Beckers Model of Household Production - Assignment Example

Full price activity changes with hourly wage rate and the different between income and substitution effects. of Crete Department : Date: Q.1. Use Becker’s model of household production to explain how the ‘full’ price of different activities changes in response to a change in the hourly wage rate According to household production model, utility is deduced from the activities (Zi) that occupy our daily lives. This can be determined by U = U ( Z1, Z2, ….Zn). Every good produced and used up within the household results from combining time and purchased inputs, according to Becker. The element of wage rate is vital here. The income constraint requires that the net household income should equal expenses on market items, where p is the price of household output, w is the hourly income, r is the price of variable inputs, and s is the price of market items. This furthermore will tell us about the bargaining power in household production unit. Thus: P ( Y­C ) – w Tw – rV = sM We obtain full income constraint by such an expression after a little change: wT = ƩNi=l FCi Where FCi= total cost of a good and FCi = pxi + wti where p= price index of xi, w= wage rate, xi= summed inputs in production and consumption of an item, while t is time spent working. In the same context, individuals will always minimize the total cost of consuming a commodity. This way we can understand the decline in fertility with increased income as well as why many people ignore coupons in grocery firms. We are also able to understand the cause of decrease expenditure on children as they become endowed. (Tran 2005). The fig.1 and 2. Show graphical examples of how the above theory can be represented. The sketch 2. Illustrates a substitution effect concerning wage rate. A rise in wage rate results in increased relative price of time and also the households substitute purchased items for time in the making and usage of a given level of each item. This income effect is shown. As the income per hour increases, there is also an increase in quantity of final commodities (zi) consumed. (Molina 2011). This increase in wage rate is likely to cause the amount of the time required for using or producing these activities to increase. These two graphs show time-intensive differences among different household activities. When the income per hour increases, the full price of time intensive items will automatically increases. In reaction, goods-intensive items are therefore exchanged for time-intensive ones. Under these two kinds of effects, a higher income rate decreases the time quantity used in household production while increasing that working time. (Welch 2009). Pursuing the subject further, let’s consider a specific illustration that was done by Gary S. Becker, on children. He acknowledged that children are usually not purchased but are self-produced in their respective families, while using the market goods and services and the parents own time. Thus if the cost of producing and bringing children up is pn and the cost of z is πz the budget of a family that is constrained becomes: Pn n + πz z = 1 and 1 = full income. (Sonoda and Maruyama 2011). Thus the demand for by family’s children would be determined by the relative prices of those children and the household full income. Moreover an increased relative price of children, in pn with respect to πz, reduces the demand for children with subsequent increases the demand for other commodities like leisure. This implies that the demand for children is highly responsive to price and the household income. It has also been shown that an increase in returns on a household activity will make the parents to spend less on those activities. Thus the parents will stead, spent more on themselves at these high family incomes by substituting from total quality and going for quantity of that item. This is because the shadow price of quantity decreases when less is spent on such items. Thus the observed elasticity of full quality could be weak and possibly negative when the benefit of such item increases e.g. Children. This happens even though if the true elasticity of total quality is positive and significant. Thus we can agree that an increase is household wage rate increases the demand for household items as seen in the case of children therefore increasing the price of that item. Another important relationship is the effect of wage rate on quality and quantity of the item thus the price. It has been shown that quantity and quality do interact clearly in demand functions that normally are depended on price in the market and wage rate. The income of the household directly influences the quantity and quality of the household items as we will find out down the road. These however, result as a direct influence of demand on those items. Changes in quantity also changes with prices of those quantities. At the same time also changes in quality also changes with their respective prices as far as the goods are concerned. This is seen when the quality of education among children goes down when they are many and at the same time, families with a single child give high quality education. Expressions Let pc be the constant cost per unit of quality of an item, q, the total quality of each item (child-in this case), and let pcqn be the total expenditure amounts on children , then the budget constraint would be as follows: Pc qn + πz z = 1 This obtained budget constrain is non linear and will depend by many fold on the values of n and q. The non linearity in this case is absolutely responsible for the interaction between quantity and quality of an item in the household. This is seen as follows: In order to get the equilibrium conditions, we maximize the utility subject to the budget constraint, obtaining, δU/δn = MUn = λpcq = λπn δU/δq = MUq = λpcn= λπq δU/δz = MUz = λλz The applicable shadow prices in this illustration, of n and q are πn and πq. Since an increase in q raises the cost of total amount spent on each child, it raises the relevant cost of each child as well. It is worth noting that πn depends on q and πq. The above values can be solved, for equilibrium values