The family as an economic unit by C. Echevarria

The family as an economic unit by C. Echevarria (BFW, ch. 3) Outline Child production Household production Others: Companionship Insurance: for better or for worse Wealth accumulation Specialization 1. Child Production Children = most important public good within a couple. Most correctly: Non-rival good: consumption (or enjoyment) of the good by one person does not exclude the consumption (or enjoyment) of the good by other person. 2. Household production Production: conversion of factors of production (labour, capital and land) into goods and services that satisfy needs and wants. Household production: conversion of purchased goods and services (intermediate goods), labour and some kind of capital and land into goods and services that we actually consume. 2.1. Gains from Exchange Exchange means giving to and receiving from the same person. Trade = exchange at a price, at a fixed rate (price) Price does not need to be expressed in terms of dollars (or any other currency). Barter: trade in which we exchange a good or service for another, at a given rate. Monetary trade: trade in which a good is traded for money. Money: anything that is generally accepted in exchange for goods and services. Summary: exchange is broader than trade. Trade can be either barter or monetary trade. 1

Exchange Barter Trade Monetary trade David Ricardo (1772-1823). Portugal and England and the trade of wool and wine. (Weekly) Production possibilities of Portugal an Britain (first number = wool; second = wine) Portugal Britain (8,0) (20,0) (7,2) (18,1) (6,4) (15,2) (4,6) (11,3) (0,9) (6,4) (0,5) Countries closed to trade wine wool Portugal 2 7 Britain 3 11 Total 5 18 Consumption = production Countries open to trade Agree to specialize (to produce only a few goods) and trade 5 tons of wine for 8 tons of wool. PRODUCTION wine wool Portugal 9 0 Britain 0 20 Total 9 20 Countries open to trade CONSUMPTION wine wool Portugal 4 8 Britain 5 12 Total 9 20 Each country should produce the good in which it has comparative advantage. A country has comparative advantage in a good if it can produce it at a lower opportunity cost. 2

Opportunity cost: best alternative forgone. Opportunity cost for\of wool wine Portugal 2 1/2 Britain 1/4 5 Lide: as a Professor, $30 per hour at home, $20 per hour Patxi: as a Professor, $12 per hour At home, $12 in the market Lide has absolute advantage in the production of both goods. Who has comparative advantage in what? OPPORTUNITY COST for\of home market Lide 1.5 2/3 Patxi 1 1 Lide: teaching Patxi: homemaking Assume 8h/day. Joint earnings if: 1. Lide stays home. 1.She makes $160 at home. 2.He makes $96 at work. 3.Total: $256 2. Patxi stays home. 1.He makes $96 at home 2.She makes $240 at work. 3.Total: $336 1. They split (both work 4 hours teaching and 4 at home). 1. He: $48 at home and $48 at work 2. She: $80 at home and $120 at work. 3. Total: 128 at home and $168 at work: $296. (This example is tricky. Better example in HW) Absolute advantage means greater productivity in the production of a good. Productivity: output per unit of input. Even if an agent has absolute advantage in everything, it cannot have comparative advantage in everything. It makes sense to specialize and exchange. 3

2.2 Economies of scale Increasing returns to scale (IRS) means that the percentage increase in output exceeds the percentage increase in inputs Consequence of IRS: economies of scale: as the scale of operation is increased, the cost per unit of output (the average total cost) decreases. 3. Others (companionship, insurance, accumulation) Externalities occur when a consumer or producer does not receive all the benefits or pay all the costs of its actions. Positive externalities: the economic agent does not receive all the benefits. Negative externalities: the agent does not pay all the costs. This is the way economists model altruism or caring for another person. Specialization What does the model say? Comparative advantage depends on two things: 1. market wages (earning potential) and 2. productivity at home. Specialization What does the model explain? Why, in the labour market, fathers earn more than childless men while childless women earn more than mothers; and why fathers from two-career tend to make less money than those whose wives do not work outside the home. Specialization Why some couples decide not to specialize? 1. We will see later the disadvantages of specialization 2. We derive utility or disutility from work itself (economic non-pecuniary decision). Specialization Does this mean that women will always do the housework? If women marry down (men marry up ) in most cases he would be the one with the comparative advantage at home. It also depends on boys housekeeping education. 4

