Labor Markets and Consumer Theory

Labor Market Discrimination

  • Labor markets are not competitive.

  • Strong evidence suggests discrimination exists.

  • The idea that equal work guarantees equal pay is unsupported.

  • Discrimination pervades society, affecting wages.

  • Multiple factors influence wage disparities.

  • It's difficult to isolate the specific causes of these differences.

  • Policy interventions require value judgments.

Correlation vs. Causation

  • Common misconception: higher pay equates to higher productivity.

  • Fallacy: payment reflects marginal product, assuming competitive labor markets.

  • Reality: labor markets aren't fully competitive.

  • Equal opportunity is essential but often lacking.

  • Individuals strive to maximize goals within available opportunities.

The Opportunity Atlas

  • The Opportunity Atlas is a tool to explore children’s outcomes in adulthood based on their upbringing location.

  • Examples:

    • Eugene, OR: Household income at age 35 is approximately 43,000.

    • Incarceration rate: 1.2\%.

    • Median rent (2012-2016): 901.

    • Job growth rate (2004-2013): 0\%.

  • Income disparities exist within cities (e.g., Eugene: South and North areas fare better than West and Springfield).

  • Madison, WI: West side outperforms East and North sides.

Consumer Theory

  • Course Survey available:

    • If 75\% of students complete the survey, everyone gets 1\% extra credit.

The Consumer Problem

  • Consumers allocate time between work and leisure.

  • Work provides income; leisure does not.

  • Income is used for consumption.

  • Utility is derived from both leisure and consumption.

  • Goal: Maximize utility given time and opportunities.

Simplification

  • The consumer problem is complex given options for jobs, leisure, and goods.

  • Simplification needed due to vast choices (e.g. 25,000 - 50,000 SKUs in supermarkets).

  • Simplification is based on the research motivation to understand:

    • Demand curves by understanding tradeoffs between one good and other things.

    • Elasticities by understanding preferences change when prices change.

  • Demand and elasticities help understand the impact of policies!

Simplest Choice: Two Goods

  • Example: Puddles chooses between beer and pizza.

  • Resource constraints and opportunity costs exist.

  • Analyze how changes in beer price, pizza price, or income affect Puddles’ choices.

Budget Constraint

  • Puddles has an income I = $24.

  • Pizza price: P_{pizza} = $4 per slice.

  • Beer price: P_{beer} = $2 per bottle.

Pizza

Beer

0

12

1

10

2

8

3

6

4

4

5

2

Plotting the Budget Constraint

  • Horizontal intercept: \frac{I}{P_{pizza}}

  • Vertical intercept: \frac{I}{P_{beer}}

  • Slope: \frac{P{pizza}}{P{beer}} = \frac{4}{2} = 2

Budget Constraint as PPF

  • Similar to a Production Possibilities Frontier (PPF), showing opportunity costs.

  • The area below the budget constraint represents the feasible set.

Preferences and Demand

  • Budget constraint defines what a consumer can do.

  • Consumer preferences determine what the consumer wants to do.

  • Utility is the satisfaction derived from combinations of goods.

  • Consumers maximize utility, leading to an optimal consumption bundle.

Illustrating Preferences

  • Examples from the Pac-12 conference mascots, “ consuming only pizza and beer.

  • Assume same income and prices, but different preferences lead to different choices.

The Stanford Tree: Perfect Substitutes

  • The Stanford Tree’s utility depends on calories; more is better.

  • Pizza and beer each have 200 calories.

  • Utility function: U = 200 * Q{pizza} + 200 * Q{beer}

  • Optimal bundle determined by utility per dollar.

  • Pizza: 200 calories for $4 = 50 \frac{cal}{\$}.

  • Beer: 200 calories for $2 = 100 \frac{cal}{\$}.

  • The Tree spends all money on beer because it provides more calories per dollar.

Indifference Curves (IC)

  • Combinations of goods yielding the same utility level.

  • Consumers are indifferent between bundles on the same IC.

  • Higher ICs represent greater utility.

  • Optimal choice: Bundle on the budget constraint that reaches the highest IC.

Marginal Rate of Substitution (MRS)

  • The slope of the indifference curve, representing the value of one good in terms of the other.

  • Compare MRS to the opportunity cost to make optimal decisions.

Wilbur Wildcat: Fixed Proportions

  • Wilbur Wildcat consumes meals of one beer and one pizza.

  • Utility equals the number of meals.

  • With I = $24, P{pizza} = $4, and P{beer} = $2: one meal costs $6.

  • Optimal consumption: 4 meals (4 pizza, 4 beer).

Puddles: Diminishing Marginal Rate of Substitution

  • Puddles likes variety, but doesn’t require it in fixed proportions.

  • As pizza consumption increases, willingness to give up beer for more pizza decreases.

  • Indifference curves are bowed inward (convex).

  • Can assign values to different indifference curves to denote Puddles’ utility

Finding the Optimal Consumption Bundle

  1. On the budget constraint (affordability).

  2. MRS = \frac{P{pizza}}{P{beer}}. Slope of indifference curve = slope of budget constraint, or marginal benefit of pizza (in beer) = marginal cost of pizza (in beer).

Demand Curve

  • To find Puddles' demand curve for pizza, the price is variable and see what becomes.
    Suppose \frac{P{pizza}}{P{beer}} = 1 (and everything else stays the same)

Income Changes

  • Income is a demand shifter.

  • At income $24, Puddles consumes 3 pizzas and 6 beers

  • At income $40, Puddles consumes 5 pizzas and 10 beers

  • If income changes, the demand curve will shift as well!

  • Pizza and beer are normal goods because consumption of both increased when income went up!

Inferior Goods

  • Example: Spam (inferior good) and Steak.