Individuals want to maximize well-being by consuming goods/leisure
2-1 Measuring the labour force
CPS (Current Population Survey) classifies everyone above 16 to 3 things:
• employed, unemployed, and out of labour force
• Employed (E): worked 1hr pay at least or 15hrs on nonpaid job
• Unemployed (U): temporary layoff from job or no job but seeking work
Labour force (LF) = E + U
Labor force participation rate = LF/P
Employment rate = E/P
Unemployment rate = U/LF
Hidden unemployed
If you don't seek work, considered as "out of labour force"
• but they might claim to be seeking to get UE benefits
Hiddden UE: when they seek, but then give up
2-2 Basic Facts about Labour Supply
Over time, in 2-1 labour force decreases, especially since people are retiring earlier.
In 2-2, a lot more women entered the workforce
Work hours also decreased over time, from 55hrs in 1900 to 34hrs in 2010
In table 2-3 (at textbook), many factors affect labor participation, like education, race, etc.
More women are in part time jobs then men
2-3 Worker's Preferences
Framework used to analyze labor supply behavior is called the neoclassical model of labourlesiure choice
• model isolates factors about whether someone works/how many hrs they would work
• Helps predict changes in economic condictions/gov policies
• Person in model recieves satisfaction from consumption of goods (C) and consumption of leisure
(L)
◦ C is $ of all goods purchased (eg. food, rent, movies, etc.)
◦ L is # of hrs of leisure consumed
Utility/Indifference Curves
Utility function for consuming goods/leisure U = f(C,L)
• U = individual's level of satisfaction/happiness
Lets say consuimg $500 worth of goods &
100hrs of leisure created 25,000 utils in a
function
• in that case, if they consume $400 and
125hrs, would be same utility
• Would be X/Y in indifference curve, as both
provide same Utils
If someone has $450 worth of goods & 150hrs
of leisure, it's 40,000 utils, and is Z (a new
indifference curve)
Indifference curve (IC) has 4 important properties:
• IC are downward sloping
• Higher indifference curves = higher utility
◦ Eg. Z has more hrs/consumption then X
• Indifference curves don't intersect
◦ Because if Y/Z are on same curve, that
means X can have same utility as Z since
X/Y are on same curver
‣ But that doesn't make sense cuz Z > X
• Indifference curves are convex to origin (has
that curve shape)
The slope of an Indifference Curve
Marginal Utility: change in utility after additional hour devoted to leisure activites, holding goods
consumed constant? (for MUL)
Marginal utility of goods: when someone consumes 1 dolllarmore of goods, but keeping leisure
constant
Based on indifference curve graph, slope of any point = rate person
is willing ot give up leisure time in return for additional consumption
• Or how much it costs to bribe them to give leisure time
RIght shows indifference curve slope
Marginal rate of substitution = ratio of marginal utlities
Difference in preference across workers
Different people have differend demands
Eg. for Cindy, takes lots of money to bribe her to give up an hr of leisure
• Cindy's MRS is very high
• For Mindy, easy to bribe her to work more
2-4 Budget Constraint
People's consumption of goods/leisure is limited since only 24hrs in a day
• People also earn income from other means, like property, stocks, lottery, etc.
◦ This can be denoted as V
Budget constraint formula is C = wh = V
• w = wage
• h = hr
• V = nonlabor income
It means expenditure of goods (C) = labor earnings (wh) + non labor income (V)
Since total time = hours worked + leisure, that means T = h + L
Therefore budget constraint can be C = w(T L) + V
or C = (wT + V) - wL
The last equation creates a budget line
E = endowment point, where if they devote all
time to L, they can still make a certain amount
of money
Budget line gives opportunity set, set of all
consumption baskets a worker can afford to
buy
• worker can also choose C/L combos below the line
2-5 Hours of Work Decision
People will always choose goods/leisure that
maximizes utility
In figure 2-6, FE budget line shows when
someone has $100 nonlabor income weekly,
faces a $10 per age wage & 110hrs for both
work/leisure weekly
Point P gives best utlity, 70hrs of leisure + $500
of goods
• Ideally U1 would be better, but it can't be
obtained, as she can't afford the goods
consumed in Y
• She can also choose A, but A gives less utility
• Optimal point for goods/leisure is when
budget line intersects indifference curve
Interpreting the Tangency Condition
If at P, where indifference curve = budget
line
• intersection of when someone is willing to
give hrs for consumption & wage rate where they compensate workers for giving an hour of time
What happens to hours of work when nonlabor income changes?
In this graph, V = $100, and to get most optimal
utility, worker works 40 hours
Then V (nonlabor income) = $200, increases
slope and lets worker be better off
• in 2-7a, because V increased, thye can
purchase more goods/leisure hrs, and
workweek reduces
• in 2-7b, addition V increases workweek
Impact of change in nonlabor income on # of
hours worked is called the income effect
• In the income effect, generally more wealth
Leisure is a normal good
• Something is considered a normal good when increases in income (while good prices are
constant) increase consumption
• Inferior good: when increase in income (w/ prices constant) decrease consumption
◦ Eg. budget cars
What happens to hours of work when the wage changes?
