Unit 3 - Scarcity, Work and Choice. Flashcards
Currently, you work for 40 hours per week at the wage rate of £20 an hour. Your free hours are defined as the number of hours not spent in work per week, which in this case is 24 hours × 7 days − 40 hours = 128 hours per week. Suppose now that your wage rate has increased by 25%. If you are happy to keep your total weekly income constant, then by how many % will your free time increase?
The new wage rate is £20 × 1.25 = £25 per hour. Your original weekly income is £20 × 40 hours = £800. Therefore, your new total number of working hours is £800/£25 per hour = 32 hours. Then your free time is now 24 × 7 – 32 = 136 hours per week, an increase of (136 – 128)/128 = 6.25%.
What is a production function?
A production function can be translated into the input of labor into output. Ex: the number of hours spent studying into a grade.
What is an Average Product?
Total output divided by a particular input, for example per worker (divided by the number of workers) or per worker per hour (total output divided by the total number of hours of labour put in) or the average number of percentage points per hour of study.
What is a Marginal Product?
The additional amount of output that is produced if a particular input was increased by one unit while holding all other inputs constant. (The increase in his grade from increasing study time by one hour)
What are diminishing returns?
A situation in which the use of an additional unit of a factor of production results in a smaller increase in output than the previous increase. (Where an extra study hour doesn’t contribute to the final grade anymore).
Compare the Marginal product to the Average product.
This basically translates into “diminishing average product of labor”. For ex: the average product of labor in food production (the food produced per worker) fell as more workers cultivated a fixed area of land.
What does Preference have to do with this Unit?
Preference of a certain agent is translated into what they are willing to give up from the output to gain free time (etc.). For instance, how many points of percentage on the final grade are you willing to give up to enjoy more free time (free time = hours NOT spent studying)
What is Utility?
A numerical indicator of the value that one places on an outcome, such that higher valued outcomes will be chosen over lower valued ones when both are feasible. (Suppose a student has the possibility to either have lots of free time and a low grade or little free time with a high grade, and that the student felt indifferent towards both outcomes. This means that both outcomes give the student the same utility)
What is an indifference curve?
A curve of the points which indicate the combinations of goods that provide a given level of utility to the individual. (Combinations that provide equal utility or satisfaction)
Extra info :) :
Indifference curves slope downward due to trade-offs: If you are indifferent between two combinations, the combination that has more of one good must have less of the other good. “you win some, you lose some”
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Indifference curves do not cross
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As you move to the right along an indifference curve, it becomes flatter. (too many study hours result in a very low marginal product which after a while becomes negative)
What is the marginal rate of substitution (MRS)?
The amount of one good that the consumer is willing to trade for one unit of the other. (The slope of the indifference curve.)
What is Opportunity Cost?
When taking an action implies forgoing the next best alternative action, this is the net benefit of the foregone alternative. (When we consider the cost of taking action A we include the fact that if we do A, we cannot do B. So ‘not doing B’ becomes part of the COST of doing A. This is called an opportunity cost because doing A means forgoing the opportunity to do B.) (downwards)
What is Economic Cost?
The out-of-pocket cost of an action, plus the opportunity cost. Another way of saying this is that you receive an economic rent from taking an action when it results in a benefit greater than its economic cost.
How do you calculate Economic Rent?
The economic rent of an action is its benefit minus its economic cost (eco cost: out-of-pocket + opportunity costs).
Define Feasible Frontier.
The curve made of points that defines the maximum feasible quantity of one good for a given quantity of the other. Ex: the highest grade he can achieve given the amount of free time he takes.
What is the Feasible Set?
All of the combinations of the things under consideration that a decision-maker could choose given the economic, physical, or other constraints that he faces.
Simply put, a set is a collection of things (–ex: all the feasible combinations of free time and grade.)
In the case of a graph, the area inside the frontier, together with the frontier itself, is called the feasible set.
Define the Marginal Rate of Transformation (MRT).
The quantity of some good that must be sacrificed to acquire one additional unit of another good. At any point, it is the slope of the feasible frontier. (upwards)
Explain MRS=MRT.
The indifference curve is tangent to the feasible frontier; The slope of the indifference curve (MRS) is equal to the slope of the feasible frontier (MRT).
= maximized utility point.
Detail a Constrained Choice Problem.
This problem is about how we can do the best for ourselves, given our preferences and constraints, and when the things we value are scarce. (which is more important to the individual?)
Why do new technologies raise the productivity of labor?
As technology develops, the more it incites a better working environment for laborers which results in fewer labor hours needed by the average individual (for the same pay)
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With technological improvements, the optimal point (which is where the slope of the indifference curve and the feasible frontier meet), is increased. Meaning that the individual can get more output (grain) for less input (farm labor).
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Technological advancements improve the living standards of an individual -> it allows the individuals to achieve higher utility. There are alternative outcomes but ultimately, the improvement of living standards is FEASIBLE.
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Remember that technological change makes the production function steeper: it increases one’s marginal product of labor.
This means that the opportunity cost of free time is higher, giving one a greater incentive to work.
Illustrate a Budget Constraint.
An equation that represents all combinations of goods and services that one could acquire that exactly exhaust one’s budgetary resources | which is given by: 𝑐=𝑤(24−𝑡)
What is the Budget Constraint formula?
𝑐=𝑤(24−𝑡) where
- where we write 𝑤 as wage
- you have 𝑡 hours of free time per day
- you work for (24−𝑡) hours
- 𝑐 is your maximum level of consumption (entertaining the idea that you cannot exceed your earnings).
Extra info :) :
Budget Constraint;
Your optimal combination of consumption and free time is the point on the budget constraint where: MRS = MRT=𝑤
Define Substitution effect.
The effect that is only due to changes in the price or opportunity cost, given the new level of utility.
Meaning; when the opportunity cost increases, so does the MRT, which gives you an incentive to work more.
Describe the impact of the Income effect and Substitution effect on a wage rise.
When offered a wage rise, one would immediately give into the possibility of more free time for the same pay (income effect), although, it is more reasonable to choose to increase work hours because the opportunity cost of free time becomes steeper. (sub effect)
Therefore, if the opportunity costs did not increase, the income effect would dominate.
Extra info :) :
A wage rise has two effects on your choice of free time:
- income effect
- substitution effect
Is the model of feasible set and indifference curve a good model for our daily lives?
An economic model is made to help us ‘see more by looking at less’. Therefore the lack of realism is an intentional feature of this model, not a shortcoming.
In real life, individuals do not act on these calculations but we can perceive similar behavior through trial and error in day to day lives.
