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Principles of Economics1 3 Income and working hours across time and countries Scarcity and choice: key concepts Decision-making under scarcity Concluding remarks and summary Principles of Economics1 3. Scarcity, work, and choice Giuseppe Vittucci Marzetti2 SCOR Department of Sociology and Social Research University of Milano-Bicocca A.Y. 2018-19 1These slides are based on the material made available under Creative Commons BY-NC-ND © 4.0 by the CORE Project , https://www.core-econ.org/. 2Department of Sociology and Social Research, University of Milano-Bicocca, Via Bicocca degli Arcimboldi 8, 20126, Milan, E-mail: [email protected] Giuseppe Vittucci Marzetti Principles of Economics 1/26 Income and working hours across time and countries Scarcity and choice: key concepts Decision-making under scarcity Concluding remarks and summary Layout 1 Income and working hours across time and countries 2 Scarcity and choice: key concepts Production function, average productivity and marginal productivity Preferences and indifference curves Opportunity cost Feasible frontier 3 Decision-making under scarcity Constrained choices and optimal decision making Labor choice Income effect and substitution effect Effect of technological change on labor choices 4 Concluding remarks and summary Concluding remarks Summary Giuseppe Vittucci Marzetti Principles of Economics 2/26 Income and working hours across time and countries Scarcity and choice: key concepts Decision-making under scarcity Concluding remarks and summary Income and free time across countries Figure: Annual hours of free time per worker and income (2013) Giuseppe Vittucci Marzetti Principles of Economics 3/26 Income and working hours across time and countries Scarcity and choice: key concepts Decision-making under scarcity Concluding remarks and summary Income and working hours across time and countries Figure: Annual hours of work and income (18702000) Living standards have greatly increased since 1870. There are disparities in free time and income across countries. Giuseppe Vittucci Marzetti Principles of Economics 4/26 Income and working hours across time and countries Scarcity and choice: key concepts Decision-making under scarcity Concluding remarks and summary Labor productivity, income and free time Labor is an input in the production of goods and services. New technologies raise labor productivity. How would that affect living standards? How would that affect the free time and working hours chosen by individuals? Modeling individual choices to explain the differences in work hours across countries and over time. Giuseppe Vittucci Marzetti Principles of Economics 5/26 Income and working hours across time and countries Production function, average productivity and marginal productivity Scarcity and choice: key concepts Preferences and indifference curves Decision-making under scarcity Opportunity cost Concluding remarks and summary Feasible frontier A simple production function Production functions show how inputs (e.g. labor) translate into outputs (e.g. goods and services), holding other factors constant. Example: a production function of a student shows how study hours produce the final grade. Giuseppe Vittucci Marzetti Principles of Economics 6/26 Income and working hours across time and countries Production function, average productivity and marginal productivity Scarcity and choice: key concepts Preferences and indifference curves Decision-making under scarcity Opportunity cost Concluding remarks and summary Feasible frontier Average and marginal productivity Marginal product (or productivity): change in output per unit change in input (evaluated at a given point, holding other inputs constant). Average product (or productivity): average output per unit of input. Giuseppe Vittucci Marzetti Principles of Economics 7/26 Income and working hours across time and countries Production function, average productivity and marginal productivity Scarcity and choice: key concepts Preferences and indifference curves Decision-making under scarcity Opportunity cost Concluding remarks and summary Feasible frontier Diminishing marginal productivity: the law of diminishing marginal returns Giuseppe Vittucci Marzetti Principles of Economics 8/26 Income and working hours across time and countries Production function, average productivity and marginal productivity Scarcity and choice: key concepts Preferences and indifference curves Decision-making under scarcity Opportunity cost Concluding remarks and summary Feasible frontier Choices, preferences and indifference curves Choices depend on preferences. Indifference curves: combinations of goods that give the same utility. The Marginal Rate of Substitution (MRS): is the slope of the indifference curve; represents the trade-offs that an individual faces. Giuseppe Vittucci Marzetti Principles of Economics 9/26 Income and working hours across time and countries Production function, average productivity and marginal productivity Scarcity and choice: key concepts Preferences and indifference curves Decision-making under scarcity Opportunity cost Concluding remarks and summary Feasible frontier Preferences and indifference curves The curves we have drawn capture our typical assumptions about people's preferences between two goods. Indifference curves slope downward due to trade-offs: if you are indifferent between two combinations, the combination that has more of one good must have less of the other good. Higher indifference curves correspond to higher utility levels: as we move up and to the right in the diagram, further away from the origin, we move to combinations with more of both goods. Indifference curves are usually smooth: small changes in the amounts of goods don't cause big jumps in utility. Indifference curves do not cross. As you move to the right along an indifference curve, it becomes flatter: it is reasonable to assume that the more free time and the lower the grade the student has, the less willing she is to sacrifice further percentage points in return for free time, so her MRS is lower. Giuseppe Vittucci Marzetti Principles of Economics 10/26 Income and working hours across time and countries Production function, average productivity and marginal productivity Scarcity and choice: key concepts Preferences and indifference curves Decision-making under scarcity Opportunity cost Concluding remarks and summary Feasible frontier Opportunity cost Opportunity cost The opportunity cost of an action is the net benefit of the next best alternative action. Opportunity costs are relevant whenever choices are limited by constraints and involve trade-offs, i.e. alternative and mutually exclusive courses of action (e.g. higher grades vs. more free time). Compare actions based on economic cost: Economic cost = Direct (monetary and non-monetary) costs + Opportunity costs If the benefit from an action exceeds the economic costs, you receive an economic rent from choosing it. Giuseppe Vittucci Marzetti Principles of Economics 11/26 Income and working hours across time and countries Production function, average productivity and marginal productivity Scarcity and choice: key concepts Preferences and indifference curves Decision-making under scarcity Opportunity cost Concluding remarks and summary Feasible frontier Opportunity cost: example Giuseppe Vittucci Marzetti Principles of Economics 12/26 Income and working hours across time and countries Production function, average productivity and marginal productivity Scarcity and choice: key concepts Preferences and indifference curves Decision-making under scarcity Opportunity cost Concluding remarks and summary Feasible frontier The feasible frontier The feasible frontier shows the maximum output that can be achieved with a given amount of input The Marginal Rate of Transformation (MRT): is the slope of the feasible frontier; represents the tradeoffs that an individual faces. Giuseppe Vittucci Marzetti Principles of Economics 13/26 Income and working hours across time and countries Constrained choices and optimal decision making Scarcity and choice: key concepts Labor choice Decision-making under scarcity Income effect and substitution effect Concluding remarks and summary Effect of technological change on labor choices Constrained choice problem Model of how individuals choose, given their preferences and the constraints they face, when the things they value are scarce. Studying example: Free time and exam score are scarce because they are both goods, each with an opportunity cost. Giuseppe Vittucci Marzetti Principles of Economics 14/26 Income and working hours across time and countries Constrained choices and optimal decision making Scarcity and choice: key concepts Labor choice Decision-making under scarcity Income effect and substitution effect Concluding remarks and summary Effect of technological change on labor choices Optimal decision making The utility-maximizing choice is where the amount of one good the individual is willing to trade off for the other good (MRS) equals the actual tradeoff between the two goods (MRT) MRS = MRT Giuseppe Vittucci Marzetti Principles of Economics 15/26 Income and working hours across time and countries Constrained choices and optimal decision making Scarcity and choice: key concepts Labor choice Decision-making under scarcity Income effect and substitution effect Concluding remarks and summary Effect of technological change on labor choices Another example: grain production (a) Production function (b) Feasible frontier Tradeoff between grain produced and free time. Technological change shifts the production function upwards,
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