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EC111LectNG8

# EC111LectNG8 - University of Essex Department of Economics...

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1 University of Essex Session 2011/12 Department of Economics Autumn Term EC111: INTRODUCTION TO ECONOMICS THE LABOUR MARKET Labour supply Here we think about the individual’s choice of how much labour to supply. In consumer theory we took th e individual’s income as given. Now it is determined by how much he or she decides to work. The individual’s problem is to choose a combination of income and leisure. Leisure is treated as a ‘good’; more leisure and less work makes the person better off, ceteris paribus. The individual has a fixed endowment of time, R, e.g. 168 hours a week, that can be divided between hours of work, H, and leisure V. Thus: R = H + V. Now consider that the individual has income from two sources, labour income, which is the wage times hours of work, wH, plus some non-wage income. He/she spends all his or her income on a composite good, consuming amount y at price P. Q: what about saving? For income equal to expenditure we have Py = wH + B, or alternatively, Py = w(R V) + B Rearranging: P B ) V R ( P w y This is the individual’s budget line. There is a trade -off between goods and leisure. Notice that there is a downward sloping relationship between q and V, with slope w/P, which is the real wage. Q: What is ‘real’ about this wage? The key insight of this analysis is that the price of leisure is its opportunity cost. This is the wage foregone, in terms of its purchasing power over goods,

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2 Note that: Leisure is measured along the horizontal axis, consumption along the vertical axis. If the individual does not work V = R and consumption is B/P. If the individual spends all his or her time working then consumption is: P B P wR . This is point A. It is some times called ‘full income’— the value of the individuals total time endowment plus non-labour income. Indifference curves. Because consumption and leisure are both ‘goods’ (i.e. the individual would like more of either) indifference curves have the usual properties: They slope down. They don’t cross. They are convex. There is a close analogy with consumer choice. But here we are assuming that the individual has chosen the combination of goods optimally and so we simply combine them together as total consumption. A V R y B/P Slope w/P
3 The slope of the budget line is w/P. The slope of an indifference curve is the marginal rate of substitution between goods and leisure, a different MRS than the one between two goods. Its slope is defined in the same way; as the ratio of marginal utilities of leisure to goods Y V MU MU MRS . Note that: At point A this individual is not maximising his/her utility, MRS > w/P. Point C is unattainable, given the individual’s wage rate and non -labour income. At the utility maximising point B we have MRS = w/P.

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