When wage changes, Endowment point stays the
same but slope of line changes
• Based on getting $10/20 an hour
• Even though wage go up, it's possible that
hours of leisure can go up or down
• Regardless of change, worker has larger
opportunity set, can make more choices w/
higher wage
• Increased wage = increased sacrifice when
choosing 1 less hr of work
In 2-9, when wage rate changes, it creates
income/substitution effect
Income effect = P -> Q, substitution effect = Q ->
R
• In 2-9a, income effect dominantes and in 2-9b,
substitution effect dominates
Subsitution effect is when it moves in the
indifference curve
In summary:
• increase in wage rate increases hrs of work if SE > IE
• Increase in wage decreases hrs of work if IE > SE
2-6 To Work or Not to Work?
E0 indicates utility without working
• What justifies a person to work beyond E0?
At GE budget line, no wage is better than E0
utility
• but at HE wage line, any point is better than
E0
When you go from wlow to whigh, the wage
that makes her indifferent to working/not
working is reservation wage
• minimum increase in income that makes
them indifferent to E and working
• Person will work when reservation wage >
market wage
2-7 The Labor Supply Curve
Labor Supply Curve: predicted relationship between hrs of work & wage rate
As seen in graph, labor supply curve records
down their wage & hours they worked
• Reservation wage is $10, because after that
point they won't work
• Curve intially curves positively, but after
income effect dominates
•
Labor supply curve in aggregate market: adding up hrs of all people willing to work in economy
Shows market labor supply curve?
Labour supply elasticity: measures responsiveness
to hrs of work to change in wage rate
• Considered inelastic if labour supply is less than
1
• if labor supply elasticity > 1, considered elastic
2-8 Estimates of the Labor Supply Elasticity
Study of relationship between working hrs/wages
model used is:
hi = # of hours person i works, wi = wage rate, vi = non labor outcome
B coefficient measures impact of 1 dollar wage increase, V coefficient measures 1 dollar increase in
nonlabor income (V)
B depends on if IE/SE dominates
• B = negaitve if IE dominate
• B = positive of SE dominates
Problems w/ the Estimated Elasticities
Doesn't specify if hours of work means hours in a week/day/year?
• More elastic if measured by hrs per year
The wage rate
Salaried worker gets paid by annual salary?
Wage rate can be inaccurate, since people can report higher hours
• people who don't work don't necessarily have 0 wage rate, but perhaps a wage below reservation
wage
Nonlabor income can be stuff like savings/investments
Unsure about reading household commodities, look back if it becomes relevant again
Also skipping 2-10 as well
2-11 Policy Application: Welfare Programs &
Work Incentives
Eg. Welfare program where Unmarried women
w/ children can earn 1k per month if they're
outside the labor force
As seen in 2-16, the option of the welfare program
creates 1, and only 1 extra dot option G
• G actually gives higher utlity then current budget
line, so it's worth choosing
• This type of program encourages people to drop
out of workforce, reduces work incentives
The impact of Welfare on Labor Supply
Pretty unrealistic to just give 1 option and thats it
• Typically when there's a welfare program, it
will do something like "we will take x%
amount of money from your wages if you do
enter the labor force"
• It would be like 2-17, and would create a
flatter slope after taking the G welfare
program
• Endowment point changes from E to G, since
not working at all at G offers a good benefit,
as you still get that even after work
• HG is a much better option than FE
• From P to Q, you can see that Q is clearly a better option
◦ P to Q movement is income effect, increases leisure demand
◦ Q to R is substitution effect
Welfare program reduces probability of person working & # of hrs they work
• When they also improse a "tax" on people who takes the program, reduces leisure price, reduces
working hrs
2-12 Policy Application: Earned Income Tax
Credit
Lets say there's the
following right example
(same example on 2b slide!)
The result would be 2-18
From E to J is when she can get the tax
advantage
• She can then maintain the benefit from J to H
(14k to 18k), which is why HJ is parallel to
budget line
◦ J Y axis is at 19k, because it's the point
where the benefit is at it's max (14040)
and the sum of the earnings + benefit
(19656)
◦ Same applies for H
• After 18k, the benefit slowly diminshes
by 21.06% for every dollar she earns, which is why it gradually intersects back to the budget line at
C
in 2-19c, worker can work less hours with new
policy
Overall, it increases # of workers, and changes
# of hrs worked
• Draws people into the labor force
Table 2-4 shows benefits of new policy
• Labor force participation rate went form
72.9% to 75.3%
However to verify this growth, a control group is
needed (group without new policy benefits)
• no change in this group, shows new policy
works
2-13 Labor Supply Over the Life Cycle
People can work more today to save/consume
more in the future
• Most people's wage in their life cycle has a
pattern, they start small young, get high to
50s, then decrease again
Change along worker wage's profile =
evolutionary wage change
• doesn't affect lifetime income
People's wage can be different from each other
tho
• Joe makes more, and probably consumes
more as well
• Difference in 2 wage profiles generate an
income effect?
• If income effect deomniate, Joes hrs of work
is below Jack
• If substitution effect dominiates, Joe will work
more hrs than jack
Evidence
Labour participation is high when wages are high
Labor Supply over the Business Cycle
Eg. what if a recession happens?
Added worker effect: because times are tough,
more people need to work
Discouraged worker effect: impossible to find jobs in a recession, gives up
Can find which effect dominates based on correlating labour force participation w/ aggregate
unemployment rate (summary measuring economic activity)
Should discouraged workers be considered in umemployment?
• Cuz technically if they want to be most efficient, they shouldn't find a job in such a tough time