4.2. Budget constraint• Definition: combinations of real income-leisure that the i can achieve

• Characteristics:1. Line “price takers”2. Slope = wage rate (w)

Maximization of U: I. Subjective or psychological preferences (IC) and objective or

market preferences (BC) highest IC, tangent to BCII. The individual and the market “are in agreement”III. Wage rate = MRS tangencyIV. Over and underemployment

4.2. IC, BC, & Max. of U• IC: all combinations of L-l desired by the i with U; subjective or psychological preferences slope MRS• BC: all combinations of L-l achievable at certain w; objective or market information slope w• Max. of U: IC & BC together tangency, same slope: MRS = w

Question: what happens if the slope of BC is steeper than that of the IC?

What do individuals do when w goes up?Answer: L up … or l up (and L down)?

Derivation of the supply of labor curve“Backward-bending” changes from person to person

Again: income effect and substitution effectSubstitution effect : ∆L due to ∆w with Y > 0Income effect : ∆L due to ∆Y with w < 0 (l: normal)Total effect: depends on the “strength” of the other two

4.2. IC, BC, & Max. of U

The reasoning behind “backward-bending”: with ∆w ∆BC substitution > income; but as t goes by, ∆w ∆BC substitution < income

Supply curve: when leisure is abundant, how is the MRS?

Different individual curves: men vs. women?

4.2. IC, BC, & Max. of U