CAS EC 101 Lecture Notes - Lecture 8: Budget Constraint, Regional Policy Of The European Union, Demand Curve

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CHAPTER: THE LABOR SUPPLY CURVE

Objective 1: Summary of the Economy

• The economy is composed of two sets of participants: Households & Firms

• The economy is composed of two types of markets: Product Markets & Factor Markets

o These markets are the inverse of each other

• Product Markets – goods/services flow from firms to households

o In this market firms are suppliers and households are demanders

• Factor Markets – goods/services used to produce other goods/services

o In this market households are suppliers (of labor and savings) and firms are

demanders (of the total capital)

• Microeconomics – essentially how people make decisions

Objective 2: Labor Budget Constraint

•

o Horizontal Axis – the value of leisure

▪ Since there are only 24 hours in a day, this intercept (indicating leisure)

can never go past 24 hours

o Vertical Axis – value of all other goods that can possibly be produced

▪ This must consider a consumer’s income (wage/hour) and the cost of

items consumed

• Consumers must make a choice between leisure or consumption

o The decision to work comes from the incentive to make money (consume)

• Slope – measured by 



 

 



o This is essentially the opportunity cost

o The slope will always be the negative of a consumer’s wage

Objective 3: Wage Change Effects on the Budget Constraint

• The budget constraint pivots around the good whose price did not change

o Vertical Intercept increases/decreases (if the consumer’s wages

increases/decreases)

o Horizontal Intercept will never change, as the amount of leisure is always set

• What happens to the Budget Constraint if wages increases?

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o The budget constraint pivots upwards around the horizontal intercept because the

vertical intercept increases

• What happens to the Budget Constraint if wages decreases?

o The budget constraint pivots downwards around the horizontal intercept because

the vertical intercept decreases

• In other words, as consumers’ wages increase, the budget constraint gets steeper

Objective 4: Deriving the Labor Supply Curve

• Graphically:

o x-axis = labor hours supplied

o y-axis = wages

• Budget Constraint – shows the possibilities of what you can do

• Indifference Curve – shows how you feel about the possibilities

• Question: why does labor increase from A to B but decrease from B to C?

o When consumers make more money they will reach a point at which they feel

they do not have to work as much

o As the wage goes above a certain level, consumers will work less and supply less

labor

▪ This results in a backwards bent labor supply curve

Objective 5: Substitution and Income Effects

• ex: substitution and income effects when wages go up, assuming leisure and all other

goods are normal goods

Leisure

Labor

All Other Goods

Substitution

Effect

DECREASE

INCREASE

Income Effect

INCREASE

DECREASE

INCREASE

Combined Effect

INCREASE (if the

IE > SE)

DECREASE (if

the SE > IE)

INCREASE (if

the SE > IE)

DECREASE (if

the IE > SE)

INCREASE

• Row 1 Explanation

o When wages go up, the price (opportunity cost) of leisure goes up as well

• Row 2 Explanation

o When wages go up, you are inherently richer, which will allow you to purchase

more of leisure

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CAS EC 101 Full Course Notes

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In other words, as consumers" wages increase, the budget constraint gets steeper. Objective 4: deriving the labor supply curve: graphically, x-axis = labor hours supplied, y-axis = wages, budget constraint shows the possibilities of what you can do. Objective 5: substitution and income effects: ex: substitution and income effects when wages go up, assuming leisure and all other goods are normal goods. Increase/decrease in wages when wages increase/decrease causing movement along. The labor supply curve: an increase in wages = increase in overall wages and movement up along the demand curve, a decrease in wages = decrease in overall wages and movement down along the demand curve. Objective 11: marginal revenue product of labor (mrpl) Involves the marginal product of labor: the additional revenue brought in by one additional hour of labor, formula: mrpl = (cid:3019) = (cid:3030) (cid:3028)(cid:3041) (cid:3041) (cid:3047)(cid:3042)(cid:3047)(cid:3028) (cid:3045)(cid:3049)(cid:3041)(cid:3048) (cid:3030) (cid:3028)(cid:3041) (cid:3041) (cid:3028)(cid:3029)(cid:3042)(cid:3045, l usually = 1, diminishing marginal product of labor.

Related Questions

What is the market for factors of production?

