chapter 2-1 chapter two labour supply chapter 2-2 chapter 2© 2007 mcgraw-hill ryerson ltd.2...

Chapter 2-1

Chapter Two

Labour Supply

Chapter 2-2Chapter 2 © 2007 McGraw-Hill Ryerson Ltd. 2

Learning ObjectivesLearning ObjectivesLabour Market Attachment

Labour Force Participation Measurement and Trends

Hours of WorkBasic Income-Leisure Model

Utility Maximizing BehaviourLabour Supply

Factors Influencing the Supply of Labour

Chapter 2-3Chapter 2 © 2007 McGraw-Hill Ryerson Ltd. 3

Learning Objectives, Learning Objectives, cont’dcont’dChanges in the Wage Rate and the

Labour Supply Extensions and Applications

Added and Discouraged Worker Effects Hidden Unemployment Moonlighting, Overtime, and Flexible Hours

Chapter 2-4

Labour Force Participation Rate

LFPR the fraction of the eligible population that

participates in the labour force LFPR=LF/POP

LF (Labour Force) individuals in the eligible population who

participate in labour market activities either employed or unemployed

Chapter 2-5Chapter 2 © 2007 McGraw-Hill Ryerson Ltd. 5

Chapter 2-6

Figure 2.2 Labour Force Participation Rates by Sex, 1901-1991

Chapter 2-7Chapter 2 © 2007 McGraw-Hill Ryerson Ltd. 7

Chapter 2-8Chapter 2 © 2007 McGraw-Hill Ryerson Ltd. 8

Chapter 2-9Chapter 2 © 2007 McGraw-Hill Ryerson Ltd. 9

Chapter 2-10Chapter 2 © 2007 McGraw-Hill Ryerson Ltd. 10

Unemployment To be considered unemployed, a

person must be in one of the following three categories:

1. Without work but has made specific efforts to find a job within the previous four weeks

2. Waiting to be called back to a job from which he or she has been laid off

3. Waiting to start a new job within four weeks

Chapter 2-11

Basic Income - Leisure ModelMax U(C,L) s.t. (1) P*C=wH+v and (2)

T=H+L.The maximization with fixed endowmentThe choice of hours worked given

opportunities and value of nonmarket time. preferences U and constraints (income and

time) individuals choose the feasible outcomes which

yield the highest level of satisfaction

Chapter 2-12

Preferences

Two “goods” consumption (C) leisure (L)

Represented by indifference curves, U Indifferent between various

combinations of consumption and leisure

Chapter 2-13

Figure 2.4a Indifference Curve

Leisure0

Co

nsu

mp

tion

B

B-abundance of leisure willing to give up for consumption

C-consumption and leisure are substitutable

C

A-abundance of consumption willing to give up for leisure

A

Slope - Marginal Rate of Substitution

Chapter 2-14

Figure 2.4b MRS Of Two Different Consumers

Leisure0

Co

nsu

mp

tion

U10

U20

A

l0

C0

l1

C21

C11

Chapter 2-15

Preferences

Preferences over all conceivable combinations of consumption and leisure

All combinations lie on some indifference curve

Represented by an indifference map

Chapter 2-16

Figure 2.4 c Indifference Curve Map For an Individual

Leisure0

Co

nsu

mp

tion

U0

U1

U2

Chapter 2-17

Constraints

Constrained by economic properties of the market

Transform consumption-leisure to income-leisure by setting the price of consumption

Chapter 2-18

Figure 2.5 a Simple Full-Time/Part-Time Choice

Leisure0

Income

T

YN

A

YNNo Paid Work

LP

IP+YN

B

IPPart-time

LF

IF+YN

C

IF Full-time

hP

hF

Chapter 2-19

Leisure0 T

Income

W1 High wage

W0 Low wage

Figure2.5 b Linear Potential Income Constraint

W1T+YN

W0T+YN

YN

Slope depends on Individual’s wage rate

Chapter 2-20

The Consumer’s Optimum Optimal amount of income and leisure Utility-maximizing equilibrium

highest indifference curve given the income constraint

Compare MRS with the Market Wage Rate MRS - measures the willingness to exchange time

for income Market Wage Rate - measures the ability to

exchange leisure for income

Chapter 2-21

Leisure0

Income

U1

U0

Figure 2.6 a Equilibrium of Nonparticipant

RMarket Wage less than the reservation wage

T

Slope=-W0

U2

YN

A=E0

Corner Solution

Slope= -WR

R

R’

