Beta September 2015 version 3 SCARCITY, WORK AND CHOICE Shutterstock HOW INDIVIDUALS DO THE BEST THEY CAN, GIVEN THE CONSTRAINTS THEY FACE, AND HOW THEY RESOLVE THE TRADE-OFF BETWEEN EARNINGS AND FREE TIME • Decision-making under scarcity is a common problem because we usually have limited means available to meet our objectives • Economists model these situations: first by defining all of the possible actions • ... then evaluating which of these actions is best, given the objectives • Opportunity cost describes an unavoidable trade-off in the presence of scarcity: satisfying one objective more means satisfying other objectives less • This model can be applied to the question of how much time to spend working, when facing a trade-off between more free time and more income • This model also helps to explain differences in the hours that people work in different countries and also the changes in our hours of work through history See www.core-econ.org for the full interactive version of The Economy by The CORE Project. Guide yourself through key concepts with clickable figures, test your understanding with multiple choice questions, look up key terms in the glossary, read full mathematical derivations in the Leibniz supplements, watch economists explain their work in Economists in Action – and much more. 2 coreecon | Curriculum Open-access Resources in Economics Imagine that you are working in New York, in a job that is paying you $15 an hour for a 40-hour working week: so your earnings are $600 per week. There are 24 hours in a day and 168 hours in a week so, after 40 hours of work, you are left with 128 hours of free time for all your non-work activities, including leisure and sleep. Suppose, by some happy stroke of luck, you are offered a job at a much higher wage—six times higher. Your new hourly wage is $90. Not only that, your prospective employer lets you choose how many hours you work each week. Will you carry on working 40 hours per week? If you do, your weekly pay will be six times higher than before: $3,600. Or will you decide that you are satisfied with the goods you can buy with your weekly earnings of $600? You can now earn this by cutting your weekly hours to just 6 hours and 40 minutes (a six-day weekend!) If this were your choice, you would enjoy an additional 33 hours and 20 minutes (about 26%) more free time than previously. The Einstein section shows you how we calculated these numbers. Or would you use the greater hourly wage rate to raise both your weekly earnings and your free time? The idea of receiving, overnight, a six-fold increase in your hourly wage, and being able to choose your own hours of work, might not seem very realistic. But we know from Unit 2 that technological progress since the Industrial Revolution has been accompanied by a dramatic rise in wages. For example, the average real hourly earnings of American workers increased six-fold during the 20th century. And while employees ordinarily cannot just tell their employer how many hours they want to work, over long periods the typical hours that we work will change. In part, this is a response to how much we prefer to work. As individuals, we can choose part-time work, although this may restrict the jobs open to us. Political parties also respond to the preferences of voters, and changes in typical hours of work have occurred as the result of legislation that, in many countries, imposed maximum working hours. So have people used economic progress as a way to consume more goods, enjoy more free time, or both? The answer is both, but in different proportions in different countries. While hourly earnings increased by a factor of more than six for 20th century Americans, their average annual work time fell by a little more than one- third. So people at the end of the century enjoyed a four-fold increase in annual earnings with which they could buy goods and services, but a much smaller increase, slightly less than one-fifth, in their free time. (The percentage increase in free time would be higher if you subtracted time spent asleep from free time, but still very small relative to the increase in earnings.) How does this compare with the choice you made when our hypothetical employer offered you a six-fold increase in your wage? Figure 3.1 shows trends in income and working hours since 1870 in three countries. As in Unit 1, income is measured as per capita GDP in US dollars. This is not the same as average earnings, but gives us a useful indication of average income for UNIT 3 | SCARCITY, WORK AND CHOICE 3 the purpose of comparison across countries and through time. In the late 19th and early 20th century, average income approximately trebled, and hours of work fell substantially. During the rest of the 20th century, income per head rose four-fold. Hours of work continued to fall in the Netherlands and France (albeit more slowly) but levelled off in the US, where there has been little change since 1960. 3,500 1870 1890 3,000 1900 1913 ed 2,500 1929 1929 1960 1950 1960 2,000 1973 US 1973 2000 1980 1990 Annual hours work 1980 1938 FRANCE 1973 1990 1,500 2000 1990 2000 NETHERLANDS 1,000 1,000 6,000 11,000 16,000 21,000 26,000 GDP per capita Figure 3.1 Annual hours of work and income (1870-2000). Source: Maddison Project. 2013. ‘2013 Edition’ . Huberman, Michael, and Chris Minns. 2007. ‘The Times They Are Not Changin’: Days and Hours of Work in Old and New Worlds, 1870–2000.’ Explorations in Economic History 44 (4): 538–67. GDP is measured at PPP in 1990 international Geary-Khamis dollars. While many countries have experienced similar trends, Figure 3.2 illustrates the wide disparities between countries in 2013. Here we have calculated free time by subtracting average annual working hours from the number of hours in a year. You can see that the higher-income countries seem to have lower working hours and more free time, but there are some striking differences. For example, the Netherlands and the US have similar levels of income, but Dutch workers have much more free time. And the US and Turkey have similar amounts of free time and a large difference in income. In many countries there has been a huge increase in living standards since 1870. But in some places people have carried on working just as hard as before, and consumed more, while in other countries people now have much more free time. Why has this happened? We will provide some answers to this question by studying a basic problem of economics—scarcity—and how we make choices when we cannot have all of everything that we want, such as goods and free time. 4 coreecon | Curriculum Open-access Resources in Economics 70,000 Norway 60,000 United States 50,000 Netherlands Denmark 40,000 Germany UK a (USD PPPs) Japan South Korea France Italy Spain 30,000 Greece Russia 20,000 Mexico Chile GDP per capit Turkey 10,000 0 6,400 6,500 6,600 6,700 6,800 6,900 7,000 7,100 7,200 7,300 7,400 7,500 Average annual hours of free time per worker Figure 3.2 Annual hours of free time per worker and income (2013). Source: OECD. 2015. ‘Level of GDP per Capita and Productivity.’ Accessed June. OECD. 2015. ‘Average Annual Hours Actually Worked per Worker.’ Accessed June. Data for South Korea refers to 2012. Study the model of decision-making that we use carefully! It will be used repeatedly throughout the course, because it provides insight about a wide range of economic problems. 3.1 LABOUR AND PRODUCTION In Unit 2 we saw that labour can be thought of as an input in the production of goods and services. Labour is work; in the Unit 1 example of making a cake, it is stirring, mixing, and preparing ingredients. In making a car it is welding, assembling, testing and similar activities. Work activity is often difficult to measure, which will be important in later units because employers find it difficult to determine the amount of work that their employees are doing. We also cannot measure the effort required by different activities in a comparable way (compare baking a cake to building a car), and so economists often measure labour simply as the number of hours worked by individuals engaged in production and assume that, as the number of hours worked increases, the amount of goods produced also increases. UNIT 3 | SCARCITY, WORK AND CHOICE 5 As a student, you make a choice every day: how many hours to spend studying. There may be many factors influencing your choice: how much you enjoy your work, how difficult you find it, how much work your friends do, and so on. Perhaps part of the motivation to devote time to studying comes from your belief that the more time you spend studying, the higher the grade you will be able to obtain at the end of the course. In this unit we will construct a simple model of a student’s choice of hours of work, based on the assumption that if you spend more time working, you’ll get a better grade. We assume this is true, but is there any evidence to back this up? A group of educational psychologists looked at the study behaviour of 84 students at Florida State University to identify the factors that affected their performance.