Choice Sets with 3 Goods

The introduction of socks then adds a third dimension because bundles of goods now consist of three numbers: one for pants, one for shirts and one for socks. With our income of $200 a $20 price for pants, and a $10 price for shirts, we can buy at most 10 pants (point A) and at most 20 shirts (point B). And if we suppose that the price of socks is $5, we can buy at most 40 socks (if we buy nothing else). That gives us point C on the socks axis.

Choice Sets with 3 Goods

Connecting A and B, we get our previous budget constraint when there was no option to buy socks.

Choice Sets with 3 Goods

We similarly get the 2dimensional budget constraint assuming there are no pants when we connect B and C. This gives all the bundles of shirts and socks that exhaust our $200 exogenous income.

Choice Sets with 3 Goods

And, when we connect A and C, we get the 2dimensional budget constraint assuming there are no shirts and all we are choosing is bundles of pants and socks.

Choice Sets with 3 Goods

When we then fill in the plane that connects the three 2-dimensional budget lines we have drawn, we get the 3dimensional budget constraints over pants, shirts and socks. The bundles that lie on or below this plane then constitute the choice set for this consumer.

Choice Sets with 3 Goods

One bundle that lies on the budget constraint, for instance, is bundle D. This bundle contains 5 pants, 5 shirts and 10 socks.
The 5 pants cost $100 (at $20 each), the 5 shirts cost $50 (at $10 each), and the 10 socks cost $50 (at $5 each). Thus, bundle D costs $200.

Composite Goods
But if we have more than 3 goods, it becomes impossible to graph the budget constraint. We thus often use the trick of aggregating all goods except for one into a composite good. A composite good is an index of dollars worth of all other goods, with the price of a composite good therefore equal to 1. When a composite good is put on the vertical axis, the slope of the budget is then simply (minus) the price of the good on the horizontal.

Working, Saving and Consuming

Workers and Savers are, of course, often the same individuals. We can model the budget constraint of a worker/saver by drawing on what we have learned and adding a third dimension to the choice set.

Working, Saving and Consuming

You might, for instance, have a leisure endowment of 600 hours this summer with no way to consume anything now or next summer unless you sell some of that leisure as labor.

This gives us our endowment bundle E on the leisure axis.

Savers and and Consuming Working, Saving Borrowers

At a wage of $20 per hour, you could then consume as much as $12,000 this summer (if you save none of what you earn).

This gives us the bundle A on the current consumption axis.

Savers and and Consuming Working, Saving Borrowers

Connecting E and A then gives us a 2-dimensional leisure/consumption budget similar to what we have drawn earlier.

The slope of this budget, as was the case in our earlier development of leisure/consumption budgets, is the negative wage rate; i.e. w.

Savers and and Consuming Working, Saving Borrowers

But we could decide to work for 600 hours and save the earnings for consumption next year.
The most we could then consume next year at a 10% annual interest rate is $13,200.

This budget constraint in the vertical plane where leisure is 0 is then similar to the intertemporal budget constraints we have drawn before.

Savers and and Consuming Working, Saving Borrowers

Or we could look at the trade-off between leisure now and consumption next year assuming we consume nothing now.
We then get a third budget constraint in the third plane created by the three axes.

Since we now save every dollar we earn, the slope of this budget is w(1+r).

Savers and and Consuming Working, Saving Borrowers

The full choice set is then formed by the plane that connects these three blue budgets lines. You might, for instance, have already committed to working for 500 hours this summer, leaving you with 100 hours of leisure. This then leaves you with the shaded intertemporal choice set.

The intertemporal budget constraints we have drawn earlier can then be viewed as slices of more complicated choice sets slices where the labor input level has already been chosen before.