ClassicalModelv2-UniversityofNorthCarolinaatChapelHill.pdfVIP

The Classical Model of Consumption and Production The Classical Model represents a primitively basic model of an economy. It is a “no-exchange economy”, but a “pure production-economy”: one person divides time into work and leisure, and supplies work hours in order to produce what they alone consume. That one person is therefore the sole firm. Prices are irrelevant: there is no one to trade with or buys things from. This is therefore also referred to as the” Robinson Crusoe Model”, or for those not familiar with that story, you can call it the “castaway model”. Ingredients: 1 consumer, 1 firm, one unit of time T (e.g. T = 16 waking hours in a day). 1 There is no past or future: the consumer cannot save, invest, have debt. The population does not grow . * * * * * Optimal Policy (i.e. the equilibrium): {w , c , L , I ,}, where w = wage, c = consumption, L = labor hours, l = T-L leisure hours, I = wL = income, and = profit. Although the consumer consumers everything produced, she is the firm and therefore receives all profit from the firm. Recall that “wage” is as pay-off for work-per-hour: if you work 5 hours and can collect 10 coconuts/hour, then the wage is 10/hour, and income is 50 coconuts. 1 As opposed to a “Blue Lagoon” economy, or “Gilligan’s Island” economy, where the population could expand. 1 1. THE CONSUMER (labor-leisure choice) The consumer receives utility from consumption c and leisure l, but work permits consumption. Since there is only one consumer, who is the firm, she receives all profits from production. Her total income I based on wage labor wL and profit is