Question

In: Economics

Using indifference curves, show how the labour/leisure trade-off determines the reservation wage, wr, where there is...

Using indifference curves, show how the labour/leisure trade-off determines the reservation wage, wr, where there is non-labour income, m, but no unemployment benefit. [50]

Show how the worker’s reservation wage and behaviour change if she becomes entitled to unemployment benefit, b? [50]

Solutions

Expert Solution

Indifference curve analysis can be used to explain an individual’s choice between income and leisure and to show why higher overtime wage rate must be paid if more hours of work is to be obtained from the workers.

It is important to note that income is earned by devoting some of the leisure time to do some work. That is income is earned by sacrificing some leisure.

The greater the amount of this sacrifice of leisure, that is, the greater the amount of work done, the greater income an individual earns.

Further, income is used to purchase goods, other than leisure for consumption. Leisure time can be used for resting, sleeping, playing, listening to music on radios and television etc. all of which provide satisfaction to the individual. Therefore, in economics leisure is regarded as a normal commodity the enjoyment of which yields satisfaction to the individual.

While leisure yields satisfaction to the individual directly, income represents general purchasing power capable of being used to buy goods and services for satisfaction of various wants. Thus income provides satisfaction indirectly. Therefore, we can draw indifference curves between income and leisure, both of which give satisfaction to the individual.

Indifference maps between income and leisure is depicted in Figure 11.12 and have all the usual properties o/indifference curves. They slope downward to the right, are convex to the origin and do not intersect. Each indifference curve represents various alternative combinations of income and leisure which provide equal level of satisfaction to the individual and the farther away an indifference curve is from the origin, the higher the level of satisfaction it represents for the individual.

The slope of the indifference curve measuring marginal rate of substitution between leisure and income (MRSLM) shows the tradeoff between income and leisure. This trade-off means how much income the individual is willing to accept for one hour sacrifice of leisure time.

However, the actual choice of income and leisure by an individual would also depend upon what is the market rate of exchange between the two, that is, the wage rate per hour of work. It is worth noting that wage rate is the opportunity cost of leisure.

In other words, to increase leisure by one hour, an individual has to forego the opportunity of earning income (equal to wage per hour) which he can earn by doing work for an hour. This leads us to income-leisure constraint which together with the indifference map between income and leisure would determine the actual choice by the individual.

The maximum amount of time available per day for the individual is 24 hours. Thus, the maximum amount of leisure time that an individual can enjoy per day equals 24 hours. In order to earn income for satisfying his wants for goods and services, he will devote some of his time to do work.


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