ECON 104 topic 5
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Questions and Answers

What happens to the opportunity cost of leisure when wages increase from w to w'?

  • It becomes irrelevant.
  • It increases. (correct)
  • It decreases.
  • It remains the same.

    • Which of the following statements best describes the reaction of the individual to an increase in wage rate?

  • The individual will work less and enjoy more leisure.
  • The individual will divide time equally between work and leisure.
  • The individual will allocate more time to work and reduce leisure time. (correct)
  • The individual will not change their work or leisure time.

    • What is indicated by the notation MRShC when wages increase?

  • Marginal Rate of Substitution decreases. (correct)
  • Marginal Rate of Substitution increases.
  • Marginal Rate of Substitution becomes equal to the wage.
  • Marginal Rate of Substitution is constant.

    • What outcome results from the change in the combination (h0, C0) due to an increase in wages?

    <p>A new utility-maximizing combination is established.</p> Signup and view all the answers

    How is the slope represented when analyzing the substitution effect from wage increase?

    <p>It is negative.</p> Signup and view all the answers

    What does the first condition of the FOCs for U-max imply about the relationship between utility and labor hours?

    <p>The marginal utility of labor is equal to the wage rate.</p> Signup and view all the answers

    How does the utility function depend on labor hours and consumption according to the content?

    <p>Utility depends negatively on labor hours and positively on consumption.</p> Signup and view all the answers

    What effect does an increase in the wage rate have on labor supply?

    <p>It leads to more hours worked due to the substitution effect.</p> Signup and view all the answers

    What induces the substitution effect in labor-leisure choices?

    <p>Increasing wages that make leisure less attractive relative to work.</p> Signup and view all the answers

    In the context of MRShC and market exchange rates, what does MRShC represent?

    <p>The individual's willingness to trade consumption for leisure.</p> Signup and view all the answers

    What is the formula for wage income as expressed in the provided content?

    <p>Y = wL</p> Signup and view all the answers

    When analyzing the behavior of an individual with MRShC ≠ w/p, what could be a result of this disparity?

    <p>The individual may adjust consumption or leisure to seek equilibrium.</p> Signup and view all the answers

    What happens to leisure (L) when the wage rate (w) increases?

    <p>Leisure decreases</p> Signup and view all the answers

    What does the variable 'h' represent in the budget constraint equation?

    <p>Leisure time</p> Signup and view all the answers

    Given the utility function U = 10h^0.5C^0.5, what does maximizing utility involve analyzing?

    <p>The trade-off between labor and consumption.</p> Signup and view all the answers

    How does an increase in the wage rate affect the consumption of normal goods?

    <p>Consumption of normal goods increases</p> Signup and view all the answers

    What does the equation wH = wh* + pC* signify in terms of resource allocation?

    <p>It captures the relationship between all consumed and earned resources.</p> Signup and view all the answers

    Which interpretation is correct regarding forgone income due to leisure?

    <p>It is calculated as 'wh' in the equations.</p> Signup and view all the answers

    What does the income effect imply when wages go up?

    <p>The value of total time resource increases</p> Signup and view all the answers

    In the equation Y = w(H - h), what does the term (H - h) signify?

    <p>Hours dedicated to work.</p> Signup and view all the answers

    What does the Lagrangian equation represent in the context provided?

    <p>Utility maximization subject to constraints.</p> Signup and view all the answers

    In the context where both C and h are normal goods, what is the effect of an increase in wage on h?

    <p>h increases</p> Signup and view all the answers

    What occurs to labor supply (L) as the wage rate (w) rises?

    <p>Labor supply decreases</p> Signup and view all the answers

    How is the slope of the consumption function determined in the provided equations?

    <p>It is calculated as -w/p.</p> Signup and view all the answers

    What optimal choice does an individual make regarding working time?

    <p>Choose h = h* and C = C* for maximum utility.</p> Signup and view all the answers

    Which statement is true regarding the relationship between wage ($w$) and consumption ($C$)?

    <p>Higher $w$ increases $C$</p> Signup and view all the answers

    In the framework of the income effect when wages decrease, what happens to leisure?

