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The Family as an Economic Unit

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  1. The Familyas anEconomic Unit

  2. The Neoclassical Modelof Specialization & Exchange Basic underlying assumption: The family is a unit whose adult members make informed and rational decisions that maximize the well-being of the family.

  3. Family well-being or utility is maximized by selecting the combination of commodities from which the family derives the greatest satisfaction. These commodities are produced by combining home time of family members with goods and services purchased in the market using labor market earnings. One such commodity might be a family evening at home watching a movie on TV. This commodity requires a TV and the time of the family members spent watching it.

  4. Law of Comparative Advantage The total output of a group, an economy, a group of nations or a family will be greatest when the output of each good is produced by the person (or firm or nation) with the lowest opportunity cost.

  5. It is frequently the case that women are relatively more productive in the home and men are relatively more productive in the market. This can be true because men and women are traditionally raised with different expectations and receive different education and training. It may also be the case that women are discriminated against in the labor market and that discrimination lowers their market earnings. Moreover, the traditional division of labor is likely to magnify differences in the household and market skills of men and women because both types of skills tend to increase with experience.

  6. While the preceding factors tend to produce gender differences in comparative advantage for homemaking versus market work, it is not necessarily the case that the traditional division of labor is the optimal arrangement. Raising children according to gender rather than individual talents and discriminating against women workers in the labor market introduces distortions. To the extent that women’s relative advantage for homemaking is socially determined and reflects unequal access to market opportunities, the traditional division of labor is not always efficient or desirable.

  7. In the following discussion, we assume that women have a comparative advantage in housework relative to men, because we are exploring a reality in which women generally have primary responsibility for homemaking. This does not imply that the traditional division of labor is inevitable or that it will persist indefinitely into the future.

  8. Example of gains from specialization & exchange Consider two people: Dave and Diane.

  9. Dave Dave makes $10 an hour in the labor market. Alternatively, with an hour he can produce $5 worth of home production (perhaps a mediocre dinner). So for Dave, the opportunity cost of $10 worth of home production is two hours of market work, which is worth $20. For Dave the opportunity cost of $10 worth of market goods is one hour of home production, which is worth $5.

  10. Diane Diane makes $15 an hour in the labor market. Alternatively, with an hour she can produce $15 worth of home production (perhaps a very good dinner). So for Diane, the opportunity cost of $10 worth of home production is 2/3 of an hour or 40 minutes of market work, which is worth $10. For Diane, the opportunity cost of $10 worth of market goods is 2/3 of an hour or 40 minutes of home production, which is worth $10.

  11. Suppose Dave and Diane both work and perform home production.

  12. Comparison of opportunity costs So, we can see that Dave has a lower opportunity cost of market production and therefore a comparative advantage in market production. Diane has a lower opportunity cost of home production and therefore a comparative advantage in home production.

  13. The law of comparative advantage indicates that their total production should be greater if there is specialization and Dave does more work and less home production and Diane does less work and more home production. Suppose Diane reduces her market work by 1 hour & increases her home production by 1 hour, while Dave does an additional 2 hours of market work instead of his 2 hours of home production.

  14. By having Dave only do market work, in which he has a comparative advantage, and having Diane do the home production, in which she has a comparative advantage, they have increased their total production value by $10, from $190 to $200.

  15. Note that it is comparative advantage, not absolute advantage, that makes possible the gains from specialization and exchange. In the example we used here, Diane had an absolute advantage over Dave in both market and home production. In an hour she could make either $15 of market production or $15 of home production, while Dave, in a hour, could only make $10 of market production or $5 of home production.

  16. Let’s look at the story using a graph. Suppose each person has 8 hours a day to allocate to market and/or home production. Remember, in a hour Dave can make either $10 dollars of market production or $5 of home production. So if he only does market work, he’ll have $80 worth of production, and if he only does home work, he’ll have $40 work of production. So Dave’s production possibility frontier has a slope of -2, which is the rate at which he trades market production for home production. Mkt Production ($) Dave 80 40 Home Production ($)

  17. Remember, in a hour Diane can make either $15 dollars of market production or $15 of home production. So if she only does market work, she’ll have $120 worth of production, and if she only does home work, she’ll have $120 work of production. So Diane’s production possibility frontier has a slope of -1, which is the rate at which she trades market production for home production. Mkt Production ($) 120 Diane 120 Home Production ($)

  18. Mkt Production ($) M 200 If Dave & Diane combine production and they both do only home work (pt. H), they’ll have $160 of production. If they both do only market production (pt. M), they’ll have $200 of production. Y H 160 Home Production ($)

  19. Mkt Production ($) Starting from H, with both doing only home work, if they were to exchange some home time for market time, it would be some of Dave’s time they trade first since we found earlier that he has a lower opportunity cost of market production & a higher opportunity cost of home production. So they’re initially trading at his tradeoff rate (slope = -2). M 200 Y H 160 Home Production ($)

  20. Mkt Production ($) M 200 If they trade all of Dave’s home production time for work time but none of Diane’s, they will be at Y. They have $120 of home production and $80 of market production. Y 80 H 120 160 Home Production ($)

  21. Mkt Production ($) M 200 At points between H & Y, Diane does only home work and Dave does both home & market work. Y 80 H 120 160 Home Production ($)

  22. Mkt Production ($) M 200 At points between Y & M, Dave does only market work and Diane does both home work & market work. Y 80 H 120 160 Home Production ($)

  23. Mkt Production ($) M 200 At points between Y & M, they are exchanging Diane’s home production time for her market time, so the slope of the production possibility frontier (PPF) is based on her tradeoff rate of –1. That’s why the PPF is flatter at the top than at the bottom. Y H 160 Home Production ($)

  24. Mkt Production ($) M 200 What determines the point on the PPF at which they operate? That depends on their tastes, that is, their preferences for market goods versus home goods. To understand that, we need the concept of indifference curves. Y H 160 Home Production ($)

  25. Indifference Curve: A curve that shows the consumption alternatives that yield the same level of satisfaction or utility. In other words, a couple is indifferent between the points on the indifference curve.

