Macroeconomics 214
Chapter 4
Consumer and Firm behaviour: The Work-Leisure Decision and Profit
Maximisation
Learning Objectives
List the properties of the representative consumer’s preference, and explain why it is useful
to assume these properties
Construct the representative consumer budget constraint
Show how the consumer optimizes given his or her budget constraint to determine labor
supply and consumption
Determine the effects of changes in the representative consumer’s environment on his or
her choices
List the properties of the production function, and explain why it is useful to assume these
properties
Show how the representative firm optimizes given its production technology to determine
labor demand and output
Analyse consumer and firm behaviour (if wages change, will consumers spend more/less, or
will they spend more time on leisure activities)
This chapter deals with the microeconomic behaviour of the representative consumer and the
representative firm. In chapter 5, this behaviour is integrated into a general equilibrium macro
model. In this chapter, only 1 time period is taken into account: right now. This assumption will
change in later chapters where we look at multiple time periods. In this chapter, we also only look at
2 agents: the consumer and firms. In later chapters we look at other agents, such as government.
With respect to consumers, consumers need to make a decision on how to allocate their time
between 2 activities: work and leisure. From this, it can be seen that there is a trade-off between
these 2. We have to work in order to earn wages, which we spend on goods and services (in order to
consume). Due to the assumption of 1 time period, all consumption takes place in 1 time period. This
implies that there is no savings in the economy.
An additional assumption to keep in mind is that in general, competitive market behaviour will apply
– firms will always strive to maximise profits, consumers will always try to maximise utility, and other
microeconomic things will apply (such as consumers being price takers)
Representative Consumer
Here, it is assumed that there is a single representative consumer, who acts as a stand-in for the rest
of the economy. This is not an unreasonable assumption because we consider consumption on
average. Consumer’s preferences over consumption and leisure are shown as represented by
indifference curves. Consumers will have a budget constraint. The consumer’s optimisation problem
is also considered: how does the consumer make him/herself as well off as possible given their
limitations as depicted by the budget constraint. The key interest lies within the following 2
, questions: how does a consumer respond to: (i) and increase in non-wage income; (ii) an increase in
the market real wage rate.
Representative Consumer’s Indifference Curves
There are several assumptions here that are important to note. The indifference curve slopes
downwards and more is preferable to less. An indifference curve is also convex which means the
consumer has a preference for diversity in their consumption bundle. This module doesn’t deal wth
inferior goods, therefore consumption and leisure are normal goods. The consumers preferences are
defined over 2 goods: consumption and leisure. We represent preferences graphically by
indifference curves. Each indifference curve represents a set of consumption bundles (combinations
of consumption and leisure) for which the consumer is indifferent.
Figure 4.1: Indifference curves
Looking at the axis, we can see that we are making use of
macroeconomic variables. Everything else is the same as
indifference curves represented in microeconomics. The fact
that A is preferred to B captures the idea that more is
preferred to less. As we move from B to D along the
indifference curve, the consumer needs to be compensated
with more leisure at the margin so as to be willing to give up
another unit of consumption. This reflects the preference for
diversity.
Figure 4.2: Properties of indifference curves
Here, take note of the marginal rate of substitution. In this case, it
is the substitution of leisure for consumption. This is the price we
pay to consume more leisure/consumption. It is the leisure we gie
up to consume more goods and services. A preference for diversity
implies that any point on the line segment AB (other than A and B)
is strictly preferred to A or B.
The Consumer’s Time Constraint
This is the first macroeconomic consideration. The textbook talks about time in herms of “h”, with 16
hours of time in the average person’s day. People need to sleep so 8 hours are allocated to that.
Therefore h is looked at as being the time the typical person spends awake. And with our awake
hours, we can allocate our time between 2 activities: work (N to the power of s) and leisure (l).
Chapter 4
Consumer and Firm behaviour: The Work-Leisure Decision and Profit
Maximisation
Learning Objectives
List the properties of the representative consumer’s preference, and explain why it is useful
to assume these properties
Construct the representative consumer budget constraint
Show how the consumer optimizes given his or her budget constraint to determine labor
supply and consumption
Determine the effects of changes in the representative consumer’s environment on his or
her choices
List the properties of the production function, and explain why it is useful to assume these
properties
Show how the representative firm optimizes given its production technology to determine
labor demand and output
Analyse consumer and firm behaviour (if wages change, will consumers spend more/less, or
will they spend more time on leisure activities)
This chapter deals with the microeconomic behaviour of the representative consumer and the
representative firm. In chapter 5, this behaviour is integrated into a general equilibrium macro
model. In this chapter, only 1 time period is taken into account: right now. This assumption will
change in later chapters where we look at multiple time periods. In this chapter, we also only look at
2 agents: the consumer and firms. In later chapters we look at other agents, such as government.
With respect to consumers, consumers need to make a decision on how to allocate their time
between 2 activities: work and leisure. From this, it can be seen that there is a trade-off between
these 2. We have to work in order to earn wages, which we spend on goods and services (in order to
consume). Due to the assumption of 1 time period, all consumption takes place in 1 time period. This
implies that there is no savings in the economy.
An additional assumption to keep in mind is that in general, competitive market behaviour will apply
– firms will always strive to maximise profits, consumers will always try to maximise utility, and other
microeconomic things will apply (such as consumers being price takers)
Representative Consumer
Here, it is assumed that there is a single representative consumer, who acts as a stand-in for the rest
of the economy. This is not an unreasonable assumption because we consider consumption on
average. Consumer’s preferences over consumption and leisure are shown as represented by
indifference curves. Consumers will have a budget constraint. The consumer’s optimisation problem
is also considered: how does the consumer make him/herself as well off as possible given their
limitations as depicted by the budget constraint. The key interest lies within the following 2
, questions: how does a consumer respond to: (i) and increase in non-wage income; (ii) an increase in
the market real wage rate.
Representative Consumer’s Indifference Curves
There are several assumptions here that are important to note. The indifference curve slopes
downwards and more is preferable to less. An indifference curve is also convex which means the
consumer has a preference for diversity in their consumption bundle. This module doesn’t deal wth
inferior goods, therefore consumption and leisure are normal goods. The consumers preferences are
defined over 2 goods: consumption and leisure. We represent preferences graphically by
indifference curves. Each indifference curve represents a set of consumption bundles (combinations
of consumption and leisure) for which the consumer is indifferent.
Figure 4.1: Indifference curves
Looking at the axis, we can see that we are making use of
macroeconomic variables. Everything else is the same as
indifference curves represented in microeconomics. The fact
that A is preferred to B captures the idea that more is
preferred to less. As we move from B to D along the
indifference curve, the consumer needs to be compensated
with more leisure at the margin so as to be willing to give up
another unit of consumption. This reflects the preference for
diversity.
Figure 4.2: Properties of indifference curves
Here, take note of the marginal rate of substitution. In this case, it
is the substitution of leisure for consumption. This is the price we
pay to consume more leisure/consumption. It is the leisure we gie
up to consume more goods and services. A preference for diversity
implies that any point on the line segment AB (other than A and B)
is strictly preferred to A or B.
The Consumer’s Time Constraint
This is the first macroeconomic consideration. The textbook talks about time in herms of “h”, with 16
hours of time in the average person’s day. People need to sleep so 8 hours are allocated to that.
Therefore h is looked at as being the time the typical person spends awake. And with our awake
hours, we can allocate our time between 2 activities: work (N to the power of s) and leisure (l).
