Question

Neoclassical economics assumes that consumers make rational, calculated choices about their consumption bundle. Explain how the budget constraint affects consumer choice in this context.

Answer 1

Answer - The consumers make the choices related to the consumtion bundle based upon their budget constraint. They cannot consume beyond their budget constraints. The rise in the income will shift the budget constrain to right increasing the purchasing power of both the goods. Decrease in income leads to reduction in purchasing power and shifts the constraint to left.

The change in the price of one good gives the rise to substitution effect and less of a good is consumed whose price as increased. Thus the rational consumers make the consumption decisions based upon their budget constraints.