Question

Consider 2 nurses: Diana and Susan. They work on similar positions and earn the same wage of $30 per hour. They both spend their 24 hours a day time between work and leisure. They both have to work at least 6 hours a day and need at least 9 hours of leisure.    

The difference between Diane and Susan is in their attitude/demand for leisure:

• If Diane’s wage goes up, she works more (i.e. demands less leisure).
• If Susan’s salary goes up, she works less (i.e. demands more leisure).

Assume that their work allows them to scale up or down their hours.

1. Currently both nurses are working 9 hours. Starting from their current wage of $30 per hour draw Diane’s and Susan’s functions of demand for leisure. (Hint: hours of leisure on horizontal axis and price of leisure – their wage on vertical axis.) Assume that each section of their demand for leisure is represented by a straight line.

2.Explain why we consider their wage as “price of leisure”.

3.Given that they both maximize their utility, explain the difference between their demand curves. Use the income and substitution effect in your explanation. To do that, draw two graphs (for Diane and Susan) showing their consumer choice if the price of leisure increases. Hint: use the quantities of leisure on the horizontal and all other goods on the vertical axis.   

Answer 1

A) Individual and Market Demand 1) Consider 2 nurses: Diana and Susan. They work on similar positions and earn the same wage of $30 per hour. They both spend their 24 hours a day time between work and leisure. They both have to work at least 6 hours a day and need at least 9 hours of leisure. The difference between Diane and Susan is in their attitude/ demand for leisure: If Diane's wage goes up, she works more (.e. demands less leisure). If Susan's salary goes up, she works less (i.e. demands more leisure). Assume that their work allows them to scale up or down their hours. a) Currently both nurses are working 9 hours. Starting from their current wage of S30 per hour draw Diane's and Susan's functions of demand for leisure. (Hint: hours of leisure on horizontal axis and price of leisure - their wage on vertical axis.) Assume that each section of their demand for leisure is represented by a straight line. Graph: demand for leisure of Susan and Diane b) Given that they both maximize their utility, explain the difference between their demand curves. Use the income and substitution effect in your explanation. To do that, draw two graphs (for Diane and Susan) showing their consumer choice if the price of leisure INCREASES. Hint: use the quantities of leisure on the horizontal and all other goods on the vertical axis. Graph: consumer choice of Diane Graph: consumer choice of Susan

B)

The demand for labor is one determinant of the equilibrium wage and equilibrium quantity of labor in a perfectly competitive market. The supply of labor, of course, is the other.

Economists think of the supply of labor as a problem in which individuals weigh the opportunity cost of various activities that can fill an available amount of time and choose how to allocate it. Everyone has 24 hours in a day. There are lots of uses to which we can put our time: we can raise children, work, sleep, play, or participate in volunteer efforts. To simplify our analysis, let us assume that there are two ways in which an individual can spend his or her time: in work or in leisure. Leisure is a type of consumption good; individuals gain utility directly from it. Work provides income that, in turn, can be used to purchase goods and services that generate utility.

The more work a person does, the greater his or her income, but the smaller the amount of leisure time available. An individual who chooses more leisure time will earn less income than would otherwise be possible. There is thus a tradeoff between leisure and the income that can be earned from work. We can think of the supply of labor as the flip side of the demand for leisure. The more leisure people demand, the less labor they supply.

Two aspects of the demand for leisure play a key role in understanding the supply of labor. First, leisure is a normal good. All other things unchanged, an increase in income will increase the demand for leisure. Second, the opportunity cost or “price” of leisure is the wage an individual can earn. A worker who can earn $10 per hour gives up $10 in income by consuming an extra hour of leisure. The $10 wage is thus the price of an hour of leisure. A worker who can earn $20 an hour faces a higher price of leisure.

C)

Most consumers have a limited amount of income to spend on the things they need and want. Alphonso, for example, has $10 in spending money each week that he can use to buy bus tickets for getting to work and the burgers that he eats for lunch. Burgers cost $2 each, and bus tickets are 50 cents each.

There are a lot of combinations of burgers and bus tickets that Alphonso could buy. So many, in fact, that it might be easier for us to describe the situation using a graph!

The graph shows the budget line as a downward slope representing the opportunity set of burgers and bus tickets.

Each point on the budget constraint represents a combination of burgers and bus tickets whose total cost adds up to Alphonso’s budget of $10. The slope of the budget constraint is determined by the relative price of burgers and bus tickets. All along the budget set, giving up one burger means gaining four bus tickets. Image credit: OpenStax CNX

The figure above shows Alphonso’s budget constraint—the outer boundary of his opportunity set. The opportunity set identifies all the opportunities for spending within his budget—in this case, bus tickets and burgers. The budget constraint indicates all the combinations of burgers and bus tickets Alphonso can afford before he exhausts his budget, given the prices of the two goods.

The vertical axis in the figure shows burger purchases, and the horizontal axis shows bus ticket purchases. If Alphonso spends all his money on burgers, he can afford five per week—$10 per week divided by $2 per burger equals five burgers per week. But if Alphonso uses all his money on burgers, he will not be able to afford any bus tickets. This choice—zero bus tickets and five burgers—is shown by point A in the figure.

Alternatively, if Alphonso spends all his money on bus tickets, he can afford 20 per week—$10 per week divided by $0.50 per bus ticket equals 20 bus tickets per week. If he does this, however, he will not be able to afford any burgers. This choice—20 bus tickets and zero burgers—is shown by point F.

If Alphonso is like most people, he will choose some combination that includes both bus tickets and burgers. That is, he will choose some combination on the budget constraint that connects points A and F. Every point on or inside the constraint shows a combination of burgers and bus tickets that Alphonso can afford. Any point outside the constraint is not affordable because it would cost more money than Alphonso has in his budget.

The budget constraint shows the tradeoff Alphonso faces in choosing between burgers and bus tickets. Suppose he is currently at point D, where he chooses to buy 12 bus tickets and two burgers. What would it cost Alphonso for one more burger? It would be natural to answer $2, but that’s not the way economists think. Economists think about the true cost of a burger—the number of bus tickets Alphonso will have to sacrifice.