1. Labor Supply

2. Roadmap Neoclassical Theory of Individual Choice Neoclassical Theory of the Decision to Work Heterodox Theory of Preferences

3. NEOCLASSICAL THEORY OF INDIVIDUAL CHOICE

4. C ONSTRAINED O PTIMIZATION The Central Organizing Principle of Neoclassical Economics ProductionConsumption Constraint ResourcesBudget Optimizing Agent FirmsIndividuals or Households

5. Resources Market Technology Consumer Preferences (or “Utility”) Firm Budget Because neoclassical economics has no theory of the causes of preferences, they are ultimately the taken-for-granted, axiomatic foundation of neoclassical theory.

6. Jeremy Bentham 1748-1832 Utilitarianism: The theory that societies should seek to maximize overall happiness. Utilitarianism and Utility Theory

7. An Example of One Good (from Keen) Marginal Utility “Law of decreasing marginal utility”

8. A Case With Two Goods Notice that several values occur for multiple combinations of bananas and biscuits Also notice that utility increases as the number of bananas increases, and as the combinations of bananas and biscuits increase. and as the combinations of bananas and biscuits increase. as the number of biscuits increases,

9. An example of indifference points. Click on the picture to open an interactive version on the web. Your browser must be Java-enabled to view the interactive page.

10. Properties of Indifference Curves Let U(X) be the utility of good X and N(X) be the number of X’s in a consumption bundle. Then indifference curves have these properties: Completeness: individual can always decide if Transitivity: Non-satiation: Convexity:

11. Completeness Any individual can always decide if

12. Transitivity

13. Nonsatiation

14. Convexity

15. Typical Textbook Indifference Curves Click on the picture to open an interactive version on the web. Your browser must be Java-enabled to view the interactive page.

16. The Budget Constraint Meet Joe: The budget constraint imposes limits on how much Joe has to spend Suppose –Joe has $300 to spend –If bananas cost 50¢ each, Joe can afford 600 bananas –If biscuits cost 20¢, Joe can afford 1,500 biscuits So on the graph Joe has a budget line that intercepts the abscissa at 600 and the ordinate at 1,500 Can also express this algebraically: –Have 2 points: (0,1500) and (600,0) –Slope: –Equation for the line: Hi, I’m Joe

17. Let’s return to typical textbook indifference curves to examine how budget constraints work Click on the picture to open an interactive version on the web. Your browser must be Java-enabled to view the interactive page.

18. Price Changes Suppose the price of bananas goes up to $1 each, what is the new optimal point? Suppose the price of bananas drops to 40¢ each, what is the new optimal point?

19. Let’s Return to Typical Textbook Indifference Curves Click on the picture to open an interactive version on the web.

20. Typical Textbook Demand Curve Click on the picture to open an interactive version on the web. Your browser must be Java-enabled to view the interactive page.

21. Income and Substitution Effects Income Effect: A change in the demand for a good or service induced by a change in an individual’s discretionary income. Substitution Effect: A change in the demand for a good or service induced by a change in the good’s relative price.

22. Graphical Procedure for Calculating Income and Substitution Effects 1.Start with original budget line; call this B 1, with coordinates (x 1,y 1 ) –Note the indifference curve to which it is tangent 2.Draw the new budget line reflecting the price change; call this B 2, with coordinates (x 2,y 2 ) 3.Draw a line parallel to the new budget line but tangent to the original indifference curve; call this B 3, with coordinates (x 3,y 3 ) 4.Substitution effect: x 3 -x 1 5.Income effect = x 2 -x 3

23. Income and Substitution Effects Click on the picture to open an interactive version on the web. Your browser must be Java-enabled to view the interactive page.

24. NEOCLASSICAL THEORY OF THE DECISION TO WORK

25. Here’s The Secret It’s essentially the same thing, with three changes: 1.Buying “leisure” with the opportunity cost of foregone wages 2.Hours of work = Maximum Leisure – Purchased Leisure 3.Money can come from other sources

26. Income and Substitution Effects Click on the picture to open an interactive version on the web. Your browser must be Java-enabled to view the interactive page.

27. HETERODOX THEORY OF PREFERENCES