Lecture 5: Work, Wellbeing, and Scarcity

Transcription

1 Lecture 5: Work, Wellbeing, and Scarcity

2 UNIT 4: INTRODUCTION

3 UNIT 4: INTRODUCTION

4 UNIT 4: INTRODUCTION

5 UNIT 4: BASIC CONCEPTS Three important concepts in economic modelling: 1. Ceteris paribus 2. Incentives matter 3. Relative prices

6 UNIT 4: DECISIONS AND TRADE-OFFS

7 UNIT 4: DECISIONS AND TRADE-OFFS

8 UNIT 4: DECISIONS AND TRADE-OFFS This is Alexei s production function Using this, we can determine both marginal and average product In this case we have diminishing returns How many hours per day will he choose to study?

9 UNIT 4: PREFERENCES His decision will depend on his preferences. We can visualize his preferences using indifference curves The slope at any point tells us the marginal rate of substitution

10 UNIT 4: PREFERENCES Generally, we can say that: Indifference curves slope downward Higher indifference curves correspond to higher utility levels Indifference curves are usually smooth Indifference curves do not cross As you move to the right along an indifference curve, it becomes flatter

11 UNIT 4: PREFERENCES 1. Does combination B give higher or lower utility than combination A? How do you know? 2. Draw a sketch of the diagram, and add another indifference curve, IC 2, through B and which crosses IC 1. Label the point where they cross as C. 3. Combinations B and C are both on IC 2. What does that imply about their levels of utility? 4. Combinations C and A are both on IC 1. What does that imply about their levels of utility? 5. According to your answers to (3) and (4), how do the levels of utility at combinations A and B compare? 6. Now compare your answers to (1) and (5), and explain how you know that indifference curves can never cross.

12 Consider indifference curves for consumption of milk and chocolates (you may assume that both are "goods"). The indifference curves are drawn with the number of chocolate bars on the horizontal axis and pints of milk on the vertical axis. You are given that consumer A has a flatter indifference curve than consumer B. In this case, we can conclude that: Select one answer a. Consumer A likes chocolate more than consumer B. b. The price of milk relative to the price of chocolates is higher for consumer A than for consumer B. c. The indifference curves of the two consumers cannot cross. d. Given the same amount of chocolates, consumer A is willing to swap one bar of chocolate with a smaller amount of milk than consumer B. Section 3.2

13 Consider indifference curves for consumption of milk and chocolates (you may assume that both are "goods"). The indifference curves are drawn with the number of chocolate bars on the horizontal axis and pints of milk on the vertical axis. You are given that consumer A has a flatter indifference curve than consumer B. In this case, we can conclude that: Select one answer a. Consumer A likes chocolate more than consumer B. b. The price of milk relative to the price of chocolates is higher for consumer A than for consumer B. c. The indifference curves of the two consumers cannot cross. d. Given the same amount of chocolates, consumer A is willing to swap one bar of chocolate with a smaller amount of milk than consumer B. Section 3.2

14 UNIT 4: OPPORTUNITY COSTS Opportunity cost : When taking an action A means forgoing the opportunity of the next best alternative action, B, the opportunity cost of A is the net benefit of action B. We receive an economic rent from taking an action when it results in a benefit greater than its economic cost Economic cost = out of pocket cost + opportunity cost

15 UNIT 4: OPPORTUNITY COSTS Imagine that an accountant and an economist have been asked to report the cost of going to concert A, a concert in a theatre, admission to which costs $25. In a nearby park there is concert B, which is free, and happens at the same time. Accountant: The cost of concert A is your "out of pocket" cost: you paid $25 for a ticket, so the cost is $25. Economist: But what do you have to give up to go to concert A? You gave up $25, plus the enjoyment of the free concert in the park. So the cost of the concert for you is the out of pocket cost plus the opportunity cost. Suppose that the most you would have been willing to pay to attend the free concert in the park (if it wasn't free) was $15. What s the total economic cost of choosing A? The economic cost of concert A is $25 + $15 = $40. If the enjoyment you anticipate from going to concert A is worth $50 to you, then you will forego concert B and buy the ticket to the theatre, because $50 is greater than $40. Question: If the pleasure you anticipate from concern A is only $35, would you go to concert A or concert B? Why?