    <p>Leisure increases</p> Signup and view all the answers

    What is the relationship between 'pC' and 'wH - wh' in the context provided?

    <p>'pC' represents consumption that must equal forgone income.</p> Signup and view all the answers

    What implication does the income effect have on the relationship between changes in wage ($w$) and labor ($L$)?

    <p>Increased $w$ results in decreased $L$</p> Signup and view all the answers

    What is the relationship between SE and IE when price of L increases leading to a decrease in hours worked (h)?

    <p>SE is greater than IE</p> Signup and view all the answers

    What happens to labor supply (L) when SE increases and IE decreases?

    <p>Labor supply increases</p> Signup and view all the answers

    How does an increase in price (w) affect the final effect (FE) on hours worked (h) given SE's positive influence and IE's negative influence?

    <p>FE leads to a net decrease in h</p> Signup and view all the answers

    In the context of labor supply, what does a positive SE and negative IE imply?

    <p>Labor supply increases overall</p> Signup and view all the answers

    If SE more significantly affects hours worked than IE, how would this be represented graphically?

    <p>A downward shift in the supply curve</p> Signup and view all the answers

    What is indicated by a scenario where SE increases labor supply while IE reduces it?

    <p>Labor supply will increase</p> Signup and view all the answers

    What does the final effect (FE) depend on in the context of SE and IE?

    <p>The magnitude of the impacts on hours and labor supply</p> Signup and view all the answers

    Given the variables h and L, how does a price increase of L (w) visually differ in its effects?

    <p>Decrease in h while increasing L</p> Signup and view all the answers

    Study Notes

    Wage Income and Budget Constraints

    • Wage income (Y) is expressed as ( Y = wL ), where ( w ) is the wage rate and ( L ) represents labor hours.
    • Consumption is denoted as ( pC ), leading to the equation ( pC = wL ), indicating a direct correlation between consumption and labor.
    • No savings are accounted for; the individual's budget constraint is expressed with total time ( H = h + L ).

    Opportunity Cost of Leisure

    • The opportunity cost of leisure is represented as ( w ), emphasizing that income foregone due to leisure consumption is equal to wage rate multiplied by leisure time (( wh )).
    • Maximum income occurs when the individual works the full time available, ( Y = wH ), while ( wh ) represents forgone income due to leisure consumption.

    Optimal Choice of Working Time

    • An individual optimizes their utility ( U(h, C) ) given their income constraint ( wH = wh + pC ).
    • A Lagrangean function ( \alpha(h, C, \lambda) ) is used, considering the utility along with the income constraint, leading to first-order conditions (FOCs) for maximization.

    Marginal Rate of Substitution (MRS)

    • The MRS of consumption for leisure (MRShC) is equal to the market rate of exchange ( \frac{w}{p} ).
    • The conditions state that higher wages increase the opportunity cost of leisure, shifting the allocation between work ( h ) and consumption ( C ).

    Effects of Wage Changes on Labor Supply

    • Substitution Effect (SE):
      • An increase in wage (( w ) to ( w' )) prompts more work hours (h decreases) and less leisure, as the reward for labor increases.
    • Income Effect (IE):
      • Higher wage increases overall income, positively affecting both leisure and consumption if both are normal goods, leading to more leisure and potential decrease in labor hours.

    Net Effects of Wage Changes

    • The final effect (FE) combines both SE and IE.
    • With rising wages, labor hours tend to decrease due to stronger substitution effect outweighing the income effect, while leisure hours increase concurrently.

    Graphical Representation

    • Graphs illustrate shifts in optimal consumption and labor supply when wages change.
    • SE leads to a decrease in hours worked while IE implies an increase in leisure hours.
    • Depending on the relative strengths of SE and IE, labor supply curves exhibit shifts in behavior, such as supply increases when wages rise but labor supply decreases overall due to higher opportunity costs.

    Conclusion

    • Understanding optimal working time balances individual utility maximization against income conditions.
    • Further analysis on behavior changes when marginal rates differ from market rates enables insights into labor-leisure choices and economic adjustments to wage fluctuations.

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