of n, q and Z as the respective functions of these shadow prices and of wage rate. (Becker 1993). N = dn (πn, πq, πz, R) Q = dq ( πn, πq, πz, R) Z = dz (πn, πq, πz R) (Becker 1993). We are able to find out that the shadow income, R is equal to the totality of the shadow amounts spent on various items. These demand functions are seen to have the usual substitution and income effects in household production. For example when shadow price of, n, q or z, increases, a reduction of own quantity demanded is realized, provided other shadow prices and shadow income are held constant, and this is as a direct effect of income. Q2. Distinguish between income and substitution effects in the household production model and consider whether this model adds anything new to the standard model of labor supply. In simple terms, income effect is always a consequence of a change in a product’s price relative to the consumer’s disposable financial gain. The income of a consumer will always change when the actual price of that good wanted by the same consumer changes. In real sense, if the price of that item goes up, then the consumer is in a worse state, because the disposable income is less available. This means the consumer can only buy less of that good, or even not buy at all. Substitution effect on the other hand occurs in specific circumstances including, a situation where the price has of a good increased. This will push the consumer to substitute another product in the place of that good, or even forego the product altogether. This concept however depends on the affected sort of product following a price increment, and the way consumer’s perspective on that product. If the product involved is a necessity, then the substitution effect will take place more clearly, because the consumer, who depends on, cannot do without the product, will change over to, or substitute, to another version of the same item having a lower cost. The two effects are also illustrated in the graphs on figures 1 and 2. It must be noted that the labor supply curve shows an upward trend in slope in cases of larger substitution effects in terms of magnitude in comparison to the income effect. On the same note, an individual may operates entirely on a backward bending part of the labor supply curve, and this occurs if the income effect magnitude is larger than the existing effects of substitution.( Becker 1993) There are several additions of this model to the standard model of labor supply. First of all, the budget factor comes to our mind. It is observed that both the income substitution effects and income effects will always matter whenever personal budget comes to the surface. If a person has unlimited monetary resource, the resulting situation will mean neither income nor substitution effects will matter at all. Since that is not normally the case, consumers operating on a on a budget must determine and measure expected gains against expected losses when a particular item changes in price. The balance should be between the price of the item and the expected utility, or rather satisfaction guarantee, which a particular good will brings. If the increase in price of a good is steep and fast, then the consequences of paying much more money for that good are likely to surpass any expected utility that is to be gained from the same product. Another important aspect occurs in terms of elasticity. Research shows that when the item of interest is a necessity, it the phenomenon is called inelastic demand, since the demand for it always remains constant despite price changes. An elastic good is one that is more of a secondary want or luxury. It is a product whose demand changes in direct proportion with changes in the price of that item as so does the economy. Medical care for a sick patient is inelastic, while on the other hand an umbrella is elastic. In the latter case, the product might be brushed aside entirely if the price goes up past reasonable levels, meaning that it is a secondary want or a luxury, most of the consumers will simply snub or forego buying the product because the ‘suffering’ brought about by the increase in price of the good will overwhelm the ‘pleasure’ of purchasing such a product. (Kooreman 1997). Lastly, variables also form part of an important contribution. There are three factors considered as variables in these two effects namely changes in price, budget constraints and the perception of the product through the eyes of the consumer. An elastic good that the consumer loves will still be bought even when the prices rises substantially. In a situation where inelastic good has its full price going up markedly, this might simply put an incision in the consumer’s budget, since the household is entirely depended or cannot live without that product. Therefore, when the household economy is in a depression and item prices such as fuel rise, the prices of most of other products rise as well. Constraints of the budget get tighter, and this makes this kind of rational measuring of utility becomes more important. (Trontz 2010). xi xi B C B A zi=zio zi=zi1 Zi=z1o ti ti Reference: Gary S. Becker (1993). A Treatise on the Family. Cambridge, U.K: Harvard University Press. 135-200. Jennifer Mcknight Trontz (2010). Home Economics. 2nd ed. Philadelphia : Quirk Books. 1-176. Cathleen D. Zick and W. Keith, Bryant (2005). The Economic Organization of the Household. Cambridge : Cambridge University Press. 70-230. Van Hoa Tran (2005). Advances in Household Economics, Consumer Behaviour And Economic Policy. 4th ed. Farnham, Surrey, United Kingdom: Ashgate Pub Co. 75-100. J. A. Molina (2011). Household Economic Behaviors (International Series on Consumer Science). New York City,U.S.A: Springer. 45-160. Patrick J. Welch and Gerry F. Welch (2009). Economics: Theory and Practice. 9th ed. Hoboken, New Jersey: Wiley. 322-432. Sophia Wunderink and Peter Kooreman (1997). The Economics of Household Behavior. 4th ed. New York City. Palgrave Macmillan. 150-211. Tadashi Sonoda and Yoshihiro Maruyama (2011). A Theory of the Producer-Consumer Household: The New Keynesian Perspective on Self-Employment . 5th ed. New York City. Palgrave Macmillan. 145-195. Read More