Question

5. Show the consumer equilibrium in the labor-leisure model. Label the amount of work, leisure, and income (consumption) this worker will choose if she works 8 hours and the wage is $5 per hour. Make sure to label the maximum leisure and income amounts on the graph as well as the slope of the budget constraint and the indifference curve. What is the marginal rate of substitution between leisure and income? (4 pts)

6. Explain using words and a graph why there is an incentive to renege (cheat) on the other duopolist if they agree to form a “shared monopoly” in which each splits the market in half.

Answer 1

5. Start with the assumption that total number of hours available is 20 which has to be utilized for leisure or by working. These 20 hours are represented on the x-axis as OA. Given the wage rate, we can draw the wage line MA. The wage rate given is $5 per hour. If the individual wotks for 20 hours without leisure, her total income will be . Slope of the wage-line i.e.OM/OA is equal to the wage rate. The individual is in equilibrium at point E. She enjoys OD hours of leisure and earns an income equal to OF amount by working for AD hours.

6. For the graph given below, the assumptions are:

i) MC line is constant i.e. constant cost condition.

ii) Two firms enter the market one-by-one and one firm's output depends on another firm's reaction.

The market has capacity of demand of 200 units. Firm A and Firm B form the duopoly market.

Output of B	Output of A
0	100
100	50
150	25

When Firm B's output is zero, half of the market is captured by A and its output is equal to 100 units ( MC = MR). AE is the corresponding MR line.

When B's output is 100, then only half of the market is available for A and again, it captures half of the available market i.e. 50 units ( MC=MR). DF is the corresponding MR line.