unit 3

Question 1

describe a model of constrained choices

Answer 1

Individuals want to consume as much as possible and have
as much free time as possible.
* However, their consumption relies on working, and so
sacrificing free time

Question 2

how to calculate the slope of a line

Answer 2

Slope = vertical change / horizontal change

Question 3

what are goods

Answer 3

anything people care about and would like to have more of

Question 4

what is a trade off

Answer 4

when you choose one thing which causes you to have to give up, or sacrifice, another

Question 5

5 facts about indifference curves realtive to the constrained choice graph

Answer 5

• Indifference curves correspond to higher utility levels: if you are indifferent between two combination, the combination that has more of one good must have less of the other good
• Higher indifference curves correspond to higher utility levels: as we move up and to the right in the diagram, further away from the origin, we move to combinations with more of both goods
• Indifference curves are usually smooth: small changes in the amounts of goods don’t cause big jumps in utility
• Indifference curves do not cross
• As you move to the right along an indifference curve, it becomes flatter

Question 6

assumptions of the karim model

Answer 6

Karim doesn’t care about the future, so does not save any of his
earnings.

Karim cannot borrow so his average spending cannot exceed his
earnings.

Question 7

what is marginal rate os substitution

Answer 7

Definition: The trade-off that a person is willing to make between two goods. At any point, the MRS is the absolute value of the slope of the indifference curve

This is the slope of the indifference curve at any point

The marginal rate of substitution is the reduction in his level of consumption that would keep Karim’s utility constant following a one hour increase of free time

.

Question 8

what is marginal rate of transformation

Answer 8

• The marginal rate of transformation (MRT) is the rate at which Karim can transform free time into consumption.
• This is the opportunity cost of one unit of free time.
• Definition: the quantity of a good that must be sacrificed to acquire one additional unit of another good. At any point, it is the absolute value of the slope of the feasible frontier

The slope of the feasible frontier - corresponds to wage - determines the size of the trade off karim faces: how much consumption is given up in return for an extra hour of free time (opportunity cost)

Question 9

what is marginal utility

Answer 9

This is the rate of change in the utility as the mount of good increases

Question 10

what does a budget contained show

Answer 10

what options are possible

The budget constraint in the contained choice graph shows the relationship between income and hours of work, the slope of the line corresponds to the wage, the slope is negative.

Question 11

feasible set and feasible frontier

Answer 11

Feasible set is all feasible points on a graph
feasible frontier is the line that shows the best choices

Question 12

what are the two trade offs under scarcity

Answer 12

• The marginal rate of substitution (MRS) measures the tradeoff that a person is willing to make between 2 goods
• The marginal rate of transformation (MRT) measures the
  trade-off that a person is constrained to make by the feasible frontier.

Question 13

what is the effect of a higher wage

Answer 13

Higher wages raise the opportunity cost of free time: this makes it more
costly to take free time compared to consumption, and will make people
work more

Higher wages make people richer: this new income can be used to buy the two things people like, free time and consumption. Being richer will make people work less

Changes your trade-off between free time and consumption

The slope of the feasible frontier is steeper: new marginal rate of transformation

Question 14

why does income or substitution effect dominate

Answer 14

If the income effect dominates, the person values free time more with higher income and works less.
If the substitution effect dominates, the higher opportunity cost of free time encourages them to work more.
For some, these effects may balance out, leading to little change in work or leisure hours.

Question 15

what is income effect

Answer 15

• The income effect (because the budget constraint shifts
  outwards): the effect that the additional income would have
  if there were no change in the opportunity cost.

Question 16

what is the substitution effect

Answer 16

The substitution effect (because the slope of the budget
constraint, the MRT, rises): the effect of the change in the
opportunity cost, given the new level of utility

Question 17

3 different types of goods

Answer 17

• normal goods: things we want more of as we get richer
• inferior goods: goods we want less of as we get richer
• bad goods: pollution and rotten food

Question 18

why is karims model not good

Answer 18

• This is not what people do!
• What about other factors?
• What about large groups of workers?
• What about the influence of culture and politics?

Question 19

what does the feasible frontier/budget constraint represent?

Answer 19

a constraint of choice

Question 20

at what point is utility maximised

Answer 20

MRS = MRT

Question 21

what is the overall effect of technological change on labour choices

Answer 21

income effect + substitution effect

Question 22

what is the veblen effect in this case

Answer 22

The more rich people consume, the longer other people will work, as to copy the standards of the rich. This is the veblen effect, as a result we would expect people to work longer hours in countries in which the rich are especially rich and people to work less where the rich are only modestly richer than the rest

Question 23

how may lowered wages affect women

Answer 23

Low wages for women give them a reduced incentive to work, but the income effect works in the opposite direction, so lower wages may lead to lower hours of work.