What is the market for factors of production?
1. The market for factors of production is where households and firms interact to trade factors of production for factor payments. For example this is where people provide firms with labor and firms pay them with wages.
What is the money market?
1. The money market is where households, firms, and the government may save and/or invest their money to earn interests. Money market includes banks, stock market, bonds market, and other financial institutions where economic actors can buy and sell financial assets to earn interests and/or dividends.
Who are the three economic actors in the circular flow model?
1. In a circular flow model, the three main economic actors are the households, firms, and the government. Households include the typical individual consumers. Firms include businesses and similar producers in the economy. Finally, the government refers to the whole government system from federal to local level.
How is the national income of an economy determined?
1. The national income of an economy is determined by measuring the total value of the output produced in an economy or the total income earned by the actors in the economy. In a circular flow model, we can see that the value of total output produced should equal the total value of income generated and earned in the economy. This is because every dollar spent by someone in the economy is received by another person in the economy as income.
What is GDP?
1. The gross domestic product or GDP represents the sum total of the value of the final goods and services produced within the economy for a given year. It is the most commonly used measure of its economy’s productivity and income.

MC Qu. 020 In a market economy:

In a market economy:

the government owns the means of production so that it can produce what is in society's best interest.

businesses design their plans to maximize their profit and the market is relied upon to see that individual self-interest is consistent with society's interest.

workers are directed by government planning boards to produce what is in society's best interest.

government sets prices to make necessities affordable because it is in society's best interest to make necessities affordable.

MC Qu. 022 Suppose that at the current price consumers would ...

Suppose that at the current price consumers would like to purchase 10 million large-screen televisions and 15 million are available. When the market coordinates the demand and supply for large-screen televisions, the price of large-screen televisions will:

rise.

fall.

stay the same.

be fixed by the government.

MC Qu. 036 Most economies today are:

Most economies today are:

pure market economies.

differentiated primarily by the degree to which they depend on markets.

differentiated primarily by who owns the means of production.

socialist.

MC Qu. 047 Households are on the:

Households are on the:

the supply side of factor markets and the demand side of goods markets.

the demand side of factor markets and the supply side of goods markets.

the supply side of both factor markets and goods markets.

the demand side of both factor markets and goods markets.

MC Qu. 050 Governments do all of the following except:

Governments do all of the following except:

oversee the interaction of households and businesses in the goods and factor markets.

demand labor services from households in the factor market.

demand for goods and services from businesses in the goods market.

supply labor services to businesses in the factor market.

MC Qu. 054 Businesses fail because:

Businesses fail because:

they follow the principle of consumer sovereignty too closely.

the invisible hand determines that they are not producing something socially valuable.

they earn excessive profits.

entrepreneurship is present.

MC Qu. 066 A business is most likely to be characterized as a...

A business is most likely to be characterized as a corporation if:

it has two or more owners, with each owner liable for every other owner's actions.

it has only one owner.

it is legally treated as a person and owned by stockholders who are liable for the actions of the corporate "person" regardless of their investment

each owner is liable only to the extent of his or her own investment.

MC Qu. 074 Which of the following statements is correct?

Which of the following statements is correct?

Stockholders are legally liable for all the debt of a corporation.

A corporation is a business that is legally owned by its employees.

Corporations are legal entities that, in law, are treated as persons.

Most large companies and many small companies in the United States are not corporations.

MC Qu. 095 Government regulation of working conditions is an ...

Government regulation of working conditions is an example of:

government as a referee.

government as owner.

government as an actor.

government as a dictator.

10. MC Qu. 104 Which of the following would most likely generate ...

Which of the following would most likely generate a negative externality?