The value of household production by C. Echevarria Outline 1. What is household production? (Bergmann, 3) 2. Consequences of not accounting for household production (Waring, 2) 1. Macro 2. Micro 3. The value of household production 4. The value of volunteering What is household production? Housework: shopping, cleaning and caring for children and other family members (International Labour Organization, ILO). Economically active: engaged in the production of goods and services for the market, barter, or home consumption, excluding housework. What is household production? Reason: try to incorporate other forms of household production in the GDP. Two problems: 1. This definition is not inclusive enough 2. What is considered housework is culturally determined: housework is what women do. Consequences of not accounting for household production 2.1. At macroeconomic level GDP (gross domestic product): market value of all final goods and services produced within an economy in a given period of time (usually a year). Needs to go to the market and needs to be recorded to be included in the GDP. Consequences of not accounting for household production 1. household production and voluntary activity are not included (non-market activities) 2. illegal activities are not included; 3. neither are underground activities (not illegal in themselves but break some regulations) 1

Consequences of not accounting for household production 4. recorded at market prices stated in the current of the country at this point in time; 5. some non-market activities (government services) are included, measured at accounting cost. Consequences of not accounting for household production GDP per capita = economists' main welfare indicator. Used to make welfare comparisons across countries and, inside countries, at different points in time. Consequences of not accounting for household production Problems: usually more important when comparing across countries than across time (when comparing two points close in time). Equivalent to income. But an economic agent (household or firm) should look not only at income, but also at wealth (assets and liabilities). Consequences of not accounting for household production Not accounting for household production 1. overstates welfare differences when making cross-country comparisons: household production, as % of GDP, is much more important in poor countries than in rich countries. 2. overstates business cycles (substitution between market and non-market goods). Consequences of not accounting for household production 3. overstates long-run economic growth: during the past three decades, activities once done inside the household (not accounted for) are being transformed into market activities (accounted for). Consequences of not accounting for household production 2.2 Microeconomic level Most microeconomic policy guided by comparisons across households (income distribution). Not accounting for household production leads to unfair tax and welfare policies. 2

The value of household production Three main methods: 1. The opportunity cost method values time at household production at the (potential) market wage of the person doing the household work. More subjective. 2. The replacement cost method values time spend at household production at the average wage of a substitute worker (housekeeper). More objective. 3. The market cost method values the final output at market cost. More objective. The value of household production Statistics Canada (1994): housework represents 41% of Canadian GDP using the market cost method and 31% using the opportunity cost method. L. Goldschmidt-Clermont (cited by M. Waring, page 279): 75 evaluations, from 1960 to 1985, in industrialized countries: estimates range from 25% to 40%. The value of volunteering Most volunteers are women: 117 women for each 100 men. Statistics Canada (1997): Saskatchewan: province with highest volunteer rate. Economic value of volunteering: 2% of GDP. Total hours volunteered: 1 billion, equivalent to 578,000 FT jobs: almost 4% of the active population. 3

9/19/2013 Outline Economics of reproduction: boys and girls by C. Echevarria 1. Demographics 2. Microfoundations (Bryant, 5) 3. The puzzle (Becker, 4) 4. Policy 5. Investing in human capital (class notes) A little demographics I anticipate that many sensitive, thoughtful people will be offended by these studies (which) may seem far beyond the realm of the economic calculus. Schultz (1974) Death (mortality) rate: annual number of deaths per 1,000 people. Infant mortality rate: probability of dying between birth and one year = annual number of deaths of babies under one year per 1,000 live births. Children mortality rate: probability of dying between birth and five years = annual number of deaths of children under five years per 1,000 live births. Demographics Children mortality heavily influenced by infant mortality; both largely determine death rate. Life expectancy at birth: number of years a newborn would live if patterns of mortality at the time of his/her birth remain constant. Differences in life expectancy across countries largely a product of differences in infant and children mortality; life span much more difficult to change. Demographics Fertility rate: average number of children that would be born alive to a woman during her lifetime. Birth (natality) rate: annual number of births per 1,000 people. Birth rate compares births to total population; fertility compares births to female population. Birth rate is static; fertility rate is dynamic. 1

9/19/2013 Demographics (Biological) population growth: difference between birth and death rates. Population growth takes into account migration. Demographics (total) Dependency ratio: Number of people under 15 and over 64 expressed as a proportion of the population of working age (15-64). Can be decomposed into child dependency (under 15) and aged dependency (65+) ratios Demographics Demographic transition: pattern of falling death rates followed, after a lag, by falling birth rates. Seems to accompany development. Demographics 1. Before transition: mortality and natality high: moderate population growth. 2. During transition: large population growth. 3. After transition: death and birth rates low: moderate growth. Demographics Western World: decline of mortality started after Industrial Revolution (approx.1750); decline in fertility, beginning of the 19th Century (half a century later): whole process completed by beginning of 20 th Century. For developing countries: mortality began to decline after WWI; fertility, circa 1965. Completed in Latin America and Asia; not completed in Africa yet. Microfoundations For considering the issue an economic problem three conditions: 1. Parents want children: children yield satisfaction. 2. Children are costly: bearing and rearing children use scarce resources. 3. Parents able to make a decision: able to choose whether to have children, how many, and when. 2

