Micro Unit 3

Question 1

3.1 Would you work fewer hours if your hourly wage doubled?

Why do people need to make choices (in an economic context)?

Answer 1

Scarcity (limited availability of resource)

Question 2

3.2 A problem of choice and scarcity

If you gain the same amount for every hour you work how would this be plotted on a graph?

Answer 2

This would be a linear line.

Question 3

3.2 A problem of choice and scarcity

What is consumption?

Answer 3

The things enabling one to spend their earnings.

Question 4

3.2 A problem of choice and scarcity

Explain how scarcity arises in terms of working and consumption

Answer 4

One would like to enjoy both a high level of consumption and plenty of free time, but choice is constrained by the relationship between hours (of free time) and income

Question 5

3.3 Goods and preferences

What do economists refer to as goods?

Answer 5

Anything that individuals care about.

Question 6

3.3 Goods and preferences

What does the model assume about the individual

Answer 6

The indivduals do not care about external factors (do not wish to save their income or the future), ONLY care about free time and total consumption. Also assumes ones spending cannot exceed earnings.

Question 7

3.3 Goods and preferences

As individuals care about two goods (free time and consumption) what does this incur?

Answer 7

A trade off-how much consumption is one willing to give up, in order to have more free time?
To understand how much one values one good in terms of another you need to understand their preferences (A description of the relative values a person places on each possible outcome of a choice or decision they have to make.)

Question 8

3.3 Goods and Preferences

What is free time and how is this displayed on a graph?

Answer 8

Free time is on the horizontal axis while consumption is on the vertical axis. Free time is all the time that one does not spend working.

Question 9

3.3 Goods and Preferences

On a graph regarding free time and consumption what do all points represent?

Answer 9

A different combination of free time and consumption

Question 10

3.3 Goods and Preferences

What does utility refer to?

Answer 10

A numerical indicator of the value that one places on an outcome. Outcomes with higher utility will be chosen in preference to lower valued ones when both are feasible. In the model considered in this chapter, this is a measure of living standard

Question 11

3.3 Goods and Preferences

If an individual is indifferent between two outcomes what does this mean about their respective utilities?

Answer 11

They incur the same utility

Question 12

3.3 Goods and Preferences

Which point of A and B will an individual prefer?

Answer 12

A (same consumption with more free time) and D (same free time with more consumption)

Question 13

3.3 Goods and Preferences

What is an indifference curve?

Answer 13

Indifference curves can be drawn on a graph through any point in the diagram, to show other points giving the same utility.

Question 14

3.3 Goods and Preferences

Do we need to know exact utility to understand preference?

Answer 14

NO- we only need to know which provides a higher utility aka a higher indifference curve. In this case B gives lower utility than A (lower curve) and C gives the lowest utility (lowest curve)

Question 15

3.3 Goods and Preferences

Higher indifference curves represent…

Answer 15

higher levels of utility- further away from the origin, we move to combinations with more of both goods.

Question 15

3.3 Goods and Preferences

What do we assume about the direction of indifference curve sloping?

Answer 15

Slopes downward due to trade offs, indifference between the two goods on the graph means that as one icnreases the other decreases.

Question 16

3.3 Goods and Preferences

Can indifference curves cross?

Answer 16

No,

Question 17

3.3 Goods and Preferences

Why are indifference curves usually smooth?

Answer 17

Small changes to combination usually do not cause high changes in utility.

Question 18

3.3 Goods and Preferences

As you move to the right of the indifference curve it becomes…

Answer 18

flatter….more willing to give up X axis good, utility changes less, less willing to give up Y axis good.

Question 19

3.3 Goods and Preferences

What is MRS (Marginal rate of substitution)

Answer 19

The trade-off that a person is willing to make between two goods. At any point, the MRS is the absolute value of the slope of the indifference curve.

Question 20

3.3 Goods and Preferences

What is MRT (Marginal rate of transformation)

Answer 20

The quantity of a good that must be sacrificed to acquire one additional unit of another good. At any point, it is the absolute value of the slope of the feasible frontier.

Question 21

3.3 Goods and Preferences

Given that one is indifferent between point A (15 hours of free time and €540 of consumption) and E (16 hours of free time and €446) what is the MRS.

Answer 21

€94 - the MRS is the reduction in level of consumption that would keep one’s utility constant following a one-hour increase of free time.

Question 22

3.3 Goods and Preferences

As an individual has more free time and less consumption what happens to the MRS?

