Problem Set VII

Buying And Selling (Slutsky Equation with Endowment)

1. Kate is not sure how many hours she should spend at work and we have to help her. Her
total available time is 24h. She has no other source of income but salary. She is a lawyer,
and a current wage rate for lawyers (per hour) is w =$100. She only consumes bananas
that cost pc =$5 per pound.
a) What is her real wage rate (wage rate in terms of bananas)?
b) Show her budget set on the graph.

Suppose her utility function is 𝑈(𝐶, 𝑅) = 𝑅 × 𝐶 where R is leisure (or relaxation

time) and C is consumption of bananas.
c) Find her optimal time spent at work, the relaxation time and consumption of
bananas.
d) How your answer in (c) would change if her wage rate was w =$200. How would
you explain the change (or possibly no change) in her labor supply?

2. Mr. Cog works in a machine factory. He can work as many hours per day as he wishes
at a wage rate of w. Let C be the number of dollars he has to spend on consumer goods
and let R be the number of hours of leisure that he chooses.
a) Mr. Cog earns $8 an hour and has 18 hours per day to devote to labor or leisure,
and suppose that he has $16 of nonlabor income per day.
i. Write an equation for his budget between consumption and leisure.
ii. Draw his budget line and mark the point A, where he does no work and
enjoys 18 hours of leisure per day.
iii. If Mr. Cog has the utility function 𝑈 (𝐶, 𝑅) = 𝐶𝑅, how many hours of
leisure (work) per day will he choose?
b) Suppose that Mr. Cog's wage rate rose to $12 an hour.
i. Write an equation for his budget between consumption and leisure, and
draw his new budget line.
ii. If he continued to work exactly as many hours as he did before the
wage increase, how much more money would he have each day to
spend on consumption?
iii. What is the change in his consumption with his new budget?
 c) Suppose that Mr. Cog still receives $8 an hour but that his nonlabor income rises
to $48 per day.
i. Write an equation for his budget between consumption and leisure, and
draw his new budget line.
ii. How many hours does he choose to work?
d) Suppose that Mr. Cog has a wage of $w per hour, a nonlabor income of $m, and
that he has 18 hours a day to divide between labor and leisure.
i. Write an equation for his budget between consumption and leisure.
ii. Find the amount of leisure that Cog will demand as a function of wages
and of nonlabor income, and Mr. Cog's supply for labor.
3. George Johnson earns $5 per hour in his job as a truffle sniffer. After allowing time for
all of the activities necessary for bodily up-keep, George has 80 hours per week to
allocate between leisure and labor.
a) Sketch the budget constraints for George resulting from the following
government programs:
i. There is no government subsidy or taxation of labor income.
ii. All individuals receive a lump sum payment of $100 per week from the
government. There is no tax on the first $100 per week of labor income.
But all labor income above $100 per week is subject to a 50% income
tax.
4. Wendy and Mac work in fast food restaurants. Wendy gets $4 an hour for the first 40
hours that she works and $6 an hour for every hour beyond 40 hours a week. Mac gets
$5 an hour no matter how many hours he works. Each has 80 hours a week to allocate
between work and leisure and neither has any income from sources other than labor.
Each has a utility function 𝑈 (𝐶, 𝑅) = 𝐶𝑅, where C is consumption and R is leisure.
Each can choose the number of hours to work.
a) How many hours will Mac choose to work?
b) At what values of C and R does Wendy’s budget line have a kink in it? Draw her
budget line using blue ink for the part of her budget line where she would be if
she does not work overtime. Use red ink for the part where she would be if she
worked overtime.
c) If Wendy was paid $4 an hour no matter how many hours she worked, how long
would she work and what would she earn?
d) If Wendy was on the red budget line, how long would she work?