Chapter Two
Labour Supply: Individual Attachment to
the Labour Market
Learning Objectives
• Define the key elements of labour force measurement employment, unemployment, labour force participation, and
hours worked - and explain how they are measured and
reported by Statistics Canada.
• Graphically illustrate how the income-leisure model reflects
the trade-offs that consumers face in deciding whether and
how much to work.
• Theoretically distinguish between the work choices made by
individuals and the economic opportunities that they choose
from.
2
Learning Objectives, cont’d
• Explain using diagrams how an increase in the wage rate
leads to offsetting income and substitution effects, and
how this yields an ambiguous effect of wage changes on
labour supply.
• Interpret the economic and other factors affecting a
married woman’s decision to work, and show how this
decision can be captured within the income-leisure
(labour supply) model.
3
Section One
The Theory of Labour Supply
To study an individual’s labour market
supply, we look at two aspects:
5
PARTICIPATION
(WHETHER TO WORK)
HOURS
(HOW MUCH TO WORK)
Labour Force Survey
• Statistics Canada conducts a monthly Labour Force Survey in which
it asks 56,000 households.
The population is divided into two groups:
1.
The potential population of labour force participants
(POP) —Civilian noninstitutional population aged 15
years and older, excluding those living in the three
territories, and Indian reserves.
2.
People too young to work (under 15 years of age) or in
institutional care or military personnel
6
Who would be counted in the labour force?
• Age Requirement: 15 years or older.
• Civilian Status: They are not in the active
military.
• Non-Institutionalized: They are not
residing in institutions such as prisons,
long-term care hospitals, mental health
facilities, or other residential institutions.
The potential population of labour
force participants is divided into
two groups:
1. People in the labour force
2. People not in the labour force
7
Labour Market Terminologies: Labour Force
and Labour Force Participation Rate
• Labour Force(LF)
• the sum of employed and unemployed workers
• Labour Force Participation Rate (LFPR)
• The fraction of the eligible population (i.e., POP) that
participates in the labour force
LFPR = LF/POP
9
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
10
The Unemployment Rate
• The unemployment rate is the percentage of the
labour force that is unemployed.
𝑼𝒏𝒆𝒎𝒑𝒍𝒐𝒚𝒎𝒆𝒏𝒕 𝒓𝒂𝒕𝒆 =
𝑵𝒖𝒎𝒃𝒆𝒓 𝒐𝒇 𝒑𝒆𝒐𝒑𝒍𝒆 𝒖𝒏𝒆𝒎𝒑𝒍𝒐𝒚𝒆𝒅
𝒍𝒂𝒃𝒐𝒖𝒓 𝒇𝒐𝒓𝒄𝒆
11
Labour Force
Concepts
(January 2020)
• LFPR=LF/POP=20.28/
31=65.4%
• UR=U/LF=1.12/20.28
=5.5%
12
Labour Force
Participation Rates by
Sex, Canada, 1901-2019
• The LF participation rates have
changed dramatically over the past
century, especially for women.
• Male participation has declined from
over 90% to a little above 70%.
13
14
15
Findings:
• The variation in overall participation is mainly due to
differences in female participation rates.
• Women seem to have higher labour force
participation rates in richer countries.
• The gap between male-female participations rates is
smaller in richer countries.
16
The figure shows that richer countries have higher female
participation rates. Why?
• Lower fertility?
Factors besides income:
• Differences in culture or attitudes to women’s market
work
As countries become richer, women’s education and job
opportunities improve, the economic roles of men and
women seem to converge.
18
Question 1
Which of the following groups of workers are considered to be
part of the labour force?
a) Full time students
b) The hard-core unemployed (i.e. individuals who have never
been employed full-time)
c) Discouraged workers
d) Members of the Canadian military
e) None of the above
19
Question 2
A labour force survey yields the following estimates:
• Working age population (i.e. POP)
• Employed
• Not working, but actively seeking work
• Full-time students
• Retired
• Not working, discouraged because of lack of jobs
• Not working, household workers
30 million
22 million
1 million
2 million
3 million
0.5 million
1.5 million
Calculate the labour force participation rate and the unemployment
rate.
20
Solution
• The labour force (LF) is calculated as the sum of the employed and the
unemployed, which in this case is 22,000,000 + 1,000,000 = 23,000,000.
• The labour force participation rate (LFPR) is calculated as the ratio of
the labour force to the working age population: 23,000,000 / 30,000,000
= 77 %.
• The unemployment rate (UR) is calculated as the ratio of the number of
unemployed workers to the size of the labour force: 1,000,000 /
23,000,000 = 4.3 %.
