Income and working hours across time and countriesScarcity and choice: key concepts
Decision-making under scarcityConcluding remarks and summary
Principles of Economics1
3. Scarcity, work, and choice
Giuseppe Vittucci Marzetti2
SCORDepartment of Sociology and Social Research
University of Milano-Bicocca
A.Y. 2018-19
1These slides are based on the material made available under Creative Commons BY-NC-ND4.0 by the CORE Project©, https://www.core-econ.org/.
2Department of Sociology and Social Research, University of Milano-Bicocca, Via Bicoccadegli Arcimboldi 8, 20126, Milan, E-mail: [email protected]
Giuseppe Vittucci Marzetti Principles of Economics 1/26
Income and working hours across time and countriesScarcity and choice: key concepts
Decision-making under scarcityConcluding remarks and summary
Layout
1 Income and working hours across time and countries
2 Scarcity and choice: key conceptsProduction function, average productivity and marginal productivityPreferences and indifference curvesOpportunity costFeasible frontier
3 Decision-making under scarcityConstrained choices and optimal decision makingLabor choiceIncome effect and substitution effectEffect of technological change on labor choices
4 Concluding remarks and summaryConcluding remarksSummary
Giuseppe Vittucci Marzetti Principles of Economics 2/26
Income and working hours across time and countriesScarcity and choice: key concepts
Decision-making under scarcityConcluding remarks and summary
Income and free time across countries
Figure: Annual hours of free time per worker and income (2013)
Giuseppe Vittucci Marzetti Principles of Economics 3/26
Income and working hours across time and countriesScarcity and choice: key concepts
Decision-making under scarcityConcluding remarks and summary
Income and working hours across time and countries
Figure: Annual hours of work and income (18702000)
Living standards have greatly increased since 1870.
There are disparities in free time and income across countries.
Giuseppe Vittucci Marzetti Principles of Economics 4/26
Income and working hours across time and countriesScarcity and choice: key concepts
Decision-making under scarcityConcluding remarks and summary
Labor productivity, income and free time
Labor is an input in the production of goods and services.
New technologies raise labor productivity.
How would that affect living standards?How would that affect the free time and working hours chosen byindividuals?
Modeling individual choices to explain the differences in work hoursacross countries and over time.
Giuseppe Vittucci Marzetti Principles of Economics 5/26
Income and working hours across time and countriesScarcity and choice: key concepts
Decision-making under scarcityConcluding remarks and summary
Production function, average productivity and marginal productivityPreferences and indifference curvesOpportunity costFeasible frontier
A simple production function
Production functions show how inputs (e.g. labor) translate intooutputs (e.g. goods and services), holding other factors constant.Example: a production function of a student shows how study hoursproduce the final grade.
Giuseppe Vittucci Marzetti Principles of Economics 6/26
Income and working hours across time and countriesScarcity and choice: key concepts
Decision-making under scarcityConcluding remarks and summary
Production function, average productivity and marginal productivityPreferences and indifference curvesOpportunity costFeasible frontier
Average and marginal productivity
Marginal product (or productivity): change in output per unitchange in input (evaluated at a given point, holding other inputsconstant).Average product (or productivity): average output per unit of input.
Giuseppe Vittucci Marzetti Principles of Economics 7/26
Income and working hours across time and countriesScarcity and choice: key concepts
Decision-making under scarcityConcluding remarks and summary
Production function, average productivity and marginal productivityPreferences and indifference curvesOpportunity costFeasible frontier
Diminishing marginal productivity: the law of diminishingmarginal returns
Giuseppe Vittucci Marzetti Principles of Economics 8/26
Income and working hours across time and countriesScarcity and choice: key concepts
Decision-making under scarcityConcluding remarks and summary
Production function, average productivity and marginal productivityPreferences and indifference curvesOpportunity costFeasible frontier
Choices, preferences and indifference curves
Choices depend onpreferences.
Indifference curves:combinations of goods thatgive the same utility.
The Marginal Rate ofSubstitution (MRS):
is the slope of theindifference curve;represents the trade-offsthat an individual faces.
Giuseppe Vittucci Marzetti Principles of Economics 9/26
Income and working hours across time and countriesScarcity and choice: key concepts
Decision-making under scarcityConcluding remarks and summary
Production function, average productivity and marginal productivityPreferences and indifference curvesOpportunity costFeasible frontier
Preferences and indifference curves
The curves we have drawn capture our typical assumptions aboutpeople’s preferences between two goods.
