Managerial Economics and Strategy, 2/e

4.3 The Budget Constraint

Knowing an individual’s preferences is only the first step in analyzing that person’s consumption behavior. Consumers maximize their well-being subject to constraints. The most important constraint most of us face in deciding what to consume is our personal budget constraint.

If we cannot save and borrow, our budget is the income we receive in a given period. If we can save and borrow, we can save money early in life to consume later, such as when we retire, or we can borrow money when we are young and repay those sums later in life. Savings are, in effect, a good that consumers can buy. For simplicity, we assume that each consumer has a fixed amount of money to spend now, so we can use the terms budget and income interchangeably. ...