Question

Bob is deciding how much labour he should supply. He gets utility from consumption of beer (given by C) and from leisure time (given by L), which he spends hanging out with his friend Doug. This utility is given by the following utility function: U(C, L) = ln(C) + θ ln(L) where the value of θ was determined by your student number and ln(C) denotes the natural logarithm of consumption etc. Given this utility function, Bob’s marginal utility from consumption is given by: MUC = ∂U ∂C = 1 C and his marginal utility from leisure is given by: MUL = ∂U ∂L = θ L Bob has 120 hours to allocate between working and leisure time. For every hour that he works he earns a wage of W. The value of this wage was determined by your student number. In addition to any income he gets from working Bob also gets $10 from his Grandmother. He spends all of his income (that is, what he gets from working plus the $10 from Grandma) on beer which costs $1 per unit. (a) If Bob devotes L hours of his time to leisure, how many hours does he work? Write out Bob’s budget constraint. (b) Suppose Bob is currently spending exactly half his time on leisure L = 60, could he raise his utility by increasing or decreasing the number of hours he works? Carefully explain your answer. (c) Solve for Bob’s optimal choice of hours worked, hours spent on leisure and beer consumption. Hint: see the solution to the two good problem at the end of this assignment. (d) Suppose Bob’s Grandmother now gives him $100 instead of $10. What would expect would happen to his consumption of beer, the number of hours he takes as leisure and his labour supply? You do not have to solve for Bob’s new optimal choices. However, you do have to explain why he changes his choices. (e) Suppose Bob’s hourly wage rate increases by $1. What would expect would happen to his consumption of beer, the number of hours he takes as leisure and his labour supply? Again, you do not have to solve for Bob’s new optimal choices, but you do have to explain why he changes his choices.

Theta=1, Wage=5, Beta=4, Y1=4

Answer 1

D) as non Labor income increases, so both consumption & leisure rises, Labor supply falls.

Bcoz increase in non Labor income has income effect. , Which means that as income rises, so the individual should enjoy more leisure, & work less, still enjoy more consumption

E) now wage rises, so it has both income & substitution effect

Since wage has increased, so work for more hours, thus enjoy less leisure & work more, more earning

Again more Labor income is earned for same amount of working hours, thus enjoy more leisure & less work

So consmption will surely rise, but effect on Labor supply depends on which effect dominates more, substitution or income effect.