1 To Supply Labor or Not to Supply Labor This is the question to which we turn.

2 Utility Maximization u The individual would like to get to the highest indifference curve possible (because then they would maximize utility – that is the utility they can obtain), but the budget constraint restricts the individual’s options to the budget line. u On the next slide let’s see what is the best the individual can do.

3 Utility Maximization income leisure a b c u1 u2 u3 Because of the budget line, u3 can not be reached u1 can be reached at points c and b, but even more utility would be obtained if the individ. went to point a on u2. The utility associated with u2 is the maximum this person can achieve given the wage rate.

4 Utility Maximization b Note why b from the previous screen was not the best point. To give up a unit of leisure and maintain the same utility the person needed to get back a certain amount of income. But the market actually gives back more income than the individual requires for the same level of utility. This trade is beneficial. The individual would thus give up the unit of leisure and be happier for the trade. C L

5 Utility Maximization Note why c from two screens ago was not the best point. To take a unit of leisure and maintain the same utility the person is willing to give up a certain amount of income. But the market actually requires the individual to give up less. This is a beneficial trade. The individual would thus take the unit of leisure and be happier for the trade. c

6 Utility Maximization In the final analysis, the individual maximizes utility when the MRS=wage(this means the indifference curve is tangent to the budget line). Distance cb is the amount of labor this individual would supply. Distance ad is the amount of income they would have. a b c d

7 At the same wage, why two people supply different amounts of labor Note the solid line indiff. curve is for the workaholic. At the workaholics optimal point, the leisure lover finds it beneficial to take on more leisure because or their willingness to give up much more inccom to get more leisure than the market requires. Note that at each persons optimal point MRS=wage. A workaholic is a person with a relatively weak preference for leisure because little income is needed to give up a unit of leisure