Unit 3: Scarcity, Work, and Choice

production function

shows how inputs (labor) translate into outputs (good and services) holding other factors constant

model of individual choice

to explain differences in work hours across countries

marginal product

change in output per unit change in input, holding other things constant

average product

average output per unit of input

Indifference curves

show all combinations of goods that give the same utility (satisfaction), prefer point farthest from the origin line

marginal rate of substitution

slope of the indifference curve, represents tradeoffs an individual faces, based on preference/what you are willing to happen

opportunity cost

net benefit of the next best alternative

economic rent

benefit > economic cost (this is monetary costs or subjective costs like effort of work)

feasible frontier

shows the maximum output that can be achieved with a given amount of input, prefer point on edge of the feasible set

marginal rate of transformation

the slope of the feasible frontier, represents tradeoffs, based on constraint/what you can get, technology changes increases MRT

utility maximizing choice

MRS = MRT, you want how much you are willing to give up to equal how much you have to give up

budget constraints

feasible frontiers for consumption choices, basically how big your budget is going to be, ex: isocost lines

2 effects of wage changes on slope of budget constraint (MRT)

1) income effect: earnings increase, working hours fixed

2) substitution effect: opportunity cost of free time increases

income effect

change in optimal choice when income changes, keeping opportunity costs (budget constraint slope) fixed, incentive to decrease working hours, countries like U.S., positive

substitution effect

change in optimal choice when the opportunity cost changes, at the new level of utility, incentive to increase working hours, negative

explanations for difference in working hours across countries

preferences, differences in cultural norms, politics, social preferences

overall effect =

income effect + substitution effect, this model omits important factors, model is used to explain technological effects on labor choices