Indifference curves slope downward due to trade-offs: if you areindifferent between two combinations, the combination that hasmore of one good must have less of the other good.
Higher indifference curves correspond to higher utility levels: as wemove up and to the right in the diagram, further away from theorigin, we move to combinations with more of both goods.
Indifference curves are usually smooth: small changes in theamounts 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 becomesflatter : it is reasonable to assume that the more free time and thelower the grade the student has, the less willing she is to sacrificefurther percentage points in return for free time, so her MRS islower.
Giuseppe Vittucci Marzetti Principles of Economics 10/26
Income and working hours across time and countriesScarcity and choice: key concepts
Decision-making under scarcityConcluding remarks and summary
Production function, average productivity and marginal productivityPreferences and indifference curvesOpportunity costFeasible frontier
Opportunity cost
Opportunity cost
The opportunity cost of an action is the net benefit of the next bestalternative action.
Opportunity costs are relevant whenever choices are limited byconstraints and involve trade-offs, i.e. alternative and mutuallyexclusive courses of action (e.g. higher grades vs. more free time).
Compare actions based on economic cost:
Economic cost = Direct (monetary and non-monetary) costs +Opportunity costs
If the benefit from an action exceeds the economic costs, you receivean economic rent from choosing it.
Giuseppe Vittucci Marzetti Principles of Economics 11/26
Income and working hours across time and countriesScarcity and choice: key concepts
Decision-making under scarcityConcluding remarks and summary
Production function, average productivity and marginal productivityPreferences and indifference curvesOpportunity costFeasible frontier
Opportunity cost: example
Giuseppe Vittucci Marzetti Principles of Economics 12/26
Income and working hours across time and countriesScarcity and choice: key concepts
Decision-making under scarcityConcluding remarks and summary
Production function, average productivity and marginal productivityPreferences and indifference curvesOpportunity costFeasible frontier
The feasible frontierThe feasible frontier shows the maximum output that can beachieved with a given amount of inputThe Marginal Rate of Transformation (MRT):
is the slope of the feasible frontier;represents the tradeoffs that an individual faces.
Giuseppe Vittucci Marzetti Principles of Economics 13/26
Income and working hours across time and countriesScarcity and choice: key concepts
Decision-making under scarcityConcluding remarks and summary
Constrained choices and optimal decision makingLabor choiceIncome effect and substitution effectEffect of technological change on labor choices
Constrained choice problem
Model of how individuals choose, given their preferences and theconstraints they face, when the things they value are scarce.
Studying example: Free time and exam score are scarce becausethey are both goods, each with an opportunity cost.
Giuseppe Vittucci Marzetti Principles of Economics 14/26
Income and working hours across time and countriesScarcity and choice: key concepts
Decision-making under scarcityConcluding remarks and summary
Constrained choices and optimal decision makingLabor choiceIncome effect and substitution effectEffect of technological change on labor choices
Optimal decision making
The utility-maximizing choice is where the amount of one good theindividual is willing to trade off for the other good (MRS) equals theactual tradeoff between the two goods (MRT)
MRS = MRT
Giuseppe Vittucci Marzetti Principles of Economics 15/26
Income and working hours across time and countriesScarcity and choice: key concepts
Decision-making under scarcityConcluding remarks and summary
Constrained choices and optimal decision makingLabor choiceIncome effect and substitution effectEffect of technological change on labor choices
Another example: grain production
(a) Production function (b) Feasible frontier
Tradeoff between grain produced and free time.
Technological change shifts the production function upwards, andexpands the feasible frontier.
Giuseppe Vittucci Marzetti Principles of Economics 16/26
Income and working hours across time and countriesScarcity and choice: key concepts
Decision-making under scarcityConcluding remarks and summary
Constrained choices and optimal decision makingLabor choiceIncome effect and substitution effectEffect of technological change on labor choices
Effect of the technological change on individual choices
Technological progress makes it feasible to both consume more andhave more free time.Choice of free time/consumption depends on relative preferencesand willingness to substitute one good for another.
