."
10:10For every extra pound of fruit I buy
10:13I have to give up 2 pounds of chocolate.
10:18You could also view this as the opportunity cost of fruit.
10:20You see this slope as we go forward,
10:23if we buy one more pound quantity of fruit
10:26we're giving up 2 bars of chocolate.
10:31One statement I did just make,
10:32I said every point on this line is a possibility
10:36and I can only say that if we assume
10:38that both of these goods are divisible goods
10:42which means we can buy arbitrarily small amounts of it,
10:45that we could buy 10th of a bar of chocolate
10:47on average especially.
10:49Or we could buy 100th of a pound of fruit.
10:52If they weren't divisible, they're indivisible
10:54then only the whole quantities
10:56would be the possibility points.
10:59We'll just assume they're divisible,
11:00especially even if the store only sells
11:02indivisible bars of chocolate.
11:04If you buy one bar of chocolate every 4 months,
11:07on average you're buying .25 bars of chocolate per month.
11:11Even that, on average, almost anything,
11:14almost anything here is divisible.
11:16This line right over here shows
11:18all of the combinations we can buy.
11:21All of the combinations
11:22of the divisible goods we could buy
11:24if we spend all of our money.
11:26That right over there is our budget line.
11:29That is our budget line.
11:35That is our budget line.
11:36And any combination out here is unaffordable.
11:42We don't have enough money for that.
11:44Any combination down here is affordable.
11:47Actually, we would end up with extra money
11:48if we're below the budget line.
11:50This isn't all that different than what we saw
11:52with the production possibilities frontier.
11:54Remember, we had a curve that really showed all of the
11:56if we were producing 2 goods,
11:58what combinations of goods we could produce.
12:00Anything on that curve
12:01for the productions possibility frontier was efficient.
12:03Anything outside of it was unattainable
12:06and anything inside was attainable but inefficient.