Unit 3. The Theory of Individual Economic Behavior (Ch. 4). Raise the Wage or Pay Overtime?.
The Theory of Individual
Economic Behavior (Ch. 4)
Boxes, Inc. produces corrugated paper containers at its plant in Sunrise Beach, TX. The plant is located in a retirement community with an aging population and a shrinking work force which has hampered the firm’s ability to hire enough workers to meet its growing production targets. This is despite the fact that the company already pays a wage rate that is twice the local average. The firm’s manager is considering two options to deal with the firm’s growing labor shortage: 1) raise the wage rate by 50% to be paid for all hours worked by workers or 2) implement an overtime wage plan that would raise the wage rate by 50% to be paid for hours worked in excess of 8 hours per day. Which plan would you recommend?
Bill is a financial planner for FVS (Financial Vision Services’). Today, he has a meeting scheduled with a client to discuss some alternative retirement investment strategies. He is trying to figure out which strategies the client is most likely to be interested in. As he reviews possible investment options, he is aware that different strategies offer his client different risk and return tradeoffs. Bill has decided to focus on higher-returning (yet riskier) investments for his client today, who is a middle-aged, white collar worker. Do you agree with his approach?
I (or M) = the amount of income or money that a consumer has to spend on specified goods and services.
X = the quantity of one specific good or one specific bundle of goods
Y = the quantity of a second specific good or second specific bundle of goods
Px = the price or per unit cost of X
PY = the price or per unit cost of Y
straight line equation
vert axis intercept = I/PY
slope = dY/dX = -Px/PY
= max Y (X = 0)
= max X (Y = 0)
= ‘inverse’ P ratio
= X axis good P/Y axis good P
¯Slope = ¯
rate at which y CAN be exchanged for x (holding $ expenses constant)
=> 2y can be exchanged for 1x
- Increases lead to a parallel,
outward shift in the budget line.
- Decreases lead to a parallel,
- A decrease in the price of good
X rotates the budget line counter-
- An increase rotates the budget
A: 1 drink, 1 pizza slice
B: 1 drink, 2 pizza slices
C: 2 drinks, 1 pizza slice
A: 1 movie, 1 dinner
B: 1 movie, 2 dinners
C: 2 movies, 1 dinner
For each, indicate which of the following you prefer:
A vs B,
B vs C,
A vs C
satisfaction received from consuming goods
satisfaction levels that can be measured or specified with numbers (units = ‘utils’)
satisfaction levels that can be ordered or ranked
the additional utility received per unit of additional unit of an item consumed (U/ X)
The shaded area represents those combinations of X and Y that are unambiguously preferred to the combination X*, Y*. Ceteris paribus, individuals prefer more of any good rather than less. Combinations identified by “?” involve ambiguous changes in welfare since they contain more of one good and less of the other.
combinations of 2 or more
goods that give a consumer
the same level of satisfaction.
Marginal Rate of Substitution
is willing to substitute one good
for another and stay at the same
U(A) = U(B) = U(C)
U(C) > U(B) > U(A)
U(A) > U(B) > U(C)
= - slope of indifference curve
= -Y/ X
= the rate at which a consumer is willing to exchange Y for 1more (or less) unit of X
U = 0 along given indiff curve
= MUx(X)+MUY(Y) = 0
= - Y/ X = MUx/MUY
= - slope = inverse MU ratio
2) Given indifference curve equation, derive ¯dy/dx directly.
=> Willing to exchange 2y for 1x
Two ways to calculate:
1) Given utility function equation, derive inverse MU ratio =
= goods for which a consumer’s willingness to exchange one good for another varies depending on Q’s of each
= goods for which a consumer is willing to exchange one good for another at a constant rate.
Represented by U = αx + BY
(= a constant)
= goods that are used in fixed or constant proportions with one another
bundle is the
that yields the
highest level of satisfaction.
Note: L = 24 – W
Q = (N + 24P)/C – (P/C)L
If C = 1,
Q = (N + 24P) - PL
C0 and C1 = Q of goods consumed
I0 and I1 = income levels
P = price of consumer goods (P0 = P1)
r = interest rate