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Unformatted text preview: Chapter 3 Economic Circumstances in Labor and Financial Markets As we noted in Chapter 2, the economic choices we make are not limited to the types of choices we face when we visit Wal-Mart on a fixed or exogenous dollar budget. 1 After all, where does the money that we can spend on consumer goods come from in the first place? Before we can spend money, we must first generate it through some form of economic activity. For most of us, this activity involves work the giving up of our time in return for pay. Alternatively, we might generate money by borrowing or by cashing in savings from savings accounts, mutual funds, real estate investments or other assets. In each of these scenarios, we are giving up some endowment something whose value is determined by prices in the economy to get money for consumption. This endowment may be our time when we work, an asset when we cash in our savings or our ability to consume income in the future when we borrow. We are, in effect, trading an endowment in order to generate the money that then can be treated as a fixed budget when we go into Wal-Mart to shop for shirts and pants. When I returned to Wal-Mart with 5 pants and 10 shirts in Chapter 2, I returned with an endowment and my endogenous income was then determined by the prices at which I could sell this endowment back to Wal-Mart for store credit. In the same way, our economic circumstances in work/leisure and savings/borrowing decisions are shaped by the endowment that we bring to the table as well as the prices that the endowment commands in the market. If the decision involves selling our leisure time for work, the relevant price becomes the wage, and when the decision involves postponing consumption (through savings) or borrowing on future income (through taking out a loan), the relevant price will be the interest rate that we can earn or that we have to pay. Thus, the choice sets that we derive in this chapter are in essence no different than the choice set we thought about in Chapter 2 when I returned to Wal-Mart with pants and shirts rather than with money all that is different is that our endowment will not be in terms of pants and shirts, and the prices will involve wage rates and interest rates. 1 Chapter 2 is recommended as prior reading for this chapter. 56 Chapter 3. Economic Circumstances in Labor and Financial Markets 3A Budgets for Workers and Savers We will begin by analyzing our choice sets as workers and then proceed to choice sets that arise as we think about saving and borrowing. As in the previous chapter, we start by focusing purely on economics and intuition relying on graphical tools to generate our basic models of choice sets....
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This note was uploaded on 05/13/2010 for the course ECON 105D taught by Professor Cur during the Fall '09 term at Duke.
- Fall '09