Lecture 4:
Scarcity, Work, and Choice
UNIT 3: INTRODUCTION
• Have people used
economic progress as a
way to consume more
goods, enjoy more free
time, or both?
Annual hours of work and income (1870-2000)
UNIT 3: INTRODUCTION
• Balancing work and
leisure is a problem
of scarcity—how we
make choices when
we cannot have all of
everything that we
want
Annual hours of free time per worker and income (2013).
UNIT 3: LABOUR AND PRODUCTION
• This is a hypothetical
student’s production
function
• Marginal Product : the
additional amount of
output that could be
produced if the input was
increased by one unit
• Here we have diminishing
marginal product
• Average Product : Total
output divided by a
selected input
• How many hours per day
will he choose to study?
How does the amount of time spent studying affect Alexei's
grade?
T3.3 Average product of labour
The average product of labour is
diminishing when:
Select all correct answers
a. The marginal product of labour is
diminishing.
b. The production function is of a
concave shape.
c. The marginal product of labour is
smaller than the average product of
labour.
d. The marginal product of labour is
negative.
Section 3.0
ANSWER: T3.3 Average product of labour
The average product of labour is
diminishing when:
Select all correct answers
Feedback
a. The marginal product of labour is
diminishing.
a. Even if, for some reason, the marginal
product of labour is increasing, as long as
it is smaller than the average product of
labour then the latter would be diminishing
(adding something smaller than the
average reduces the average).
b. The production function is of a
concave shape.
c. The marginal product of labour is
smaller than the average product of
labour.
d. The marginal product of labour is
negative.
Section 3.0
UNIT 3: PREFERENCES
• Preferences : These determine
the utility we associate with
each possible outcome
• Utility : An indicator of the
value that one places on an
outcome.
• Indifference Curve : A curve
the points of which indicate
the combinations of goods
that provide a given level of
utility to the individual.
• Marginal Rate of Substitution :
the trade-off a person is
willing to make between two
goods. At any point, this is the
slope of the indifference
curve.
Mapping Alexei's preferences.
UNIT 3: PREFERENCES
1. Does combination B give higher or lower
utility than combination A? How do you
know?
2. Draw a sketch of the diagram, and add
another indifference curve, IC2, through B
and crossing IC1. Label the point where they
cross as C.
3. Combinations B and C are both on IC2. What
does that imply about their levels of utility?
4. Combinations C and A are both on IC1. What
does that imply about their levels of utility?
5. According to your answers to (3) and (4),
how do the levels of utility at
combinations A and B compare?
6. Now compare your answers to (1) and (5),
and explain how you know that indifference
curves can never cross.
Mapping Alexei's preferences.
T3.5 Choice of goods
Consider indifference curves for consumption of milk and chocolates (you
may assume that both are "goods"). The indifference curves are drawn
with the number of chocolate bars on the horizontal axis and pints of milk
on the vertical axis. You are given that consumer A has a flatter
indifference curve than consumer B. In this case, we can conclude that:
Select one answer
a. Consumer A likes chocolate more than consumer B.
b. The price of milk relative to the price of chocolates is higher for
consumer A than for consumer B.
c. The indifference curves of the two consumers cannot cross.
d. Given the same amount of chocolates, consumer A is willing to swap
one bar of chocolate with a smaller amount of milk than consumer B.
Section 3.2
UNIT 3: OPPORTUNITY COSTS
• Opportunity cost : When taking an action A means
forgoing the opportunity of the next best alternative
action, B, the opportunity cost of A is the net benefit
of action B.
• In economics, opportunity costs are relevant
whenever we study individuals choosing between
alternative courses of action.
• We receive an economic rent from taking an action
when it results in a benefit greater than its economic
cost
• Economic cost = out of pocket cost + opportunity
cost
UNIT 3: OPPORTUNITY COSTS
Imagine that an accountant and an economist have been asked to report the cost of
going to concert A, a concert in a theatre, admission to which costs $25. In a nearby park
there is concert B, which is free, and happens at the same time.
Accountant: The cost of concert A is your "out of pocket" cost: you paid $25 for a ticket,
so the cost is $25.
Economist: But what do you have to give up to go to concert A? You gave up $25, plus
the enjoyment of the free concert in the park. So the cost of the concert for you is the
out of pocket cost plus the opportunity cost.
Suppose that the most you would have been willing to pay to attend the free concert in
the park (if it wasn't free) was $15. What’s the total economic cost of choosing A?