Chapter 2-22

Figure 2.6 b Equilibrium of a Participant

Leisure0

IncomeMarket wage exceeds thereservation wage

T

R

R’YN

Indifference curve tangentTo budget constraint

U1U2

U0

l0

W0h0+YNE0 Interior Solution

Chapter 2-23

Figure 2.7 The Effect of an Increase in Nonlabour Income on Supply

Consume more Consume less

Chapter 2-24

Effect of Non-labour Income on Hours of Work in nonlabour income results in a parallel

shift outward of the budget constraint normal good-if leisure is a normal good more

will be consumed resulting in less work hours inferior good- if leisure is an inferior good less

will be consumed and more work hours are spent

Chapter 2-25

Change in Wage Rate

Two effects Income effect

the worker has more income to buy more goods including leisure (reduces work hours).

The effect is positive on leisure if leisure is normal, I.e., dL/dv>0.

Substitution effect individual may work more because the returns are greater

substituting away from leisure it is negative, I.e., dL/dw<0 (where d represents “change”)

Chapter 2-26

E0

leisure0

Income

U0

T

-W0

Figure 2.8 Income and Substitution Effect of Wage Increase

l0

E’

l’

Substitution effectIncome effectNet effect

W0T=YN

W1T=YN

l1

U1

E1

-W1

Chapter 2-27

Effect of Wage Increase on Participation

Both substitution effect and income effect If income effect dominates, hours of work

may decline (not withdraw )For a nonparticipant an W may leave the

equilibrium unchanged or induce the individual to participate

Other institutional constraints such as fix working hours may affect the result

Chapter 2-28

Effects of an Increase in Nonlabour Income on Participation

Opposite to wage increasePure income effectMay cause participants to leave the

labour force (which occurs when nonlabour income is sufficiently high)

Examples include transfer payments from government (incentives are reduced)

Chapter 2-29

Individual Supply CurveSubstitution effect > income effect

wage leads to labour suppliedAs wages continue to

there is a point where substitution effect and income effect offset each other

Supply curve bends backward when income effect > substitution effect

Chapter 2-30

Elasticity of Labour Supply

Responsiveness of labour supply to changes in the wage rate

Uncompensated elasticity % change in labour supply from a 1% increase in wage

(indeterminate) Income elasticity

% change in labor supply from a 1% increase in nonlabour income (negative)

Compensated elasticity % increase in labour supply from a 1% increase in wage

after compensating for increased income (positive)

Chapter 2-31

Moonlighting, Overtime, Flexible Work HoursWhy do some people moonlight at a

second job at a wage less than their market wage on their first job?

Why do some people require an overtime premium to work more?

Chapter 2-32

0

Income

Leisure

Y1

T

C

Lc

Yc

Figure 2.11 a Fixed Hours Constraint

Chapter 2-330

Income

Leisure

C

Lc

Yc

YT

T

Uc

Ud

Figure 2.11 b Underemployment

D

Ld

Yd

Chapter 2-34

Overtime and Overemployment

Prefer to work fewer hours at the going wage rate

Induced to work more hours through an overtime premium

Chapter 2-35

Yt

Yt

Figure 2.12 Overemployment and Overtime

0

I

TtL

0

I

ud

Uc

LTYo

C

Uc

Ud

Lc

CYc

Ld

DYd

O

Chapter 2-36

Overtime PremiumSubstitution effect is larger than the income

effectPrice of leisure is higher for overtime hoursExamples include medical doctors working

overtimePeople in safe cities often work overtime

(relative to those in unsafe cities)

Chapter 2-37

Overtime Premium vs Straight Line Equivalentworker would not remain at overtime

equilibrium New equilibrium on a higher utility curve Income effect outweighs the substitution

effect causing the person to supply less work

Chapter 2-38L

0

I

Uc

T

C

Yt

Gains for Alternative Work Schedules

F

YfF- willing to give up wagesfor preferred work schedule

C-some individual are discontent

Ud

D

D- preferred work schedule

Chapter 2-39

Comparison:No difference in utility between C and F

even though F implies a lower wage rate

Allowing workers to work desired amount of hours can improve utility as long as w> T Yf line

Chapter 2-40

End of Chapter Two