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Budget constraint

Updated: Aug 20, 2021

The limit to expenditure. For any economic agent, whether an individual, a firm, or a government, expenditure must stay within limits set by the ability to finance it. In a single-period setting no borrowing or lending can take place, so expenditure cannot exceed the sum of initial wealth and income earned within the period. With more than one period, the budget constraint must take account of the ability of the agent to transfer wealth across periods by borrowing and lending. When there is a perfect capital market, the rate of interest for borrowing is equal to the rate for lending and each agent can borrow or lend as much as they wish. The budget constraint then requires that the present discounted value of expenditures cannot exceed the present discounted value of initial wealth plus future income. If the capital market is imperfect, the rate of interest for borrowing will exceed that for lending and there may be credit constraints. In such a case the form of the budget constraint will be determined by the particular set of credit market imperfections.

Reference: Oxford Press Dictonary of Economics, 5th edt.

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James Knight
Editor of Education
James is a lead content editor for Invezz. He's an avid trader and golfer, who spends an inordinate amount of time watching Leicester City and the… read more.