  26. Characteristics of indifference curves: • Downward sloping (negative slope) • Two curves cannot intersect. • Each point on the graph has exactly one indifference curve passing through it. • Utility is greater for curves that are higher and further to the right. • Usually assumed to be convex. Mkt Production ($) U4 U3 U2 U1 Home Production ($)

  27. Indifference curves are downward sloping because you can be equally happy with fewer goods from market production if you have more goods from home production. At point B you have fewer goods from market production than at point A, but you have more goods from home production. Mkt Production ($) A 8 B 3 U1 4 10 Home Production ($)

  28. Mkt Production ($) Indifference curves can not intersect, because that would imply that the point of intersection gives two different levels of satisfaction. Point A gives the satisfaction associated with U1 but also the satisfaction associated with U2. A U2 U1 Home Production ($)

  29. Mkt Production ($) Each point on the graph has exactly one indifference curve passing through it. For any point you can pick, there is one indifference curve passing through it. Home Production ($)

  30. Mkt Production ($) Each point on the graph has exactly one indifference curve passing through it. For any point you can pick, there is one indifference curve passing through it. A Home Production ($)

  31. Mkt Production ($) Each point on the graph has exactly one indifference curve passing through it. For any point you can pick, there is one indifference curve passing through it. A U1 Home Production ($)

  32. Utility is greater for curves that are higher and further to the right. Indifference curve U1 has a lower utility or satisfaction level than U2 Mkt Production ($) U2 U1 Home Production ($)

  33. Utility is greater for curves that are higher and further to the right. Indifference curve U1 has a lower utility or satisfaction level than U2, and U2 has a lower utility level than U3 Mkt Production ($) U3 U2 U1 Home Production ($)

  34. Utility is greater for curves that are higher and further to the right. Indifference curve U1 has a lower utility or satisfaction level than U2, and U2 has a lower utility level than U3, and U3 has a lower utility level than U4. Mkt Production ($) U4 U3 U2 U1 Home Production ($)

  35. Indifference curves are usually assumed to be convex. This means that the magnitude of the slope decreases as you move from left to right. At a point like A, where market goods are relatively plentiful and home goods are relatively scarce, it would take a fairly large amount of market goods ($10) to induce a couple to give up a little bit of home goods ($2) and still remain equally well off. Mkt Production ($) B 110 A 100 U1 8 10 Home Production ($)

  36. At a point like C, where home goods are relatively plentiful and market goods are relatively scarce, it would only take a small amount of market goods ($3) to induce a couple to give up even a fairly large amount of home goods ($12) and still remain equally well off. This seems realistic because when goods are scarcer they are usually valued more highly. Mkt Production ($) D C 8 U1 5 100 112 Home Production ($)

  37. Now we can combine the production possibilities frontier (PPF) with the indifference curves to see what choices a couple would make. A couple will choose a point where they have the highest level of satisfaction that they can achieve given their PPF.

  38. Mkt Production ($) No points on U4 are attainable. Notice that both point A on U1 and point B on U2 make full and efficient use of resources, but they do not maximize the couple’s satisfaction. The couple is best off at point C on U3 . B C U4 U3 U2 U1 A Home Production ($)

  39. Mkt Production ($) In this particular case, Dave does only market work and Diane doesboth home work &market work. The couple has relatively strong preferences for market goods. B C U4 U3 U2 U1 A Home Production ($)

  40. Mkt Production ($) In this case, the couple would be best off at point A on U3 . Here, Diane does only home production and Dave does both home work & market work. The couple has relatively strong preferences for home goods. U4 U3 U2 U1 A Home Production ($)

  41. In this intermediate case, the couple would be best off at point A on U3 . Here, Diane does only home production and Dave does only market work. Mkt Production ($) A U4 U3 U2 U1 Home Production ($)

  42. There are other advantages to forming a family, besides gains from specialization and exchange. • These advantages include • Economies of scale • Public goods • Externalities in consumption • Opportunities for marriage-specific investments • Risk pooling and • Institutional benefits

  43. Economies of scale Housing for two people does not cost twice as much as housing for one. It does not take twice as long to prepare meals for two people as it does to prepare them for one person.

  44. Public goods A public good has the characteristic that the consumption of the item by one person does not diminish the amount available for consumption by others. For example, if there is a movie on television, the amount of consumption and satisfaction an individual obtains from the movie is probably not reduced if another person is watching it too.

  45. Externalities in consumption When two people care for one another, one partner may derive satisfaction from the enjoyment and happiness of the other.

  46. Opportunities for marriage-specific investments Marriage-specific investments refers to the development of skills, knowledge, and other items that are worth more in the marriage than if the marriage were terminated. The prime example is the rearing of children. Children provide their parents with considerable satisfaction. However, they may form an obstacle to forming a new relationship with another partner.

  47. Risk pooling If one spouse becomes unemployed, the couple can rely on the other spouse to cover at least part of the household expenses.

  48. Institutional benefits These benefits include coverage by a spouse’s health insurance, pension benefits, and Social Security benefits.

  49. There are alsopotential problemsassociated with specialization of market and household production.

  50. Market/Household Specialization - Problem 1 It is unlikely that one person has a comparative advantage in all household tasks. It is therefore likely that both members of a couple will do some household production. Furthermore, if the level of utility or disutility of work is influenced by the amount performed, it may be preferable that both members of a couple do both market and household production.