Answer 22

MRS will fall, less would be willingly spent on an extra hour of free time. MRS corresponds to the slope of the indifference curve, and it falls as we move to the right along the curve

Question 23

3.3 Goods and Preferences

Indifference curves get (a) if you increase the amount of free time, and (b) if you increase consumption

Answer 23

(a)-flatter and (b)-steeper

Question 24

# 3.4 The feasible set Why does free time have an oppurtunity cost?

Answer 24

To get more free time, one has to forgo the opportunity of higher consumption.

Question 25

# 3.4 The feasible set State the income equation

Answer 25

y=hw where y is income, h is hours and w is wage

Question 26

# 3.4 The feasible set compare t (hours of free time) to h (hours worked)

Answer 26

24-t=h so c=w(24-t) where c is consumption at its maximum

Question 27

# 3.4 The feasible set What does c=w(24-t) equation refer to?

Answer 27

Budget constraint

Question 28

# 3.4 The feasible set Is the budget constraint graph a curve or line?

Answer 28

Linear graph-always downward sloping straight line

Question 29

# 3.4 The feasible set What does the bduget constraint graph's gradient refer to?

Answer 29

The decrease in consumption for evry extra hour of free time

Question 30

# 3.4 The feasible set On the graph below explain why C is not feasible while D is

Answer 30

C is ABOVE budget constraint line so it is not in the feasible set (everything below the feasible set line). At C the individual has 12 hours of free time and consumption of 450, which is not feasible as with 12 hours of free time, they work 12 hours, making 360 only. D is below the budget constraint (in the feasible set) and 18 hours of free time but only 70 consumption, meaning they work 6 hours and make 180.

Question 31

# 3.4 The feasible set Describe the feasible set and feasible frontier:

Answer 31

Feasible set: All of the combinations of goods or outcomes that a decision-maker could choose, given the economic, physical, or other constraints that they face. Feasible frontier: The curve or line made of points that defines the maximum feasible quantity of one good for a given quantity of the other.

Question 32

# 3.4 The feasible set What is the opportunity cost of one hour of free time is equal to?

Answer 32

The wage

Question 33

# 3.4 The feasible set How does MRT relate to the budget constraint graph?

Answer 33

The feasible frontier shows the marginal rate of transformation (MRT)

Question 34

# 3.4 The feasible set Compare MRS and MRT

Answer 34

MRS is the trade off one is willing to make between consumption and free time. The marginal rate of transformation (MRT):this measures the trade-off that the individual is constrained to make by the feasible frontier.

Question 35

# 3.5 Decision-making and scarcity What does point E represent?

Answer 35

MRS = MRT and the individual maximises their utility at this point. Model predicts that an individual will choose this point

Question 36

# 3.5 Decision-making and scarcity Why would an individual not pick B or D?

Answer 36

At B and D, the amount of consumption they are willing to trade for an hour of free time (MRS) is greater than the amount they would have to trade (MRT), so he prefers to increase his free time. MRS too high compared to MRT

Question 37

# 3.5 Decision-making and scarcity Why would an individual not pick A?

Answer 37

At A, the MRT is greater than the MRS (very low), so he prefers to decrease his free time. And, as expected, at E the MRS and MRT are equal.

Question 38

# 3.5 Decision-making and scarcity What is a constrained choice problem model?

Answer 38

A problem in which a decision-maker chooses the values of one or more variables to achieve an objective (such as maximizing profit, or utility) subject to a constraint that determines the feasible set (such as the demand curve, or budget constraint). - IN THIS UNIT: free time and consumption are both scarce good that the decision maker values - both incur an opp. cost as more of one means less of the other

Question 39

# 3.5 Decision-making and scarcity MRS and MRT values for maximising utility must be...

Answer 39

equal.

Question 40

# 3.5 Decision-making and scarcity Describe the value of MRS and MRT in terms of the indifference curve and the feasible frontier

Answer 40

MRS is equal to the absolute value of the indifference curve MRT is equal to the absolute value of the feasible frontier

Question 41

# 3.6 Hours of work and technological progress When wage increases what happens to the feasible set?

Answer 41

Feasible set expands so the individual can have more of both goods.

