3. Wellbeing and Working Hours

Chapter 3: Wellbeing and Working Hours

Introduction

  • The chapter explores the interactions between well-being, working hours, and individual choices in labor productivity.

  • It addresses how new technologies impact free time and the work hours chosen by individuals.

  • Central questions:

    • How do people allocate their time between shopping and relaxing, given increased productivity due to new technologies?

    • Has economic progress led individuals to consume more goods, enjoy more free time, or both?

    • If hourly wages increase, how would individuals choose their working hours?

Changes in Living Standards and Hours Worked

  • There has been a significant increase in living standards since 1870, though disparities exist across countries in terms of free time and income.

GDP per Capita and Free Time

  • GDP per capita ($PPP) displayed vast disparities in free time and wealth across countries (2020 data reference).

  • Example countries mentioned:

    • Norway, Netherlands, Denmark, Germany, UK, and others.

The Question in This Chapter

  • Despite rising living standards, working hours have not reduced uniformly across all countries.

  • Some countries maintain high work rates while enjoying higher consumption, while others experience increased free time. The chapter seeks to understand why these differences exist.

The Approach in this Chapter

  • A model of individual decision-making is constructed to explain variations in working hours both over time and among countries.

A Model of Choice Under Scarcity

  • The focus is on decision-making when individuals face resource limitations (scarcity of time and money).

  • Key points:

    • Individuals desire various goods and services as well as leisure time.

    • Decisions must be made on how to trade-off free time versus goods and services, taking into consideration wages and individual preferences.

Example: Karim Moves to Madrid

  • Karim can earn €30 per hour with a maximum work limit of 16 hours per day.

  • Daily income equation: Daily income = €30 × (hours worked).

Karim's Problem

  • Scarcity: Karim wants both a high level of consumption and ample free time.

  • Opportunity cost of free time: How much consumption must be sacrificed for each additional hour of leisure?

  • The model assumes Karim doesn't consider future savings or have borrowing power, meaning his spending is solely dependent on current earnings.

Goods and Preferences

  • Free time and total consumption are categorized as economic goods.

  • The concept of goods in economics encompasses any desirables that individuals wish to acquire more of.

  • Karim’s decisions involve trade-offs between the goods of free time and consumption, emphasizing his value judgment of each.

Preferences and Indifference Curves

Utility

  • Defined as a numerical value indicating the satisfaction derived from an outcome.

Indifference Curve

  • A graphical representation that connects combinations of two goods providing the same level of utility, demonstrating individual preferences.

General Properties of Indifference Curves

  • Downward sloping: More of one good leads to less of another while maintaining the same utility level.

  • Higher Curves = Higher Utility: Moving right/upwards implies gaining more of both goods.

  • Smoothness: Minor changes in goods yield gradual utility changes.

  • Non-crossing: Indifference curves cannot intersect.

  • Flatter Rightward: Indifference curves become less steep as one moves to the right, indicating diminishing marginal utility.

Marginal Rate of Substitution (MRS)

  • Definition: MRS quantifies how much consumption one is willing to forego for one additional unit of free time, while keeping utility stable.

  • Example: Moving from point A to E illustrates Karim willing to give up 94 units of consumption for an additional hour of leisure, indicating MRS at point A equals 94.

The Budget Constraint

Definition

  • Budget Constraint: Represents combinations of goods and services accessible within total budget limits.

    • Equation Example: c = 30(24 - t) where c is consumption, and t is hours spent working.

Feasible Set

  • The collection of commodity combinations that can be purchased with available resources.

Optimal Choice

Definition

  • The optimal choice consists of the highest utility combination of free time and consumption given a feasible budget.

Indifference Curves and Optimal Choice

  • At the optimal choice, the indifference curve is tangent to the budget constraint, indicating the maximum satisfaction.Critical point is where benefits of time versus monetary gain balance.

Intuition for Optimal Choice

  • Example with counter-intuitive selections:

    • If MRS exceeds the budget slope, increasing free time would yield higher utility gains, thus suggesting the original point was suboptimal.

Technological Progress and Choices

  • Technological advancements raise labor productivity, impacting wages positively.

  • The model assesses how wage increases influence working hours and standards of living, intertwined with considerations of free time and income.

Keynes’ Predictions on Technological Progress

  • Reference to John Maynard Keynes' predictions of substantial improvement in living conditions due to technology, suggesting a reduction in working hours to 15 hours weekly by 2030, although reality has not followed this trajectory as expected.

Introducing Technological Progress in Karim's Scenario

  • As wages rise to €45 per hour, Karim’s decision-making framework evolves, leading to adjustments in working hours and income.

  • Resulting optimal choice placement shifts from E to F on the utility framework, further increasing living standard references.

Income and Substitution Effects

Income Effect

  • An increase in wages expands the budget constraint, allowing higher consumption and free time choices.

    • Income Effect Definition: Relates to how changes in income alter goods purchased; commonly implies increased acquisition as income rises.

Substitution Effect

  • As wages rise, the opportunity cost of leisure grows, causing a diminutive consumption tendency concerning free time.

    • Substitution Effect Definition: The response of goods purchased due to changes in price and relative opportunity costs.

Total Effect of Wage Increase on Free Time

  • Both effects can contradict; the dominant effect dictates the overall change in free time:

    • Note that graphs illustrate which effect is presumed stronger.

New Scenario Example

  • Planning use of a 10-week summer break with opportunities for paid work versus leisure choices and study time allocation.

  • Calculation for consumption based on days worked provided as: c=90(70-d) with d as days off.

Income Effect Through External Fund

  • The introduction of a financial gift alters the budget setting without changing opportunity costs, showcasing pure income effects through budget function modifications.

Effects of Higher Wages

  • Presentation of altered budget lines with various opportunities evaluated from lower to higher wage constraints.

Decomposition of Effects

  • Further analysis of income, substitution, and total effects illustrating complexity in decision-making as defined by economic responses to increases in wages.

Here are short definitions for the terms you provided:

  • WTP (Willingness To Pay): The maximum price an individual is willing to pay to obtain a good or service, reflecting its perceived value to them.

  • Net Benefit: The total benefits of a financial transaction or economic activity minus the total costs. It represents the overall gain or loss from a decision or action.

  • Opportunity Cost: The value of the next best alternative that must be foregone when making a choice. It is what one gives up to get something else.

  • Economic Cost: The sum of explicit (out-of-pocket) costs and implicit (opportunity) costs. It includes both monetary costs and the value of resources used that do not have a direct monetary payment.

  • Equilibrium: A state in an economic model where opposing forces are balanced, and in the absence of external disturbances, the economic variable being explained will not change. For example, in a market, it's where supply equals demand.

  • Endogenous Variables: Variables that are explained within an economic model, meaning their values are determined by other variables and relationships within the model.

  • Exogenous Variables: Variables whose values are determined outside of the economic model and are taken as given inputs to the model. They influence the endogenous variables but are not explained by the model itself.

  • Ceteris Paribus: A Latin phrase meaning 'all other things being equal' or 'holding other things constant.' Economists use this assumption to analyze the effect of one change in an economic variable while assuming all other relevant variables remain unchanged.