Chapter 3

# Chapter 3 - Chapter 3 Choice Sets in Labor and Financial...

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Unformatted text preview: Chapter 3 Choice Sets in Labor and Financial Markets 1 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. 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. 3A Choice Sets in Labor and Financial Markets 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. Then, in Section 3B, we will translate some of that intuition into mathematical language in order to demonstrate how to generalize it. 3A.1 Our Choice Sets as Workers As we have already noted, “work” involves giving up one of our most precious endowments — our time. Depending on our innate talents and characteristics as well as our educational background and work experience, our time may be worth more or less to employers (or to the market more generally if we are self employed). Let’s assume that you are on summer break and have found a 1 Chapter 2 is recommended as prior reading for this chapter. 52 Chapter 3. Choice Sets in Labor and Financial Markets 2 job with an employer who is willing to pay you \$20 per hour. Your employer is trying to determine how many other summer workers she needs to hire, and so she asks you how many hours per week you would like to work this summer. You now have to determine how much work is best for you given your circumstances. The more you work, the less leisure time you will have this summer but the more consumption goods you will be able to buy with your newfound wealth. The opportunity cost of taking 1 hour of leisure time is how much consumption you implicitly give up by not working during that hour — \$20 worth of consumption if your wage is \$20 per hour. Put differently, the opportunity cost of an hour of leisure is the wage you could have earned in that hour....
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## This note was uploaded on 04/07/2008 for the course ECON 55 taught by Professor Rothstein during the Fall '07 term at Duke.

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Chapter 3 - Chapter 3 Choice Sets in Labor and Financial...

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