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To get a better understanding of how we make choices,
we first need to understand the elements that go
into making a decision.
And not all of them are within our control.
The world is constantly, invisibly determining the prices
of goods and services.
Take the price of a cup of coffee.
It depends on so many variables.
Think culture, demographics, the cost of beans, the weather,
the supply and demand for oil,
even the high rent at your hip neighborhood coffee shop.
You get the idea.
All of this economic activity is magically being simplified
into a price for a cup of coffee.
How about your salary -- the price of one hour of your labor?
It depends on you, of course, on your skills and effort,
but it also depends on many factors outside
of your control -- for example, the demand for your services,
nearby competition, even how fun your job is.
Every day you make decision after decision about what to buy,
comparing hundreds of different goods and services.
There are so many choices.
To simplify things, let's think about what you would do
if you had a weekly budget of $50 to spend on just two goods,
coffee and pizza.
Coffee costs $5 and pizza cost $10.
So pizza is twice as expensive as coffee.
There are several different combinations of coffee and pizza
you could buy with this money.
Let's plot a few of your options on a graph.
On the "x"-axis, we have the number of pizzas per week.
And on the "y"-axis, we have the cups of coffee per week.
You could buy two cups of coffee and four pizzas,
four cups of coffee and three pizzas,
five pizzas with no coffee,
or 10 cups of coffee but no pizza.
When you connect to different options that represent
the ways you can spend your $50, you get a straight line.
This is your budget constraint.
And it represents all possible combinations of coffee and pizza
you can buy -- given your budget and the prices of coffee and pizza.
This budget line also separates what you can afford
from what you cannot afford.
Maybe you wish you could buy two cups of coffee and six pizzas,
or four cups of coffee and 10 pizzas.
But these are not in your budget.
Sorry.
All these different combinations cost more than you have.
So they're unaffordable, given your budget
and the prices of these two goods.
Combinations of coffee and pizza below the budget line,
on the other hand, are within your means.
So they're affordable,
and you could buy them if you wanted.
The budget constraint also reflects how the market substitutes
between the two goods.
Remember, pizzas are twice as expensive as coffee.
And this simply means that the relative price
of one pizza is two cups of coffee.
You see this on the slope of the budget constraint,
which is 2.
Well, actually it's -2, but we're less concerned
about the sign.
Although, it does remind us that having more of one good
requires giving up some of the other.