9/19/2013 Microfoundations Probabilistic control: discrepancies between "planned" (or desired) and "actual" number of children: 1. Many people have more children than planned. 2. Couples may end up with fewer children than planned. Microfoundations Advantages Children 1. love parents and are loved by them. 2. produce goods and services. 3. provide security in old age. social, psychological, and economic On average: planned and actual should be close most of the time. Microfoundations Children = a durable good: produce a flow of satisfaction over many years. Becker, satisfaction depends on: 1. quantity: the number of children; and 2. quality (infelicitous term): the human capital of each child. Costs Two kinds: Microfoundations 1. Financial costs: health care, food, clothes, shelter, education. 2. Opportunity cost: time required for bearing and rearing children. Mostly determined by female wages. The puzzle Relation between number of children and income is negative Two reasons: 1. OC of having children increases with income per capita. The puzzle 2. Trade-off quantity/quality: either a large number of poorly educated children or fewer highly educated children. If returns increase, parents will have fewer, more educated children. Returns positively correlated with income per capita price of education decreases, and opportunities increase Children are a normal good: positive income effect. 3

9/19/2013 Policy After a few decades of pushing birth control: the problem was not the discrepancy between the desired and the actual number of children. Nowadays, UN putting more emphasis in women's education: trying to increase the OC. Strong negative correlation between female education and lower fertility rates. Investing in human capital Assumption: parents are the agents who make decisions concerning human capital. Parents invest in HC for two main reasons: 1. To increase children's future happiness 2. Because children are the main source of old age security Investing in human capital When considering differential treatment of siblings, two kinds of concerns: Investing in human capital Girls (women) receive less education, less health care, and less food (nutrition) than boy (men) in many countries. 1. Equity concerns. 2. Efficiency concerns. (Trade-offs at times) Investing in human capital Explanations: 1. Equity concerns. Parents prefer boys to girls in many cultures 2. Efficiency concerns. (private) Returns are lower for girls because: Discrimination in the labour market. A shorter working lifetime. A higher opportunity cost. Investing in human capital Plus cultural reasons In rich countries primary and secondary education are compulsory and (basically) free; likely a factor explaining a smaller (even negative) gender gap. 4

Outline Intrahousehold distribution of resources by C. Echevarria 1. The disadvantages of specialization (BFW, 43-49) 2. The critique to the unitary model 3. Game theory (class notes) 4. Collective models: marriage as a cooperative game (class notes) 5. Workload indices (not in readings) 6. Consequences of collective models 7. Critiques to the bargaining approach (Sen) The disadvantages of specialization Advantages of specialization large. Disadvantages: 1. Disutility partners may derive. 2. Locking oneself in : if one decides to stay at home: 1. one s spouse's skills at home deteriorate while his/her earning potential increases; and 2. one s earning potential decreases while one s skills at home vastly improve. 3. The power of the purse. The critique to the unitary model Arrow's impossibility theorem: there is no "democratic" way of aggregating preferences of different individuals. Only way of aggregating preferences: assume the existence of a benevolent dictator (pater familiae or "head" of the household) Haddad and Hoddinott: lots of informal evidence against this assumption Game theory 1. Marginal approach: agent is small -lots of agents- compared to the market; she has no influence on prices (perfect competition). 2. Game theory : few agents; agent has influence on the outcome (buying a car or a house) and behaves strategically: thinks of the response of other agents to her actions. Game theory A game (oligopoly) has: players (oligopolist firms) rules: refers to the environment (economic, social, legal) strategies: possible actions of the players (changes in price, advertising, differentiation) payoffs (profits) 1

Game theory Two kinds: 1. Cooperative: actions are results of bargaining; in the bargaining, each player maximizes utility. Bargaining: negotiations between two or more parties about terms of possible cooperation. Game theory Implies communication and a binding agreement either it is better to cooperate or there is an enforcing mechanism (legal, etc.) Game theory 2. Non-cooperative. 1. either players cannot communicate (chess, oligopolies) or 2. there is not binding agreement 1. It is not better to cooperate and 2. there is not enforcing mechanism. Game theory Cooperative games: players able to gain by cooperating: common and conflicting interests. Outcome fulfills certain conditions: 1. individual rationality (IR): players better off cooperating, and 2. efficiency. Game theory (Nash - symmetry: if players are symmetric, outcome should treat them symmetrically) Outcome dependant on BATNA (best alternative to a negotiated agreement): the outcome if they fail to cooperate. BATNA: "threat point", "status quo position" or "breakdown point Collective models: marriage as a cooperative game Collective models: 1. household composed of (few) individuals 2. individuals behave strategically. Some models non-cooperative: individuals cannot enter into binding contracts and not self-enforcing. 2

