Supply - Chapter 2

Question 1

What is the price of leisure?

Answer 1

The price of leisure is the opportunity cost of consuming leisure
[This means you are giving up the opportunity to earn income (or do something else productive) by choosing leisure]
- cost of leisure is the wage rate
when we talk about the “price” of leisure, we’re referring to what you forgo in terms of earnings or other benefits by choosing to enjoy leisure time instead of working
- if you decide to spend an hour on leisure instead of working, and you earn $20 per hour, then the cost of that hour of leisure is $20, which is your wage rate

Question 2

Consumers choose combinations of goods that maximize utility subject to budget constraint

Answer 2

1. Located on the budget line
2. Highest indifference curve on budget line

Question 3

who is this: their value of leisure > their value of wage rate

Answer 3

individuals who do not work

Question 4

when does a corner solution exist?

Answer 4

if a consumer buys all one category of a good
- individual does not work
- MRS is not equal to W at the chosen bundle

Question 5

What happens to leisure and consumption choice when wage rate changes?

Answer 5

Substitution effect:
- Buy more* of the relatively less expensive good and less* of the relatively more expensive good
- Assume utility level held constant
Income effect:
- buy more* of both goods (consumption + leisure) when the wage rises
- assume price does not change
* - if possible - not possible for corner solution as only one good is consumed

Question 6

What happens to consumption and leisure when there is a wage increase?

Answer 6

Income effect: more* leisure and more* of the consumption
Substitution effect: more* consumption good and less* leisure
- For both effects, consume more* of the consumption good
- Effect on leisure is unclear

Question 7

What happens to leisure and consumption choice when there is a wage decrease?

Answer 7

Income effect: less* leisure and less* of the consumption good
Substitution effect: less* consumption good and more* leisure
- For both effects, consume less* of the consumption good
- effect on leisure is unclear

Question 8

What are the possible effect of a wage increase for someone not working?

Answer 8

• start working
• continue not working

Question 9

What are the benefits and costs of retiring now?

Answer 9

Benefits: more leisure
Costs: lower consumption

Question 10

What are the benefits and costs of retiring five years from now?

Answer 10

Benefits: more consumption
Costs: less leisure

Question 11

What does a worker’s retirement age depend on?

Answer 11

• wage
• pension
• preferences
  We assume they delay retirement as their retirement fund (pension) is getting bigger

Question 12

(1) Lump Sum Child Care Subsidy - Suppose government offers a child care subsidy of €100 per week for working (single) parents. How does this subsidy change the budget line and the labour supply decision?
For non worker?

Answer 12

With subsidy, single parent enters labour force

Question 13

(1) Lump Sum Child Care Subsidy - Suppose government offers a child care subsidy of €100 per week for working (single) parents. How does this subsidy change the budget line and the labour supply decision?
For a single parent already in the work force?

Answer 13

Subsidy acts as an increase in income.
Because this subsidy is a lump sum, it acts as non-labour income

Question 14

(2) Subsidy based on the number of hours of work. For non working parent

Answer 14

For non-working parents
Subsidy makes it more likely for single parent to enter the labour force

Question 15

(2) Subsidy based on the number of hours of work. For working parent

Answer 15

For working parents
- Substitution effect is to work more
- Income effect is to work less
- Overall effect on labour supply is not clear

Question 16

If wage increases what happens to the budget line?

Answer 16

its slope becomes steeper

Question 17

Retirement question - what happens with a wage increase

Answer 17

substitution effect dominates -> more consumption + less leisure

Question 18

Retirement question - what happens with an increase in the value of pensions?

Answer 18

there is only an income effect so we know the worker will work less

Question 19

What is Marginal rate of Substitution (MRS)?

Answer 19

The slope of the indifference curve at any point tell how a person is willing to trade off any two goods and remain indifferent between the bundles.

Question 20

How do you calculate MRS?

Answer 20

• Change in Consumption / Change in Leisure

Question 21

What are indifference curves?

Answer 21

represent all combinations that are equally preferred by the consumer
- combinations up and to the right are preferred
- they cannot cross

Question 22

What is a budget constraint?

Answer 22

a constraint on a person’s ability to consume based on their income and prices for goods

Question 23

What is a budget line?

Answer 23

Indicates all combinations of two goods an individual can buy given their total income and the prices of the two goods

Question 24

What does the slope of the budget constraint tell us?

Answer 24

How we can trade off two goods without spending any more money

Question 25

What does the slope of indifference curve tell us?

Answer 25

How we can trade off two goods without changing our level of utility

Question 26

What is the slope of the indifference curve?

Answer 26

MRS = - change in Consumption / change in Leisure

Question 27

What is the slope of the budget line?

Answer 27

• W / Pc = -W
  Utility is maximised when MRS = W
  for corner solution MRS does not equal Wage