16 UNIT 4: OPPORTUNITY COSTS

17 UNIT 4: FEASIBLE SET This is the feasible set. This allows us to determine the marginal rate of transformation. What is the opportunity cost to Alexei of going from point C to point A? MRS and MRT are our two trade-offs

18 UNIT 4: DECISION MAKING AND SCARCITY What point will Alexei end up on? Why? This is an example of a constrained choice problem.

19 UNIT 4: DECISION MAKING AND SCARCITY

20 UNIT 4: HOURS OF WORK AND ECONOMIC GROWTH How would a technological improvement change or shift the production function?

21 UNIT 4: HOURS OF WORK AND ECONOMIC GROWTH

22 UNIT 4: HOURS OF WORK AND ECONOMIC GROWTH

23 UNIT 4: HOURS OF WORK AND ECONOMIC GROWTH

24 UNIT 4: HOURS OF WORK AND ECONOMIC GROWTH

25 UNIT 4: HOURS OF WORK AND ECONOMIC GROWTH

26 UNIT 4: EXPLAINING OUR WORKING HOURS A wage rise Raises your income for any level of free time, increasing the level of utility you can achieve Increases the opportunity cost of free time So it has two effects on your choice of free time: The income effect The substitution effect

27 UNIT 4: EXPLAINING OUR WORKING HOURS Before 1870: Consumption was low, so weak income effect Wages started increasing, increasing incentive to work long hours Substitution effect dominates 20 th Century Consumption relatively high, so income effect was strong Similar to before Income effect dominates

28 UNIT 4: EXPLAINING OUR WORKING HOURS

29 UNIT 4: IS THIS A GOOD MODEL? Is this a good model for understanding how working hours are determined? At this point, you may be thinking: this is not what people do! So how can this model be useful?!? Milton Friedman argued that economists do not claim that we actually think through these each time we make a decision.

30 UNIT 4: IS THIS A GOOD MODEL? A second unrealistic aspect of the model: employers typically choose working hours The hours that many people work are regulated by law It may be that changes in working hours partly reflects worker preferences. This explanation stresses culture and politics.

31 UNIT 4: IS THIS A GOOD MODEL? Cultures seem to differ. Legal limits on working time differ. In Belgium and France the normal work week is limited to hours, while in Mexico the limit is 48 hours and in Kenya even longer. Political institutions shape and constrain our ability to convert preferences into reality

32 UNIT 4: IS THIS A GOOD MODEL?

33 UNIT 4: WORK, FREE TIME, AND WELL-BEING: A SOCIAL DILEMMA One of the reasons why a person may choose to work longer hours is to be able to afford positional goods The purchase and public display of positional goods is known as conspicuous consumption Conspicuous consumption and the accumulation of positional goods creates an externality. What are some examples of positional goods? How has social media influenced the role/importance of conspicuous consumption?

34 UNIT 4: WORK, FREE TIME, AND WELL-BEING: A SOCIAL DILEMMA

35 UNIT 4: WORK, FREE TIME, AND WELL-BEING: A SOCIAL DILEMMA What kind of game is the game to the right? How could these two families avoid the Pareto inefficient outcome? How big would a tax on luxury housing have to be for the Modest/Modest outcome to be assured?

36 UNIT 4: WORK, FREE TIME, AND WELL-BEING: A SOCIAL DILEMMA The negative externality of conspicuous consumption is sometimes called the Veblen effect. Veblen effects help to explain two facts about modern economies: 1. People work longer hours in countries in which the very rich receive a larger fraction of the income 2. As a nation gets richer, its citizens often do not become happier