Collective models: marriage as a cooperative game Most models: cooperative: Threat-point (BATNA): 1) if thinking of getting married: status-quo; 2) if already married: divorce Players are better off by cooperating: public goods, economies of scale, advantages of specialization, externalities, etc. Players have common interests and private (own) interests: if they cooperate, pie is bigger; each player wants a bigger share of the pie. Collective models: marriage as a cooperative game Conclusions: distribution of resources inside the couple (satisfaction of husband and wife) depends on threat point: situation if marriage breaks down Whoever is in a better situation in the threat-point has more bargaining power. Collective models: marriage as a cooperative game Many solutions efficient and IR. Which one is the outcome of the bargaining depends on: 1. negotiating abilities, 2. ideas (perception) of fairness influence outcome but outcome not necessarily fair 3. tradition (focal point). Collective models: marriage as a cooperative game What the model does and does not say 1. Model for marriage as a whole: alternative, divorce 2. Power of the purse: in the traditional division of labour, the main "breadwinner" has more to say. 3. Does not say that husband and wife care only about their own welfare: Collective models: marriage as a cooperative game 4. Factors affect the threat point (bargaining power) Likelihood of remarrying For the homemaker: ability of getting a job Emotional attachment to children. Divorce laws: alimony and child support Eligibility rules and benefit levels under welfare. Collective models: marriage as a cooperative game 5. Utility a function of 1. public goods: the number of children, their quality, house, 2. private goods: our leisure, etc. 3. non-measurable: love, companionship, etc. The one with more bargaining power has more to say on public goods but both receive satisfaction. Difficult to know who is getting more out of marriage. 3

Collective models: marriage as a cooperative game Economists usually look at private goods. Even in this case, two problems: 1. What is sometimes considered private consumption is not such. 2. IF woman is more emotionally attached to children: receives more satisfaction even if has less leisure and less private consumption. Workload indices From Economic gender equality indicators (2000). 1. Canadians spend more time in unpaid than in paid work: largest amount of unpaid work devoted to children. 2. StatsCan began measuring unpaid work in the 1970s (time-use in Gral. Social Surveys) - world leader. Workload indices Total workload index Paid work index 1998 1.04 0.62 1.56 1992 1.08 0.6 1.73 1986 1.07 0.53 2.16 Unpaid work index Workload indices 1. Men spend more time than women in paid work while women spend more time in unpaid work. 2. While the gender gap remains substantial, it declined between 1986 and 1998. 3. 1.08 means 30 minutes more per day: equivalent to 5 weeks of vacation. Implications of collective models The increase in divorce 1. Widening of eligibility and increase in benefits under welfare (income maintenance). Similar: Progresa in Mex. 2. Strong decline in fertility over time: benefits of marriage greater when young children are present. Implications of collective models 3. Incorporation of women to the labor force: threat point change: fewer individual rational cooperative outcomes. 4. Increase in female education: increases women s bargaining power: fewer outcomes IR (why many women stay on the job even if it does not look worth the effort when considering only the present) All factors interrelated. 4

Implications of collective models Policy implications 1. (Haddad and Kanbur) Ignoring intra-household distribution of resources understates poverty measures. 2. Labour market policies should take into account that husband's and wife's labour supply are not determined as predicted by the unitary model. Implications of collective models 3. Ignoring these issues may mean policy outcomes different than expected: income is not pooled; households adopt different arrangements. Control of income translates into different patterns of expenditure. One income Whole wage Allowance Two incomes Shared management Independent management Critiques to the bargaining approach (Sen) Two critiques to (neoclassical) economics: 1. Criticizes utilitarianism in economics: two people with different levels of consumption can have the same level of satisfaction, because, for example, one of them has been socialized to "sacrifice". 2. Argues that social arrangements should be considered part of available technology. (Actually considered so by neoclassical economists.) Critiques to the bargaining approach (Sen) Criticisms to bargaining theory and its application to marriage: 1. It is assumed that 1) each player is trying to maximize their utility and 2) each player has a clear perception of their interest: may not be so because the concept has no meaning for them (example of rural Indian woman asked about her welfare). Critiques to the bargaining approach (Sen) 2. Informational basis of bargaining models is insufficient -does not include questions of legitimacy (game theorists aware of this). Critiques to the bargaining approach (Sen) For Nash: contributions not important (threat point is) perceptions not important. Contributions may be important (ideas of fairness) perceptions may be important. (Sen s critique not well formulated) 5

Critiques to the bargaining approach (Sen) Example of treatment of women in Punjab: does not need to be explained as a perceived contribution response can be explained by (Nash) threat point: no access to outside earnings. 6