Question 42

# 3.6 Hours of work and technological progress Show the budget constraint graph with old line and new line (before and after a wage increase). Also include how this affects indifference curve

Answer 42

- budget constraint pivots so 24,0 maintained but shifts up from this point - Steeper line made - Feasible set is larger so a higher indifference curve is achievable - Point on the new budget constraint is chosen where MRT=MRS - Living standards increase

Question 43

# 3.6 Hours of work and technological progress What are the two ways in which wage increase can affect an individual?

Answer 43

1. Income effect : if we can afford to have more goods (both free time and consumption) we will choose to 2. Substitution effect: one good (free time in this case) becomes more expensive relative to the other, we will use our resources to obtain less of it, and more of the other. -> Substitution effect of wage rise means an individual wants to take less free time

Question 44

# 3.6 Hours of work and technological progress What is the relationship of substituion effect and income effect with wage rise relative to each other?

Answer 44

These work in opposite directions

Question 45

# 3.6 Hours of work and technological progress If an individual picks point F which of substituion and income effect dominate? What may lead to other effect dominating and what would occur?

Answer 45

Income effect dominates. If substitution effect dominated this would cause extra incentive to work to dominate, in which case workers respond to rising wages by working longer hours.

Question 46

# 3.7 Income and substitution effects on hours of work and free time What will always rise when wages rise and what is variable?

Answer 46

Living standards will always rise, and the number of hours worked can vary

Question 47

# 3.7 Income and substitution effects on hours of work and free time If w is the daily wage, you take d days of free time and you have 70 days of summer, what is maximum consumption in terms of an equation?

Answer 47

c=w(70-d)

Question 48

# 3.7 Income and substitution effects on hours of work and free time What does the slope of the budget constraint correlate to? (calculate)

Answer 48

The wage, which is 90 pounds.

Question 49

# 3.7 Income and substitution effects on hours of work and free time What is MRT/opp cost of a free day in this graph?

Answer 49

90

Question 50

# 3.7 Income and substitution effects on hours of work and free time Why is A an ideal point?

Answer 50

MRS=MRT=W (Rate at which you are willing to substitute free time for consumption = Rate at which you can transform free trade to consumption). This is also

Question 51

# 3.7 Income and substitution effects on hours of work and free time If given 1000 pounds extra at no cost, what would happen to this budget constraint. Give graph and equation: 𝑐=𝑤(70−𝑑)

Answer 51

𝑐=𝑤(70−𝑑) +1000

Question 52

# 3.7 Income and substitution effects on hours of work and free time Has the oppurtunity cost of free time changed?

Answer 52

No, each hour of free time still reduces the wage by 90 pounds (wage=budget constraint slop and slope stayed the same).

Question 53

# 3.7 Income and substitution effects on hours of work and free time Why may one not just spend the extra 1000?

Answer 53

They may choose to pick ideal point b where new MRT=MRS. This way they can consume a little more as well as take a little more free time.

Question 54

# 3.7 Income and substitution effects on hours of work and free time In this graph what is the income effect value (+/-/0) and has the MRS and MRT changed?

Answer 54

MRT AND MRS ARE CONSTANT (slope of both lines is the same). The MRS for this person suggests that because there is no change the willingness to take an extra hour of free time. The income effect=0 as there hasnt been change to the level of free time this individual chooses.

Question 55

# 3.7 Income and substitution effects on hours of work and free time Why is there no substitution effect that can be considered at all in this graph?

Answer 55

The MRT has not changed so there is no change in incentive to work. The shift up is as a result of unearned income. There is no reason to subsititute consumption for free time.

Question 56

# 3.7 Income and substitution effects on hours of work and free time Why does an increase in unearned income make you work less days, with increase in wage making you want to work more days?

Answer 56

With increased wage the substitution effect is larger than the income effect: DESPITE: - The feasible set expands: For each level of free time you have more consumption, MRS is higher at a point with higher income, meaning you are more willing to sacrifice consumption for more free time THERE IS BIGGER: - Steeper budget constraint: Oppurtunity cost of free time is higher, MRT is higher, more incentive to work Substitution>Income

Question 57

# 3.7 Income and substitution effects on hours of work and free time Use the graph to precisely determine the overall effect accounting for substitution and income effect

Answer 57

-Wage increase means a higher indifference curve can be reached - At point D, your MRS is equal to the new wage, $130. You have only 30 free days, but your consumption has risen to $5,200. - If a dotted line was drawn where the MRT did not change, then a point C (right of A) would be chosen over point D (left of A). - Income effect shifts ideal point from A to C (more free time) - Substitution effect shifts ideal point from A to D (less free time) - Overall effect (shifting right and left is dependent on sum of income and substitution) - In this case the shift is to the left therefore substitution>income

Question 58

# 3.7 Income and substitution effects on hours of work and free time Define income and substituion effect in terms of budget constraint shifts and slope.