The economic cost of concert A is $25 + $15 = $40. If the enjoyment you anticipate from
going to concert A is worth $50 to you, then you will forego concert B and buy the ticket
to the theatre, because $50 is greater than $40.
Question: If the pleasure you anticipate from concern A is only $35, would you go to
concert A or concert B? Why?
UNIT 3: OPPORTUNITY COSTS
UNIT 3: THE FEASIBLE SET
• The feasible frontier plots the
highest grade he can get given the
amount of free time he takes.
• Combinations outside the feasible
frontier are infeasible or
unattainable
• A combination lying inside the
frontier is inefficient.
• Marginal Rate of
Transformation: the quantity of
some good that must be
sacrificed to acquire one
additional unit of another good.
• What is the opportunity cost to
Alexei of going from point C to
point A?
How does Alexei's choice of free time affect his grade?
UNIT 3: DECISION-MAKING AND
SCARCITY
• Alexei maximises his
utility at point E, at
which his indifference
curve is tangent to the
feasible frontier.
• This is an example of a
constrained choice
problem.
How many hours does Alexei decide to study?
UNIT 3: HOURS OF WORK AND
ECONOMIC GROWTH
We are interested in two
questions:
1.
2.
Figure 3.12 A grain technology: Angela’s production function.
How many hours will
Angela choose to
work?
An improvement in
technology means
Angela could produce
the same amount of
grain with fewer hours
of work. How much
more free time would
she choose?
UNIT 3: HOURS OF WORK AND
ECONOMIC GROWTH
• We can think of the
combination of free time
and grain at point A as
representing her
standard of living.
• What happens to the
feasibility frontier and
the production function
when there is a
technological
improvement?
Figure 3.13 Angela’s choice between free time and grain.
UNIT 3: HOURS OF WORK AND
ECONOMIC GROWTH
Angela’s production function after an improvement in technology.
UNIT 3: HOURS OF WORK AND
ECONOMIC GROWTH
Angela’s feasible frontier after an improvement in technology.
UNIT 3: HOURS OF WORK AND
ECONOMIC GROWTH
• Why does Angela
increase her free
time?
• She has a greater
incentive to work,
but she is even more
willing to sacrifice
grain for free time.
• It is important to
realize that this is
just one possible
result.
Angela’s choice between free time and grain after an
improvement in technology.
UNIT 3: HOURS OF WORK AND
ECONOMIC GROWTH
Angela's response to an improvement in technology, with different
preferences.
UNIT 3: INCOME AND SUBSTITUTION EFFECTS
ON HOURS OF WORK AND FREE TIME
Your preferred choice of free time and consumption..
• Imagine that you are
looking for a job after
you leave college. You
expect to be able to earn
a wage of $15 per hour.
Jobs differ according to
the number of hours you
work—so what would be
your ideal number of
hours?
• Budget constraint : An
equation of all
combinations of goods
and services that one
could acquire that
exactly exhaust one’s
budgetary resources.
UNIT 3: INCOME AND SUBSTITUTION EFFECTS
ON HOURS OF WORK AND FREE TIME
• For you, the MRT is equal
to your wage: it is $15
for your first hour of
work, and still $15 for
every hour after that.
• What would be your
ideal job?
• Your optimal
combination of
consumption and free
time is the point on the
budget constraint where:
MRS = MRT = w
Your preferred choice of free time and consumption..
UNIT 3: INCOME AND SUBSTITUTION EFFECTS
ON HOURS OF WORK AND FREE TIME
Your two trade-offs.
UNIT 3: INCOME AND SUBSTITUTION EFFECTS
ON HOURS OF WORK AND FREE TIME
• While considering this
decision, you receive an
email. A mysterious
benefactor would like to
give you an income of
$50 a day for life, no
strings attached.
• What does the new
budget line look like?
• How will this affect your
choice? Will your work
more or less?
The effect of additional income on your choice of free time and
consumption.
UNIT 3: INCOME AND SUBSTITUTION EFFECTS
ON HOURS OF WORK AND FREE TIME
• Income effect : The effect
that the additional
income would have if
there were no change in
the opportunity cost.
• Your income effect,
shown in last slide, is
positive—that is, extra
income raises your
choice of free time.
• For the person in this
figure, the income effect
is zero.
The effect of additional income for someone whose MRS doesn’t
change when consumption rises.
UNIT 3: INCOME AND SUBSTITUTION EFFECTS
ON HOURS OF WORK AND FREE TIME
• Imagine you refuse the
money and return to the
original plan. A year later,
your employer offers a pay
rise of $10 per hour, and
the chance to renegotiate
your hours.
