1. Chapter 4
Consumer and Firm Behavior: The Work-Leisure Decision and Profit Maximization

2. The Representative Consumer
Preferences
Goods: The Consumption Good and Leisure
The Utility Function
More Preferred to Less
Preference for Diversity
Consumption and leisure are normal goods
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3. Marginal Rate of Substitution (MRS)
Indifference Curves
Downward Sloping (more preferred to less)
Convex to the Origin (preference for diversity)
Marginal Rate of Substitution (MRS)
Slope of the Indifference Curve
Rate at which consumer is willing to substitute leisure for consumption goods
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4. Figure 4.1 Indifference Curves
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5. Figure 4.2 Properties of Indifference Curves
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6. Budget Constraint Price-taking Behavior The Time Constraint
Real Disposable Income: after tax
A Graphical Representation
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7. Figure 4.3 Representative Consumer's Budget Constraint (T > p)
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8. Figure 4.4 Representative Consumer's Budget Constraint (T < p)
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9. Optimization
Rational Behavior: can make informed optimization decision
Optimization Condition: MRS = Relative Price
A Graphical Representation
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10. Figure 4.5 Consumer Optimization
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11. Figure 4.6 The Representative Consumer Chooses Not to Work
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12. Comparative Statics Experiments
Changes in Dividends () and Taxes (T): Pure Income Effect, relative price (w) no change  both c and l 
Changes in the Real Wage (w): Income and Substitution Effects  c , l  or 
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13. Figure 4.7 An Increase p – T for the Consumer
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14. Figure 4.8 Increase in the Real Wage Rate—Income and Substitution Effects
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15. Question: What does L Supply Curve look like in the data?
Labor Supply Curve:
Substitution Effect > Income Effect  upward-sloping labor supply curve
Substitution Effect < Income Effect  downward-sloping labor supply curve
Question: What does L Supply Curve look like in the data?
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16. Figure 4.9 Labor Supply Curve
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17. Figure 4.10 Effect of an Increase in Dividend Income or a Decrease in Taxes
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18. Figure 4.12 Real Wage in the United States, 1980–2003
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19. Figure 4.13 Average Weekly Hours in the United States, 1980–2003
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20. An Example: consumption and leisure are perfect complements (with Leontief preference)
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21. Figure 4.11 Perfect Complements b/w C and L
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22. Non-wage disposable income -T   both c and l 
Wage w   both c and l  (no substitution effect)
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23. The Representative Firm
The Production Function
Properties of Production Function
Constant Returns to Scale
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24. Monotonicity: Declining MPK Declining MPN
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25. Changes in Capital and MPN Total Factor Productivity
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26. Figure 4.14 Production Function, Fixing the Quantity of Capital and Varying the Quantity of Labor
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27. Figure 4.15 Production Function, Fixing the Quantity of Labor and Varying the Quantity of Capital
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28. Figure 4.16 Marginal Product of Labor Schedule for the Representative Firm
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29. Figure 4.17 Adding Capital Increases the Marginal Product of Labor
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30. Figure 4.18 Total Factor Productivity Increases
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31. Figure 4.19 Effect of an Increase in Total Factor Productivity on the Marginal Product of Labor
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32. TFP and Aggregate Production Function
Cobb-Douglas production function
Check it satisfies all the properties
Capital income share =
The measure of the TFP: Solow Residual
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33. Figure 4.20 The Solow Residual for the United States
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34. Profit Maximization Profits = Total Revenue  Total Variable Costs
Firm maximizes profits by setting optimization condition
This condition defines the labor demand curve
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35. Figure 4.21 Revenue, Variable Costs, and Profit Maximization
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36. Figure The Marginal Product of Labor Curve Is the Labor Demand Curve of the Profit-Maximizing Firm
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