Question

As unearned income rises within the standard labor/leisure model, it has a predictable effect on hours of work and the consumption of leisure. Use a graph to show this effect. Explain the graphical system in your answer.

Answer 1

Pragya has 70 hours per week that she could devote either to work or to leisure and her wage is $10/hour. The lower budget constraint in figure shows Pragya’s possible choices. The horizontal axis of this diagram measures both leisure and labor, by showing how Pragya’s time is divided between leisure and labor. Hours of leisure are measured from left to right on the horizontal axis, while hours of labor are measured from right to left. Pragya will compare choices along this budget constraint, ranging from 70 hours of leisure and no income at point S to zero hours of leisure and $700 of income at point L. She will choose the point that provides her with the highest total utility. For this example, let’s assume that Pragya’s utility-maximizing choice occurs at O, with 30 hours of leisure, 40 hours of work, and $400 in weekly income.

Figure show how a Rise in Wages Alters the Utility-Maximizing Choice. Pragya’s original choice is point O on the lower opportunity set. A rise in her wage causes her opportunity set to swing upward. In response to the increase in wages, Pragya can make a range of different choices available to her: a choice like D, which involves less work; and a choice like B, which involves the same amount of work but more income; or a choice like A, which involves more work and considerably more income. Pragya’s personal preferences will determine which choice she makes.

For Pragya to discover the labor-leisure choice that will maximize her utility, she does not have to place numerical values on the total and marginal utility that she would receive from every level of income and leisure. All that really matters is that Pragya can compare, in her own mind, whether she would prefer more leisure or more income, given the tradeoffs she faces. If Pragya can say to herself: “I’d really rather work a little less and have more leisure, even if it means less income,” or “I’d be willing to work more hours to make some extra income,” then as she gradually moves in the direction of her preferences, she will seek out the utility-maximizing choice on her labor-leisure budget constraint.

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