1. Application 1: Labor supply

2. Review Model of choice We know preferences and we find
The two differences – net demands
Buying, selling?

3. Geometry x2 w2 w1 x1

4. Three Applications 1. Labor Supply (Labor-Leisure Choice)
2. Intertemporal Choice
(Consumption-Savings Choice)
3. Uncertainty (Insurance)
(Consumption across states of the world)

5. Labor Supply Model (One day)
Two “goods”: leisure time, R,
and consumption, C
A worker is endowed with time 24h
Consumption good’s price is pc.
w is the wage rate in $
New: Labor supply

6. Translation:

7. Budget set
The worker’s budget constraint is where C, R denote gross demands for the consumption good and for leisure.
This can be rewritten as

8. Budget set C 24 R

9. Budget set C 24 R

10. Quiz: Real Price
Budget set depends on wage and price only through ratio
Ratio is called a real wage rate
Q: Real wage rate is a “price” of
time in terms of $
time in terms of commodity
commodity in terms of $
commodity in terms of time

11. Preferences C 24 R

12. Labor supply Curve: Definition24

13. Cobb Douglass: Optimal Choice

14. Cobb Douglass: Labor Supply24 R

15. Cobb Douglass: Labor supply

16. Empirical Evidence:
Inelastic Backward-Bending Labor supply

17. Solution: overtime wage
First 8 hours of work: w
The following hours: w’>w
w’ is an overtime wage rate

18. Overtime wage rate: Budget set