Question

2. Suppose that Person B has 16 hours a day available to work for pay or do unpaid activities. This person's wage rate is $10/hr. Person B obtains the highest level of utility by working 5 hours/day (remotely). Today, Person B was told that she will begin receiving $20/day in unearned income, say from interest on a savings account.

a. (5 points) Draw a fully-labeled graph to illustrate the shape of indifference curves that could lead Person B to quit working upon receiving the $20/day of unearned income. Explain what kind of real-life circumstances might be such that the person would be better off by quitting work.

b. (5 points) On the same graph above, illustrate Person B's reservation wage after receiving the unearned income. There is not a numerical value that you can calculate for this question, just draw what is needed on the graph and describe in words how the reservation wage is determined and what the reservation wage represents.

c. (10 points) On a second, fully-labeled graph illustrate a case where Person B will continue to work after receiving the unearned income. Do they work more or less than they were before? Explain.

Answer 1

Answer a) Please refer to the Diagram 1

We know that from today Person B is going to receive $20 per day as unearned income.

Person B's wage rate is $ 10/hr.

She would be getting $20 at 0 work hours. From the diagram we can see the graph S1, S2 and S3 represent the options in front of Person B. We know that she obtains highest level of utility by working for 5hrs. She can avoid working for 2 hrs and still get $20 which she would have got by working. this will impact her efficiency as 2 out of 5 hrs of top utility work will be lost. According to the Leisure-Labor model she will prefer to spend the extra time and money in Leisure activity which will increase consumption but would also result in lost opportunity cost of earning more.

Answer b): Please refer to the Diagram 1 .

Reservation wage refers to the least amount of money a person would consider working for in a particular position or type of employment. If you were looking for a job as a supermarket packer and your reservation wage was $8 per hour, it would mean that any packer’s position paying less than $8 per hour would be rejected by you.

Hence reservation wage represents an amount of wage below which the candidate would not want to work as he feels its better to not to work at that wage.

Answer c); Please refer to the Diagram 2.

It is very difficult to predict the behavior of person B to evaluate if she will work more or less than before. We can lay out both the possibilities.

Works more: Assuming that she works more we can see from the graph how her income graph will go up. She would want to increase the 5hrs of her maximum utility. Doing this will reduce the leisure time she use to spend before. This will help raise her income can would increase the chances of her acquiring more knowledge a the work place. Her regular work might increase her chances of getting promotion and a further hike in pay.

Works Less: If she is satisfied with what she is earning plus the unearned income it will decrease her overall efficiency. she will prefer to spend the time in leisure activity like watching tv, movies, eating out. this will reduce her savings and increase expenses. Leisure activities might give her peace of mind and will reduce stress.