# Lecture 8 Microeconomics

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Outline
• Application 1: Labor supply

• Application 2: Education
Labour supply
• competitive labour market
• individual workers who supply hours of
labour to the market.
• Trade-off between leisure and
consumption.
• The workers like consumption but
• dislike work (because they have to forego
leisure when working).
Objectives of choice

U  U ( L, C )

where
C = consumption
L = leisure
Indifference curves
u
C

A

C
L
The budget constraint
The worker faces two constraints:
The time constraint: Lmax = L+S
The budget constraint: pC = wS + M
Lmax = total number of hours
S = hours of work
w = wage rate
M = non-labour income
p = price of consumption
Combine
the two….

pC  M  w( Lm ax  L)
pC  wL  M  wLmax
w   M  wLmax
C   L
p       p
The budget line
C

M

L
Lmax
The Choice

C

C*
M

L
L*    Lmax
No labour supply

C

C*=M

L
Lmax
C
C        p=1
B
A

w    L
w2
w1

w0
S
Three effects of an increase in w
• The substitution effect: for give real
income, the fact that leisure becomes more
expensive induces the worker to substitute
away from leisure.
• The “normal” income effect: for given
nominal income, real income decreases
and the worker buys less of both goods (if
they are normal).
The third effect
• The endowment effect: when the wage
rate increases, the value of the worker’s
full income increases and that leads to an
increase in the consumption of both
goods.
C
M=0

D
B
C
A

Lmax
L
Education
• Publicly financed schools

• Privately financed schools

• Voucher program
Model
• Two goods:
– Educational services (E)
– All other goods (C)
• Given income: m
• Given price of educational services: p

max U ( E , C )
s.t. m  C  pE
Private market
C

m

E
EP    m/p
Public and private market
C

m

A

E
EF EP   m/p
Public and private market
C           Education EF is provided
at no direct cost
m       B
A

Increase
in E!
E
EP EF   m/p
Public and private market
C              Education EF is provided
at no direct cost
m     B

A
Unchanged
E.
E
EF   EP   m/p
Voucher Proposal
• All parents get vouchers to buy
educational services equal to EF.
• They are free to buy the services from a
public or private provider.
• The vouchers cannot be used for other
purposes than education.
Public and private market
C

m

C
A

E
EF EP Ev m/p
Summary
• The economic model of behavior can be
used to analyse many situations,
including
– consumption choices
– labor supply
– education
• and it gives us empirically testable
predictions about hwo changes in the
opportunity set of agents affect their
choices.

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