education

a lighthouse

cigarette smoke

employment

magentasnail731

Market Analysis Market Participants Market participants act as if they are rational, self-interested, and forward-looking. For example, financial managers try to maximize the present value of profits for their particular companies, rather than ignore future values. Companies pursue many goals, but it is a financial mistake for managers to pursue any goal that conflicts with the primary goal of maximizing their firm's profits. Decentralized decision making by individual market participants is more economically efficient that centralized decision making by government policymakers. For example, it is more economically efficient to have financial managers obtain financing for their particular companies than to have government obtain it. A high degree of competition among market participants is the most economically efficient disciplining mechanism. For example, highly competitive financial markets discipline financial managers to pay fair market interest rates on the debt securities issued by their particular companies. The market system of prices is the most economically efficient allocative mechanism. For example, it is more economically efficient to distribute a firm's corporate stock to those buyers who are willing and able to pay the market price of the stock than to have the government distribute the stock. It is economically efficient for market participants to buy low and sell high globally. For example, it is economically efficient for U.S. firms to sell their financial securities to the highest bidders, no matter where they live in the world economy. Market imperfections can create considerable risk to market participants. For example, because of market imperfections, firms operating in the international financial markets encounter foreign exchange rate risk, political risk, interest rate risk, and default risk. Consumer Sovereignty The principle of consumer sovereignty tells us that by making their dollar votes, consumers indirectly determine the quantity and quality of products that firms will produce. For example, it is not economically efficient for financial managers to obtain more financing for their particular firms than is needed for their firms to produce the profit-maximizing level of output demanded by consumers. Market Economy A highly competitive market economy is largely self-regulating, in the absence of substantial market imperfections, in that economic conditions cannot be substantially improved by government regulation or other types of government intervention beyond laissez-faire policies. For example, if a firm's corporate stock is overvalued by a market economy, market forces will tend to drive down the value of the stock to a market price at which it is neither overvalued nor undervalued. As if by an invisible hand, highly competitive market forces will tend to create a harmony of interests among individual market participants, in the absence of substantial market imperfections. Consequently, the interests of shareholders and other stakeholders are compatible. For example, in trying to maximize profits, firms produce employment, income, consumer products, and wealth for households, as well as tax revenue for government, which helps maximize consumer utility and maximize social welfare. In a market economy, resources, products, and assets flow to their highest valued uses among alternative uses. For example, the shares of firms' corporate stocks will be acquired by those market participants who most highly value them, as indicated by the fact that they are willing to pay the most to acquire them. The efficient economic role of government is limited to Laissez-Faire ("hands off") policies, which create very little intervention in a market economy. For example, government regulations of banking and securities industries to maintain healthy, reasonably profitable, consumer-oriented financial markets would not be needed in a highly competitive market economy in the absence of substantial market imperfections. In a market economy, it is economically efficient for each market participant to specialize according to comparative advantage in producing what they can produce relatively better than other market participants, rather than produce all the outputs they can produce absolutely better than others. For example, it is economically efficient for people who are relatively better at being financial managers than others, to specialize in financial management even if they are absolutely better than others in doing many other types of work. If all labor were allocated to its comparative advantage, then no possible reallocation of labor would exist that could increase the rate of return to labor (i.e., the wage). There is no such thing as a free lunch, because all resources, products, and assets in a market economy are scarce. For example, current federal government budget deficits are not free to current market participants in that the deficits must be financed by future tax increases and/or future decreases in government spending and/or future inflation. For additional information on the Market Economy click here. Marks, R. E. (2006, December). There Is No Such Thing As Free Lunch. Australian Journal of Management. 31(2). 1-7. Financial Decisions An efficient financial decision, practice, transaction, or condition is one that is optimal -- meaning best; it cannot be improved, from society's perspective. If there is some profitable way to improve some business practice that would benefit society, that practice is somewhat inefficient. Any change in a financial decision, practice, transaction, or condition that improves society is an efficiency improvement. For example, it is an efficiency improvement for a business to cut production costs by reducing waste (e.g., by reducing spending on unprofitable activity. A financial decision, practice, transaction, or condition is fair-- meaning just or equitable, if the financial benefits are distributed to those involved in proportion to how much they each voluntarily contributed to produce those benefits. For example, a financial practice that discriminates against some people on the basis of race, age, gender, nationality, or religion is unfair. For example, an unethical business practice is unfair. For additional information relating to Market Analysis and fair financial decisions, click on the following: Teaching Ethical Economic Practices to Business Managers. Johnston, C. (2009, October). The Proceedings of the Annual Conference of The International Academy of Business and Economics. Fairness is a necessary condition, but not a sufficient condition, for efficiency. All efficient financial practices are fair, but some fair practices may still fail to be efficient. For example, embezzling company funds is an unfair and inefficient, criminal financial activity. As another example, an ethical business practice that could be improved is fair but not efficient. Opportunity Cost Principle Opportunity cost principle: The efficient measure of the cost of any allocation of resources, products, money income, wealth, or time is its opportunity cost -- the value of the next best use. The opportunity cost of how one uses his or her resources is the value of the highest valued alternative use. The opportunity cost of one investment is the expected return on the next best investment available to the firm. For example, the opportunity cost of a firm using some of its profits to pay dividends to its stockholders would be the present value of future income those profits could have earned if invested in the firm's highest valued investment project.

Discussion Questions These questions stem from the Class Discussion Questions you will be anwering in the Discussion Board. Think about the questions and how they relate to the financial management principles above.

2. Applications: State the financial management principle that appears to be violated in each of the following cases and explain how it is violated:

(a) A corporation is maximizing sales growth and the price of its corporate stock is falling.

(b) A highly paid financial manager in the auto industry quit his job to set up his own small auto repair shop, which is expected to incur a loss for the first three years then earn normal profits.

CAS EC 101 Lecture Notes - Lecture 8: Budget Constraint, Regional Policy Of The European Union, Demand Curve

CAS EC 101 Full Course Notes

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