• What does the new budget
line look like?
• With an increase in
unearned income you want
to work fewer hours, while
the increase in the wage
makes you decide to
increase your work hours.
Why does this happen?
The effect of a wage rise on your choice of free time and
consumption.
UNIT 3: INCOME AND SUBSTITUTION EFFECTS
ON HOURS OF WORK AND FREE TIME
• Two effects of a wage
increase:
1. More income for every
hour worked
2. The budget constraint is
steeper
• Substitution effect : The
effect of the change in
the opportunity cost,
given a new level of
utility.
The effect of a wage rise on your choice of free time and
consumption.
UNIT 3: INCOME AND SUBSTITUTION EFFECTS
ON HOURS OF WORK AND FREE TIME
A wage rise
• Raises your income for any level of free time,
increasing the level of utility you can achieve
• Increases the opportunity cost of free time
So it has two effects on your choice of free time:
• The income effect
• The substitution effect
If the income effect dominates the substitution effect,
workers will prefer fewer hours of work.
UNIT 3: IS THIS A GOOD MODEL?
• At this point, you may be thinking: this is not
what people do! So how can this model be
useful?!?
• Milton Friedman explained that economists
do not claim that we actually think through
these each time we make a decision.
• Instead we each try various choices and
adopt those that make us feel satisfied and
not regretful about our decisions.
UNIT 3: IS THIS A GOOD MODEL?
• A second unrealistic aspect of
the model: employers typically
choose working hours
• The hours that many people
work are regulated by law
• It may be that changes in
working hours over time, and
differences between countries,
partly reflect the preferences
of workers.
• This explanation stresses
culture and politics.
UNIT 3: IS THIS A GOOD MODEL?
• Cultures seem to differ.
• Some northern European
cultures highly value their
vacation times, while South
Korea is famous for the long
hours that employees put in.
• Legal limits on working time
differ.
• In Belgium and France the
normal work week is limited to
35-39 hours, while in Mexico
the limit is 48 hours and in
Kenya even longer.
UNIT 3: EXPLAINING OUR WORKING
HOURS
Applying the model to history: Increased goods and free time in
the US (1900-2013)
UNIT 3: EXPLAINING OUR WORKING
HOURS
How could reasoning in this way explain the other historical data
that we have?
Consider the period before 1870 in Britain, when both working
hours and wages rose:
•
•
•
Income effect: At low level of consumption, workers’ willingness
to substitute free time for goods did not increase with higher
wages.
Substitution effect: But they were more productive and paid
more, so each hour of work brought more rewards than before
in the form of goods, increasing the incentive to work long
hours.
Substitution effect dominated: Therefore before 1870 the
negative substitution effect (free time falls) was bigger than the
positive income effect (free time rises), so work hours rose.
UNIT 3: EXPLAINING OUR WORKING
HOURS
During the 20th century we saw rising wages and falling
hours. Our model accounts for this change as follows:
• Income effect: By late 19th century workers had a higher
level of consumption and valued free time relatively more,
so income effect of a wage rise was larger.
• Substitution effect: This was consistent with the period
before 1870.
• Income effect now dominates: When the income effect
began to outweigh the substitution effect, working time
fell.
UNIT 3: EXPLAINING OUR WORKING
HOURS
UNIT 3: EXPLAINING OUR WORKING
HOURS
• Could it be that South
Koreans have the same
preferences as
Americans, so that if the
wage increased in South
Korea they would make
the same choice?
Using the model to explain free time and consumption per day
across countries (2013).
UNIT 3: EXPLAINING OUR WORKING
HOURS
• More plausible is the
hypothesis that South
Koreans and Americans (on
average) have different
preferences.
Using the model to explain free time and consumption per day
across countries (2013).
UNIT 3: EXPLAINING OUR WORKING
HOURS
• In the last part of the
20th century hours of
work rose in the US,
even though wages
hardly rose. Hours of
work also increased in
Sweden during this
period. Why?
• Perhaps Swedes and
Americans came to value
consumption more over
these years due to rising
inequality, which
changed preferences.
UNIT 3: CONCLUSION
•
•
•
In 1930 Keynes predicted that in
the 100 years that would follow,
we would be about eight times
better off, and we would not
have to work more than, say, 15
hours per week.
Keynes’ prediction for the rate
of technological progress in
countries such as the UK and
the US has been approximately
right, but it seems very unlikely
that working hours will have
fallen to 15 hours per week by
2030.
Nevertheless the high-income
economies will continue to
experience a declining role of
work in the course of our
lifetimes.