Basic Idea

• "Budget constraint" is a common concept in people's daily lives. Assume for instance that you set aside $120 for entertainment per month and enjoy going to the movies as well as eating out. Suppose going to the movies cost $20, including the ticket, bus fare and popcorn, while eating at your favorite restaurant costs $30, on average. With your $120, you can go to the movies six times, or eat out four times in a month. However you cannot watch six movies while also eating at the restaurant four times within the same month. The more you engage in one of these activities, the less you can enjoy the other. Budget constraint simply aims to formally express this basic concept.
  
  

Practical Application

• You have other viable ways to divide up your budget between your two favorite types of entertainment activities. As described in the previous example, you can stay within your budget if you forgo eating out completely and watch six movies in a month. You can also skip the movies and eat out four times a month. Furthermore, you may watch three movies and eat out twice. Or, you can go to the movies just once and eat out three times. This last combination will leave you with $10, which is not enough to watch an additional movie or eat out once.
  
  

Formula

• The amount of money you spend on entertainment per month can be expressed as
  
  EC = 20M +30R, where EC stands for entertainment cost, M is the number of times you go the movies and R is the number of times you eat out during the month. This equation is called your budget constraint. To see if a given combination is financially feasible, you can plug the numbers in this equation and compare the resulting EC to your budget. Going to the movies twice and eating out three times produces an expenditure of $130, for example, and exceeds your budget; hence, it is infeasible.
  
  

Business Use

• The concept of budget constraint is equally useful for a business as it is for an individual. Naturally, a large business may spend money an a wider variety of items than a single individual or a family. Therefore, businesses use financial software to crunch complex budget equations. The basic idea, however is always the same; your total expenditure must stay below your budget and the more you spend on one good or service, the less you can allocate to others. To ease the calculations, large businesses divide their budgets among departments or activities such as marketing, production and customer service, performing calculations separately for each department.