14.01SC | Fall 2011 | Undergraduate

Principles of Microeconomics

Unit 2: Consumer Theory

Applying Consumer Theory: Labor

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Session Overview

Along with what to buy, another key decision that we make every day as economic agents is how much to work and how much to relax. The decision about supplying labor can be analyzed with the same tools used to analyze the market for pizza or movies, and we call this the analysis of the labor market. This lecture provides an overview of the economics of the labor market.

The decision to nap instead of work can be analyzed by economic tools. Image courtesy of Joi Ito on Flickr.

Keywords: Labor supply; Giffin good; leisure; consumer theory; labor economics; child labor.

Session Activities


Before watching the lecture video, read the course textbook for an introduction to the material covered in this session:

  • [R&T] Chapter 7, “The Analysis of Consumer Choice.” Sections 7.2.
  • [R&T] Chapter 12, “Wages and Employment in Perfect Competition.”
  • [Perloff] Chapter 5, “Applying Consumer Theory.” (optional)

Lecture Videos

The lecture video for this session consists of two parts.



Check Yourself

Concept Quiz

This concept quiz covers key vocabulary terms and also tests your intuitive understanding of the material covered in this session. Complete this quiz before moving on to the next session to make sure you understand the concepts required to solve the mathematical and graphical problems that are the basis of this course.

Question 1

What is a Giffen good?

A good where consumption falls when the price increases. close
A good where consumption increases when the price increases. check
A good where consumption rises when income falls. close
A good where consumption rises when income rises. close
Check Show Solution

Consumption rising when income rises describes a normal good, and consumption rising when income falls describes an inferior good. Consumption falling when price increases is the most common case of own-price effect, where the substitution effect dominates the income effect. Consumption increasing when price increases is a Giffen good, where the income effect dominates the substitution effect.

Question 2

When we model the consumers trade-off between consumption and leisure, what is the slope of the budget constraint?

The price of the consumers favorite good. close
The ratio of prices between two goods the consumer consumes the most. close
The ratio of the wage rate to the price of the consumers favorite good. close
The wage rate. check
Check Show Solution

Just as in our previous analyses we used the ratio of prices of the two goods the consumer has the option to consume. In this case, we want the ratio of the price of income to the price of leisure. The price of income is one (it takes a dollar to buy a dollar), and the price of leisure is the wage rate. For every hour that you relax, you give up the hourly wage you could have earned by working that hour. You 'pay' your hourly wage for that hour of leisure.

Question 3

If the income effect dominates the substitution effect in the labor supply decision, what happens when the wage increases?

It depends on their specific preferences. close
Workers work less. check
Workers work more. close
Workers work the same amount. close
Check Show Solution

When the wage increases, there is both an income effect (each worker feels relatively richer) and a substitution effect (each hour of work has higher returns.) A richer worker will want to consume more leisure (since it is a normal good), and thus will work less. On the other hand, the fact that each hour of work has higher returns may impel a worker to work more. If the first (income) effect dominates, then workers will work less at a higher wage.

Question 4

If rural households in Vietnam begin to earn more money for their crops and become richer, what will happen to the supply curve for their children's labor? (Hint: assume that education is a normal good.)

It depends on their preferences. close
It will shift left. check
It will shift right. close
No change. close
Check Show Solution

If education for children is a normal good, families will consume more of it (i.e., school attendance will increase) when their income increases. Accordingly, the supply curve for child labor will shift left because children are spending more time in school.

Further Study

These optional resources are provided for students that wish to explore this topic more fully.

Textbook Study Materials

See the [Perloff] chapter for the topics covered, as well as quizzes, applications, and other related resources.

Other OCW and OER Content

14.64 Labor Economics and Public Policy, Fall 2009. MIT OpenCourseWare An in-depth course on labor economics.

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Course Info

As Taught In
Fall 2011
Learning Resource Types
Lecture Videos
Recitation Videos
Problem Sets with Solutions
Exams with Solutions
Lecture Notes
Exam Materials
Problem Sets