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Unformatted text preview: C H A P T E R 3 Choice Sets in Labor and Financial Markets This chapter is a straightforward extension of Chapter 2 where we had shown that budget constraints can arise from someone owning an endowment that he can sell to generate the income needed for purchasing a different consumption bun- dle. That’s exactly what workers and savers do: Workers own their time and can sell it to earn income, and savers own some investment that they can sell and turn into consumption. (Borrowers, on the other hand, own some future asset — such as the income they can earn in the future — that they can sell.) Once you under- stand how budgets can arise from stuff we own, it becomes straightforward to think about workers and savers/borrowers. Chapter Highlights The main points of the chapter are: 1. Wages and interest rates are prices in particular markets — and therefore give rise to the opportunity costs we face when making choices in those mar- kets as leisure time or investments are sold. 2. When budgets arise from the sale of endowments, price increases no longer unambiguously shrink budgets nor do price decreases unambiguously in- crease budgets as budget lines rotate through the endowment bundle . 3. Endowment bundles are those that can always be consumed regardless of what prices (or wages or interest rates) emerge in the economy. 4. Government policies can change the economic incentives faced by workers and savers by changing the choice sets they face. 5. An amount $X in the future has a present value less than $X — because bor- rowing on that amount to consume more now entails paying interest. Choice Sets in Labor and Financial Markets 20 6. The 2-dimensional models of leisure/consumption and intertemporal bud- gets are really just “slices” of higher dimensional budgets along which some things are held fixed. Using the LiveGraphs For an overview of what is contained on the LiveGraphs site for each of the chapters (from Chapter 2 through 29) and how you might utilize this resource, see pages 2-3 of Chapter 1 of this Study Guide . To access the LiveGraphs for Chapter 3, click the Chapter 3 tab on the left side of the LiveGraphs web site. As I am writing this, we do not yet have any plans for Exploring Relationships modules for this Chapter. However, if you are having any difficulty at all with the concept that our 2-dimensional graphs are coming out of higher-dimensional mod- els that hold some aspects of the problem fixed, I urge you to play the animated graphic for Graph 3.5. This graphic shows how, for instance, an intertemporal consumption budget set is contained within a large choice set that also contains a choice of how much to work. 3A Solutions to Within-Chapter Exercises for Part A Exercise 3A.1 Illustrate what happens to the original budget constraint if your wage increases to $30 per hour. What if your friend instead introduces you to caffeine which allows you to sleep less and thus take up to 80 hours of leisure time per week?...
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This note was uploaded on 02/13/2011 for the course ECON 100A taught by Professor Woroch during the Fall '08 term at Berkeley.
- Fall '08