EXAM 3 Flashcards
Theory of Labor Supply/Labor-Leisure Choice
Indiv makes a choice on how much time will he devote to labor and leisure respectively.
Components of special utility function U(c,h)
c = consumption of goods
h = hours of leisure
Formula for Time constraint and budget constraint
Time constraint = l +h = 24
Budget constraint = c = wl (consumption = wages x hours of labor)
Normal budget constraint of c + wh = 24w components
price of consumption is 1 = (1)c
Price of leisure is the wage = (w)h
Total income possible = 24w
Values of slope, H-Int, and V-Int [LABOR]
Slope (-p1/p2) = -w
X-int (m/p1) = 24
Y-int (m/p2) = 24w
Graph structure of Labor-Leisure w/ IC
X axis: h
Y axis: c
X-int: 24
Y-int : 24w
IC Curve: point tangent to the budget line
h: Equilibrium point
c: Equilibrium point
Equilibrium condition of Labor-Leisure choice
|slope of budget line| = |slope of the indifference curve|
Substitution and Income effect
Substitution Effect w/ increased wages:
Leisure DECREASES, Supply for labor INCREASES
Equilibrium point shifts to the LEFT
With labor increasing, labor supply curve is UPWARD SLOPING
Income Effect w/ increased wages:
Leisure INCREASES, supply for labor DECREASES
Equilibrium point shifts to the RIGHT
With labor decreasing, labor supply curve is DOWNWARD SLOPING
Nature of labor-supply curve given uncertainty
backward-bending labor supply curve
Rate of return
r = (change in c1 / change in c0) - 1
p1 == (change in c1 / change in c0) = 1 / 1+r
The price of future goods is the amount of present goods that must be sacrificed (change in c0) to get some one more unit of future good (change in c1)
Intertemporal budget line equation
W = c0 + (1 / 1+r)c1
c1 = W(1 + r) - (1 + r)c0
Graph of Capital
X: c0
Y: c1
x-int: W
y-int: W(1+r)
Eq.x: c0*
Eq.y: c1*
IC: U(c0,c1)
If r increases in capital graph
see notes
Allocation
pair of consumption bundles i.e., one consumption bundle per person
Feasible Allocation
total amount of each good consumed is equal to the total endowments
Pareto optimality
particular point or allocation maximizes welfare if it is not possible to increase the utility of one person without decreasing the utility of the other person
Subject matter of finding the best Pareto optimal allocation
Welfare economics; making a social choice
Social Welfare Function (SWF)
Aggregates the individual utilities of all persons in society from person 1 to n
If the SWF is CONVEX,
social optimum is when the SWF is tangent to the utility possibilities curve
Why is majority voting flawed
Lead to intransitivity (Condorcet paradox)
Condorcet Paradox
x>y | y>z | z>x
which outcome is chosen is based on the order the vote is taken
Forced peer evals; Making people assign a score increasingly
Rank-Order Voting (Borda Method)
*violates independence axiom; provide a third alternative
Arrow’s Impossibility Theorem
Unrestricted domain: the social decision must satisfy the same properties
Pareto Optimality: if every1 prefers x to y, social decision must prefer x to y
Independence: x and y is not affected by third alternative z
Non-dictatorship: no single indiv to make the social decision
Property of Public Goods
(a) Non rivalry: use of one does not diminish for use of others
(b) Non exclusive: No ways to prevent someone from using
Necessary Condition of Pareto Optimality
r1 (reservation prices | max willing to pay) > g1 | r2 > (possible contributions | cost share) g2
Sufficient Condition for Pareto Optimality
r1 + r2 > g1 + g2 > c (cost of public good)
When Agent 1 lies about reservation price
Temptation to free ride
-> Either agent 2 will pay for it all (if 2 is honest)
-> or the good will not be provided if both lies