Answer 58

The income effect (because the budget constraint shifts outwards): the effect that the additional income would have if there were no change in the opportunity cost The substitution effect (because the slope of the budget constraint, the MRT, rises): the effect of the change in the opportunity cost, given the new level of utility.

Question 59

# 3.8 Is this a good model? What is good about the MRT/MRS model?

Answer 59

* Only focuses on essential tradeoff by stripping other variables * Realistic predicition that doesnt depend on actual calculation : predicts the typical or average behavior * Useful for comparison (e.g. what happens if wages change) * Basis for more complex models

Question 60

# 3.8 Is this a good model? What are limitations of the MRS/MRT model?

Answer 60

* People do not always make choices with perfect calculation in mind * Model ignores other constraints and motives (e.g. long term plans, non monetary factors, social norms) * Assumes a typical set of preferences and constraints * Feasible set is often limited by extraneous variables * Risk that omitted factors matter — especially when they change.

Question 61

# 3.8 Is this a good model? What do economic theorists evaluate about the model?

Answer 61

- The model only used to provides insight which is why it omits realistic setting - Realistic behaviour usually aligns with the models prediction

Question 62

# 3.8 Is this a good model? What is ceteris parabis?

Answer 62

Economists often simplify analysis by setting aside things that are thought to be of less importance to the question of interest. The literal meaning of the expression is ‘other things equal’. In an economic model, it means an analysis ‘holds other things constant’. - The ceteris paribus assumptions can make it difficult to apply a model to changes that happen over a long period of time: the longer the period, the more likely it is that other things will change too.

Question 63

# 3.9 Explaining our working hours: Changes over time How does the labour–leisure model explain why working hours rose before 1870 in Britain but fell in the 20th century, even though wages increased in both periods?

Answer 63

Before 1870 (wages ↑, hours ↑): * Income effect (small): Consumption levels were low → rising wages didn’t greatly increase workers’ desire for more free time. * Substitution effect (large): Higher productivity and wages made each hour of work more rewarding → incentive to work more. * Outcome: Substitution effect dominated → free time ↓ → working hours rose. 20th century (wages ↑, hours ↓): * Income effect (large): Workers now consumed more and valued free time more highly → higher MRS → stronger desire for leisure when wages rose. * Substitution effect (same direction): Higher wages still made work more attractive. * Outcome: Income effect dominated → free time ↑ → working hours fell.

Question 64

# 3.10 Application: Work hours, free time, and inequality What is consipicuous consumption and the Veblen effect?

Answer 64

Conspicuous consumption: The purchase of goods and services to publicly display one’s social and economic status. Veblen effect: A negative effect on others that arises from a person’s consumption of goods such as luxury housing, clothing, or vehicles, that display or signal social status.

Question 65

# 3.10 Application: Work hours, free time, and inequality How does the Veblen effect differ based on the groups individuals are surrounded by and what do economists hypothesis are its effects?

Answer 65

Its effects: The more rich people consume, the longer other people will work, so as to try to copy (as best they can) the standards of the rich. As a result, we would expect people to work longer hours in countries in which the rich are especially rich, and people to work less where the rich are only modestly richer than the rest.

Question 66

# 3.11 Explaining our working hours: Gender and working time In what two ways does the gender pay gap exist?

Answer 66

1. Wage gap 2. Number of paid working hours gap

Question 67

# 3.11 Explaining our working hours: Gender and working time When women are paid lower wages than men how does this alter the income and substitution effect?

Answer 67

Substitution Effect dominates Income effect Substitution effect: Lower wages → lower reward for working so lower opp cost of free time. This reduces the incentive to work Income Effect: Lower wage → lower potential income. Women may need to work more to reach target living standard. Overall: Substitution effect outweighs income effect, especially due to unpaid domestic labour + discrimination. → Women supply fewer paid hours on average.

Question 68

# 3.12 Explaining our working hours: Differences between countries What does intersection in the indifference curves of two individuals/countries mean?

Answer 68

Workers do not share the same preference as intersection is only at one point and means the slopes are not parallel. To have the same preferences the same shape and slope of IC is required.

Question 69

# 3.12 Explaining our working hours: Differences between countries What leads to cross-country difference in working hours?

Answer 69

Combination of constraints and preferences