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