Allocation Between the Household and the Labor

Market

The Indifference CurveSubstitution in Consumption

vs. Production

Rational Consumer Notation

P – Preferred I – Indifferent A, B, C, etc. Represent Bundles of

goods

Rule 1- More is preferred to less

Rational Consumer Rule 2- Transitivity

A P B and B P C then A P C A I B and B P C then A P C A P B and B I C then A P C A I B and B I C then A I C A P B and A P C then we do not know

the relation between B and C Rule 3- Completeness

Indifference Curve

.A

.B

.C.D

Good X

Good Y

Indifference Curve

.A.B

.C.D

Good X

Good Y

Properties of Indifference Curves

Good Y

Good X

.A

.B

So A and B should beindifferent and A is preferred

To B at the same time.C

A I C

A I B

A P B

Budget Constraint

Good X

Good Y

Convex vs. Concave Indifference Curves

Good X

Good Y

.A

.B

.C

Concave

Maximize Utility

Good X

Good Y .A

.B

.C

Convex

TWO SEPARATE HOUSEHOLDS

Significant A

Home Goods

Mark

et

Good

s

Home Goods

Mark

et

Good

s

Significant B

50

90

80

30

COMBINED INCOMEM

ark

et

Good

s

Home Goods

130

120

Percapita Consumption of Combined Household

Mark

et

Good

s

Home Goods

50

90

80

30

65

60

Consumption area improved by joining households

Areas that are lost by joining

households and

consuming in equal parts

So what will they consume?

As Individuals And as compared with a joint

household It will depend on the individual

indifference curves And their indifference curves as a

household

TWO SEPARATE HOUSEHOLDS

Significant A

Home Goods

Mark

et

Good

s

Home Goods

Mark

et

Good

s

Significant B

50

90

80

30

If as a Household more Inclined towards Market

goodsM

ark

et

Good

s

Home Goods

50

90

80

30

65

60

If as a Household more Inclined towards Home

goodsM

ark

et

Good

s

Home Goods

50

90

80

30

65

60

If as a Household is somewhat indifferent

between Market and Home goods

Mark

et

Good

s

Home Goods

50

90

80

30

65

60

Alternatives Substitution in Production

Some goods can be produced by Using goods intensive technique

For example, hiring someone to clean the house for you

Using time intensive technique For example, cleaning house yourself

Alternatives Substitution in Consumption

Goods intensive to produce Goods using large amount of market

goods and little nonmarket time Going out to eat Vacation

Goods using large amount of time (time intensive goods)

Raising kids

Indifference Curves in Labor Market

On the vertical axis are the market goods

On the horizontal axis there is the number of hours that could be dedicated to market time

Budget constrain is based on the wage one would get and the number of hours worked

Indifference Curves in Labor Market

Good Y

Convex

0

16

16

0Hours for NonMkt Time

Hours for Mkt Time

Budget Constraint

160

016

A

B

Hours for NonMkt TimeHours for Mkt Time

190

Market Goods

150

Reservation Wage

160

016

A

B

Hours for NonMkt TimeHours for Mkt Time

192

Market Goods

96

88

So at a wage of $12 an hourthis individual would work

8 hours

Reservation Wage

160

016

A

B

Hours for NonMkt TimeHours for Mkt Time

192

Market Goods

96

88

So at a wage of $12 an hourthis individual would

not work

Reservation Wage

160

016

A

B

Hours for NonMkt TimeHours for Mkt Time

192

Market Goods

96

88

Which of these individuals is more likely to represent a Hispanic immigrant and which represent

a second or third generation Hispanic

1

2

Impact of Additional Wage on the Work/Leisure

Decision

160

016

A

B

Hours for NonMkt TimeHours for Mkt Time

192

Market Goods

96

88

At higher wage this personWorks less hours

(Income Effect Overpowers Substitution Effect)

Decrease the

Working Hours

Impact of Additional Wage on the Work/Leisure

Decision

160

016

A

B

Hours for NonMkt TimeHours for Mkt Time

192

Market Goods

96

88

At higher wage this personWorks more hours

(Substitution Effect OverpowersIncome Effect)

Increase the

Working Hours