[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

Opportunity Sets and Trade-offs
Market economic systems leave to individuals and firms the question of what to
consume and what to produce. How are these decisions made?
For a rational individual or firm, the first step in the economic analysis of any
choice is to identify what is possible—what economists call the opportunity set,
which is simply the group of available options. If you want a sandwich and have only
tuna fish and cheese in the refrigerator, then your opportunity set consists of a tuna
fish sandwich, a cheese sandwich, a tuna and cheese sandwich, or no sandwich. A
ham sandwich is out of the question. Defining the limitations facing an individual
or firm is a critical step in any analysis of choice. You can spend time yearning after
the ham sandwich, or anything else outside the opportunity set, but when it comes
to making decisions, only what is within the opportunity set is relevant.
So the first step in analyzing choice is to identify what is within the opportunity set.
TABLE 2.1
MICHELLE’S
OPPORTUNITY SET
DVDs
CDs
6 0
5 2
4 4
3 6
2 8
1 10
BUDGET AND TIME CONSTRAINTS
Constraints limit choice and define the opportunity set. In most economic situations,
the constraints that limit a person’s choices—that is, those constraints that actually
are relevant—are time and money. Opportunity sets whose constraints are
imposed by money are referred to as budget constraints; opportunity sets whose
constraints are prescribed by time are called time constraints. A billionaire may feel
his choices are limited not by money but by time, while the limits for an unemployed
worker are set by lack of money rather than lack of time.
The budget constraint defines a typical opportunity set. Consider the budget
constraint of Michelle, who has decided to spend $120 on either CDs or DVDs. A CD
costs $10, a DVD $20. So Michelle can buy 12 CDs or 6 DVDs; or 8 CDs and 2 DVDs;
or 4 CDs and 4 DVDs. The various possibilities are set forth in Table 2.1. They are
also depicted graphically in Figure 2.1. 2 Along the vertical axis, we measure the
number of CDs purchased, and along the horizontal axis, we measure the number
of DVDs. The line marked B 1 B 2 is Michelle’s budget constraint. The extreme cases,
in which Michelle buys only DVDs or only CDs, are represented by the points B 1 and
B 2 , respectively. The dots between these two points, along the budget constraint,
represent the other possible combinations. The cost of each combination of CDs
and DVDs must add up to $120. If Michelle decides to buy more DVDs, she will have
to settle for fewer CDs. The point actually chosen by Michelle is labeled E, where
she purchases 6 CDs (for $60) and 3 DVDs (for $60).
Michelle’s budget constraint is the line that defines the outer limits of her opportunity
set. But the whole opportunity set is larger. It also includes all points below
the budget constraint—in the figure, the shaded area. The budget constraint shows
the maximum number of DVDs Michelle can buy for each number of CDs purchased,
and vice versa. Michelle is always happiest when she chooses a point on her budget
constraint rather than below it. To see why, compare the points E and D. At point E,
0 12 2 See the chapter appendix for help in reading graphs. Economists have found graphs to be extremely useful and
they will be employed throughout this book. It is important that you learn to read and understand them.
34 ∂ CHAPTER 2 THINKING LIKE AN ECONOMIST