Lecture 3 - Econ 490 ECONOMICS and PSYCHOLOGY(Behavioral...

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Econ 490 ECONOMICS and PSYCHOLOGY (Behavioral Economics) Lecture 3 Econ 490 Yusufcan Masatlioglu
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An Application: Labor Supply Suppose that a worker can choose how many hours she works every day, and there are frequent temporary changes in her hourly wage. For example, on some days she can earn $5 an hour, and on other days $10 an hour. In this situation, the neoclassical theory of labor supply predicts a positive relationship (or perhaps no relationship) between the worker ± s hours and her wage.
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An Application: Labor Supply Why? Because it is easier to accrue a given amount of income by working more on high-wage days and working less on low-wage days, than doing the reverse. Suppose a worker works 8 hours on two days, on one of which the wage is $5, and on the other of which the wage is $10. That gives her $120 of total income. She could make those same $120 by working 9 hours on the high-wage day, and only 6 hours on the low- wage day. That gives her the same income and more leisure.
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An Application: Labor Supply If she hates working different amounts on the two days, she might stick with the 8 hours each day. But what really makes no sense (from the point of view of the classical model) is to work nine hours on the low-wage day, and six hours on the high-wage day, for a total income of $105. She still works different hours—in fact, the same distribution of hours—but for less income.
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Labor Supply Econ 490 Yusufcan Masatlioglu • Daily labor supply by cabbies, bike messengers, and stadium vendors Effort h (no. of hours) Hourly wage w Returns of effort: Y = w * h Linear utility U(Y ) = Y Cost of effort c(h) = h 2 /16 (convex)
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Labor Supply Standard model: Agents maximize U (Y ) c (h) = w*h h 2 /16 Econ 490 Yusufcan Masatlioglu high wage h Profit h * low wage
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Labor Supply Standard model: Agents maximize U (Y ) c (h) = w*h h 2 /16 F.O.C. with respect to h (first order condition, derivative = 0) 0=w-h/8 h=8*w There is a positive relation between wage and labor supply. Econ 490 Yusufcan Masatlioglu
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Demand-Supply Analysis After Demand Shock (Rain), Wage # hours Econ 490 Yusufcan Masatlioglu supply demand w * Wage # hours h *
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An Application: Labor Supply It has proven very difficult to test this prediction.
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