Question

1. Steve derives his income from his job at McDonald’s, which in turn allows him to consume goods. The job pays $5 an hour and he has (of course) 24 hours each day to allocate between leisure and work. He is then given the additional opportunity to take on a salaried (not hourly) position as a research assistant. If he takes the job, he is required to work EXACTLY 4 hours per day at this research job, in turn receiving a lump-sum payment of $40 per day. Assume that after putting in his 4 hours as a research assistant, he can work additional hours at McDonald’s if he wishes to do so.

1. Graph and label the original budget constraint and the new budget constraint which includes the research assistantship.
2. Steve considers leisure an inferior good. If he originally works 6 hours per day at McDonald’s, sketch both the original indifference curve and a possible new indifference curve. Explain your reasoning. (Hint: think about whether Steve should end up working more or less than 6 hours total when he gets the research assistantship.)

Answer 1

a) Hours available = 24 hours

Wage rate = $5

Let the expenditure on consumption that this consumer can do be denoted by C. Also, let the hours of leisure be denoted by L.

Price of leisure can be measured by taking into consideration the opportunity cost of leisure. When the consumer indulges in 1 hour of leisure, he foregoes $5 (which he would have earned by working the same hour). Hence, the opportunity cost of leisure = $5. So, price of leisure = opportunity cost = $5

If Steve does entire 24 hours of work, then Steve can earn $5 * 24 = $120. This is the maximum amount of consumption that this person can achieve.

The consumer's consumption budget constraint (for a single day).

Expenditure on consumption + price of leisure * units of leisure = income

C + w L = maximum consumption

Where C = consumption

w = price of leisure

L = units of leisure

Putting the values:

C+5L=120

Plot consumption on y-axis and hours of Leisure on x-axis. The consumer's budget constraint has been plotted in figure 1 in blue color.

Now, Steve is given the additional opportunity to take on a salaried (not hourly) position as a research assistant. He has to give 4 hours and gets $40 in return.

So, now if he takes the opportunity, he has 24-4= 20 hours to spend on leisure and working at McDonald’s.

Maximum amount that he can earn = working for 20 hours in McDonald’s + 4 hours of work as research assistant = 20*5 + 40 = 140

Steve get $5 as wage but has $40 lumpsum income and he can have at max 20 hours of leisure.

The new budget line is plotted in red color in figure 1

Figure 1

b) He worked for 6 hours in McDonald’s. This means he enjoyed 24-6 = 18 hours of leisure and had 6*$5 = $30 worth of consumption.

Now, Leisure is considered as an inferior good. As income increases, the hours of leisure must fall. Earlier they were 18 hours, now leisure hours must be less than 18 hours.

Earlier, he consumed at point A now he consumes at point B where the leisure hour falls to L₁ from 18 hours and consumption rises to C₁ from $30.

Figure 2

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