Giuseppe Vittucci Marzetti Principles of Economics 17/26
Income and working hours across time and countriesScarcity and choice: key concepts
Decision-making under scarcityConcluding remarks and summary
Constrained choices and optimal decision makingLabor choiceIncome effect and substitution effectEffect of technological change on labor choices
Choice between income and free timeBudget constraints are the feasible frontiers for consumption choices.The optimal choice is where the slope of the indifference curve(MRS) equals the wage (MRT).
Giuseppe Vittucci Marzetti Principles of Economics 18/26
Income and working hours across time and countriesScarcity and choice: key concepts
Decision-making under scarcityConcluding remarks and summary
Constrained choices and optimal decision makingLabor choiceIncome effect and substitution effectEffect of technological change on labor choices
Income effect and substitution effect
Wage changes affect the slope of the budget constraint (MRT).
A wage increase has two effects:
income effect: total earnings increase, holding working hours fixed;substitution effect: the opportunity cost of free time increases.
Giuseppe Vittucci Marzetti Principles of Economics 19/26
Income and working hours across time and countriesScarcity and choice: key concepts
Decision-making under scarcityConcluding remarks and summary
Constrained choices and optimal decision makingLabor choiceIncome effect and substitution effectEffect of technological change on labor choices
Income effect
The optimal choice changes when income changes, keepingopportunity costs (the budget constraint slope) fixed.A wage increase gives more income per hour worked⇒ incentive to decrease working hours.
Giuseppe Vittucci Marzetti Principles of Economics 20/26
Income and working hours across time and countriesScarcity and choice: key concepts
Decision-making under scarcityConcluding remarks and summary
Constrained choices and optimal decision makingLabor choiceIncome effect and substitution effectEffect of technological change on labor choices
Substitution effect
The optimal choice changes when the opportunity cost changes, atthe new level of utility.A wage increase raises the opportunity cost of free time⇒ incentive to increase hours worked.
Giuseppe Vittucci Marzetti Principles of Economics 21/26
Income and working hours across time and countriesScarcity and choice: key concepts
Decision-making under scarcityConcluding remarks and summary
Constrained choices and optimal decision makingLabor choiceIncome effect and substitution effectEffect of technological change on labor choices
Overall effect on labor choice
Income effect is negative.Substitution effect is positive.Which effect dominates depends on individual preferences.
Overall effect = Income effect + Substitution effect
Giuseppe Vittucci Marzetti Principles of Economics 22/26
Income and working hours across time and countriesScarcity and choice: key concepts
Decision-making under scarcityConcluding remarks and summary
Constrained choices and optimal decision makingLabor choiceIncome effect and substitution effectEffect of technological change on labor choices
Working hours: differences over time
Income and substitution effects can explain trends in working hours.
E.g. In the US, the income effect dominated the substitution effect,so consumption and free time both increased.
Giuseppe Vittucci Marzetti Principles of Economics 23/26
Income and working hours across time and countriesScarcity and choice: key concepts
Decision-making under scarcityConcluding remarks and summary
Constrained choices and optimal decision makingLabor choiceIncome effect and substitution effectEffect of technological change on labor choices
Working hours: cross-country differences
Differences in working hours can be explained by preferences thatdiffer across countries.
There are other possible explanations.
Giuseppe Vittucci Marzetti Principles of Economics 24/26
Income and working hours across time and countriesScarcity and choice: key concepts
Decision-making under scarcityConcluding remarks and summary
Concluding remarksSummary
Is this a good model?
Not realistic:
People don’t actually do MRS/MRT calculations.Most people cannot choose their working hours.
But still a good approximation:
Over time, people learn what combination of working hours and freetime suits them best.Working hours can change due to culture and politics (indirectchoice).People can choose which jobs to apply for.
It helps us understand real-world phenomena:
Preferences and income/substitution effects can explain differencesin working hours across countries and over time.
Giuseppe Vittucci Marzetti Principles of Economics 25/26
Income and working hours across time and countriesScarcity and choice: key concepts
Decision-making under scarcityConcluding remarks and summary
Concluding remarksSummary
Summary
Economics is the science that studies human behaviour as a re-lationship between given ends and scarce means which have al-ternative uses.
(Robbins, 1932)
Simple model of decision-making under scarcity
Indifference curves represent preferences;Feasible frontier represents choice constraints;Utility-maximizing choice where MRS = MRT.
Used model to explain effect of technological change on labor choices
Overall effect = Income effect + Substitution effect
Limitations of model: it omits important factors
Giuseppe Vittucci Marzetti Principles of Economics 26/26