CONSUMPTION-LABOR FRAMEWORK

(aka CONSUMPTION-LEISURE FRAMEWORK)

CHAPTER 2
 In this chapter

•  We will solve consumer’s static problem of

choosing consumption and leisure (2-goods
problem).
•  We will derive goods demand and labor supply.
•  We set the building blocks of our macroeconomic
model.
 Introduction

BASICS
q  Consumption-Leisure Framework – provides foundation for
q  Labor-market supply function
q  Goods-market demand function
q  An application of the basic consumer theory model…
q  …we will put a macro interpretation on it
q  Only one time period – no “future” for which to save

q  Notation
q  c: consumption (“all stuff”)
q  n: number of hours spent working per week
n + l = 168
q  l: number of hours leisure per week (time spent not working)
q  P: dollar price of one unit of consumption (a nominal variable)
q  W: hourly wage rate in terms of dollars (a nominal variable)
q  t: tax rate on labor income
 Introduction

BASICS
q  Consumption-Leisure Framework – provides foundation for
q  Labor-market supply function
q  Goods-market demand function
q  An application of the basic consumer theory model…
q  …we will put a macro interpretation on it
q  Only one time period – no “future” for which to save

q  Notation
q  c: consumption (“all stuff”)
q  n: number of hours spent working per month
n + l = 720
q  l: number of hours leisure per month (time spent not working)
q  P: dollar price of one unit of consumption (a nominal variable)
q  W: hourly wage rate in terms of dollars (a nominal variable)
q  t: tax rate on labor income
 Introduction

BASICS
q  Consumption-Leisure Framework – provides foundation for
q  Labor-market supply function
q  Goods-market demand function
q  An application of the basic consumer theory model…
q  …we will put a macro interpretation on it
q  Only one time period – no “future” for which to save

q  Notation
q  c: consumption (“all stuff”)
q  n: number of hours spent working per unit
n+l=1
q  l: number of hours leisure per unit (time spent not working)
q  P: dollar price of one unit of consumption (a nominal variable)
q  W: hourly wage rate in terms of dollars (a nominal variable)
q  t: tax rate on labor income

q  “Weekly,” “monthly,” “yearly” is a detail

q  Just need to take SOME stand on the length of a “period”
q  n + l = 1 à n (l) is the percentage of time working (in leisure)
 Introduction

BASICS

q  Building blocks of consumption-leisure framework

q  Utility
q  Describes the benefits of engaging in labor market (and other)
activities

q  Budget constraint
q  Describes the costs of engaging in labor market (and other) activities

q  Utility and budgets two DISTINCT concepts

q  As in basic consumer analysis (Chapter 1)

q  Only after describing utility and budgets separately do we bring

the two together to obtain predictions from the framework
 Model Structure

UTILITY
q  Preferences u(c, l) with all the “usual properties”
q  Strictly increasing in c
q  Strictly increasing in l
q  Diminishing marginal utility in c
q  Diminishing marginal utility in l
q  Plotted in good-by-good spaces:
u(c,l) u(c,l)

c leisure

c
q  Plotted as indifference curves

q  Utility side of consumption-leisure

framework identical to Chapter 1
framework leisure

BUDGET CONSTRAINT
q  Consumer must work for his income
q  Y no longer “falls from the sky”
Simply an application/re-
interpretation of our basic
consumer theory framework
Model Structure
Pc = Y
Y = (1-t)Wn (all income is after-tax labor income)
Pc = (1 − t )Wn
n=1–l
Pc = (1 − t )W (1 − l )
(After-tax) wage is opportunity cost
Rearrange
of leisure, hence the “price” of leisure
- opportunity costs are real economic
Pc + (1 − t )Wl = (1 − t )W costs/prices
Spending on “Spending” A constant from the
consumption on leisure point of view of the
individual (price-
taker)
Pc
1 1 + P2 c2 = Y
Chapter 1 budget constraint
Spending Spending A constant from the point
on c1 on c2 of view of the individual
 Notes
•  We did until here in Lecture 1 (Aug
29).
•  We see that the consumption- •  Next time we will solve the
leisure problem looks exactly like consumption-leisure problem.
the good 1-good 2 choice problem.
• 
•  But good 1 is general consumption
(c) (e.g., consumption per capita
data) and good 2 is leisure (l).
•  The opportunity cost of leisure
(‘price’) is the (after tax) wage rate.
•  Thus the budget constraint tells us
that total expenditure for the two
goods that the consumer likes (c
and l) equals her total exogenous
income (which is the after tax wage
for working 100% of her time)