Optimal Consumption: Income & Substitution Effects

Unit 3: Optimal Consumption

• Focus on the relationship between income and substitution effects in consumption choices.

Historical Context

• Key Prediction by John Maynard Keynes (1930):

• Forecasted that technological advancements and economic growth would reduce the average workweek to only 15 hours by the year 2030.

• This prediction has not materialized as foreseen, leading to exploration of dynamics between wage variation and working hours.

Key Concepts

• Labour vs. Leisure Choices:

• Investigates historical and cross-country variations in the decisions regarding labor and leisure time allocation.

• Emphasizes the need for mapping individual preferences through the concept of indifference curves, which reflect the trade-offs between leisure and labor.

• Budget Constraints and Feasible Consumption Sets:

• Defines the slope of the budget constraint as MRS = - \text{wage}, which indicates the trade-offs an individual must face between consumption (goods) and leisure time.

• Optimal Consumption:

• Integrates individual preferences and budget constraints to identify the optimal consumption choices.

• Analyzes the emergence of income and substitution effects as a consequence of price fluctuations affecting consumer choices.