Problem 2 (4 points) Consider the following information about Tony Stark. His cu
ID: 1215241 • Letter: P
Question
Problem 2 (4 points) Consider the following information about Tony Stark. His current hourly wage is $10. Every day he chooses between consumption of two goods: leisure and the basket of other goods. You can think that the price of the basket is normalized to 1. (a) What will happen to his choice given that his hourly wage falls to $8? Explain. Show all your work. (b) Now suppose he works 8 hours at the wage rate $8. Suppose now the company offers the new scheme that will pay an overtime premium of $3 per hour for anyone that works 10 hours or more. What will happen to the choice of Mr. Stark in this case? Explain. Show all your work.
Explanation / Answer
It is a problem of maximizing utility. Tony Stark is consuming two goods. They are leisure and a basket of other goods. Leisure is the number of hours he is enjoying without work. From total hours available, deduct hours worked to get leisure hour. He has to work for say h hours to earn wages. This amount will be used to buy baskets of other commodities. More hour he worked mean less hours available for leisure but more money available for buying baskets of other commodities.
Answer (a): At present his hourly wages rate is $10. Now it will drop to $8. So to earn same amount he has to work more hours. Thus 'h' will increase and leisure 'l' will decrease.It will reduce utility level he was enjoying earlier. Note that leisure cannot be perfect substitutes of baskets of goods. So wages earned can be reduced a little, but he has to work more to get minimum required income.
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(b) They are working for 8 hours a day. At $10 wage rate total earning is $80. Now at $8 rate, the total earning is $64. So a defecit of $80-$64 =$16 is there. He has to work at least 2 extra hour to compensate it. In that case his leisue hour will drop from l to l-2 hours. But due to overtime premium, he will earn extra $3 for extra 2 hours worked. The amount is $6. It will compensate the reduction of utility due to decrease in leisure hour. But it cannot be said whether he will be better off in this process or not. It will depend upon the nature of his utility function. If extra satisfaction from $6 extra oods consumed is more than decrease in satisfaction from 2 hours decrease in l, then total utility will increase. He will be better off.
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