21
Hours
• Hours-of-work
- Hours per day, days per week, weeks per year
- It may affect the quantity and the quality of labour
supply
22
Distribution of Hours Worked Per Week by
Sex, 2019
45%
28%
23
Findings:
• Men are more likely to work 40 hours per week (typical
work pattern). The work patterns of women are varied.
45% of men work 40 hrs per week, while 28% of women
work 40 hrs per week.
• Possible reasons?
-
Higher wages for men lead to higher average hours worked.
-
Women may prefer part-time, flexible jobs to better meet family
commitments.
24
Basic Income–Leisure Model
• It represents an individual’s choice of hours worked given
opportunities and value of non-market time
• preferences and constraints
• individuals choose the feasible outcomes which yield
the highest level of satisfaction
25
Preferences
• Two “goods”
• Consumption of goods and services
• Leisure (i.e. nonlabour market activities: household work,
education, pure leisure activities, etc.).
• Represented by indifference curves
(A person is indifferent between various combinations of
consumption and leisure on an indifference curve)
26
Consumption
Consumption-Leisure Indifference Curves
(a) Indifference Curve
Review
A - willing to give up abundance
of consumption for leisure
A
|Slope| is Marginal Rate of Substitution (MRS)
𝑴𝑹𝑺𝒍,𝒄 = 𝑴𝑼𝒍/𝑴𝑼𝒄
B
0
B - willing to give up
abundance of leisure for
consumption
Leisure (time)
(non-market activity)
27
(b) The MRS of Two Different Consumers
Consumption
(goods and services)
C1Ted
C1Lisa
A
C0
Ted’s indifference curve is
steeper → Ted has a higher
valuation of leisure → requires
more compensation to
sacrifice leisure.
U0Lisa
U0Ted
0
l1
l0
Leisure (time)
(non-market activity)
28
• Preferences over all conceivable combinations of
consumption and leisure
• All combinations lie on some indifference curve
• Represented by an indifference map
30
Consumption
(c) Indifference Curve Map for an Individual
U2
U1
U0
Leisure (time)
(non-market activity)
31
Constraints
• Constraints are determined by the economic properties of
the market, which, in turn, transform consumption-leisure
to income-leisure by setting the price of consumption
• Let P=price of consumption, P×C is the value of consumption.
Assume there is no saving, P×C = total expenditure = Income
• Normalize P=$1, Consumption C = Income
• The income constraints show the combination of income
(or consumption) and leisure available to an individual.
32
Full-Time/Part-Time Choice
Working full-time
Working part-time
Working 0 hour
The number of hours worked = time endowment T – leisure time
33
(b) Typical Linear Potential Income Constraint
Income
W1T+YN
W1 High wage
W0T+YN
Slope depends on
the wage rate
W0 Low wage
YN
0
Non-labour
income
T
Leisure
Time endowment, or maximum amount of leisure available
34
(c) Nonlinear Potential Income Constraint
• Wage is not constant per hours worked.
• This would be the case for a self-employed person.
35
The Consumer’s Optimum
• Optimal combination of income and leisure
• Utility-maximizing equilibrium
- touches the highest indifference curve given the income
constraint
36
Reservation wage
The wage rate at which an
individual would be
indifferent between
participating and not
participating in the labour
force.
It is the slope of the
individual’s indifference
curve at zero hours of work
36
Describe the Consumer’s Optimum
• A useful way to describe the optimum is to compare MRS with
the Market Wage Rate
• MRS: measures the willingness to exchange leisure for
consumption (or income)
• Market Wage Rate: measures the ability to exchange leisure
for income
• MRS at zero hours of work > the market wage rate W, the
individual’s implicit value of leisure is higher than the explicit
market value of that time→ he/she will not participate
37
Case 1: Equilibrium of a Participant
Slope = -W0
U1
U2
• Market wage W0 exceeds the reservation
wage (the absolute value of the slope of RR’)
U0
• Optimum is E0
(Interior Solution)
E0
W0h0+YN
R
Slope= -WR
R’
YN
0
T
l0
h0
Leisure
39
Case 1:
• The reservation wage is the slope of the individual’s
indifference curve at zero hours of work (i.e., given by the
slope of RR’ and is the MRS at zero hours of work (where
leisure = T).
• Market wage is the slope of the income constraint (i.e. the
green line)
• RR’ is flatter than the income constraint → this individual’s
reservation wage < the market wage rate → he/she will
participate in the labour market.
39
Case 2: Equilibrium of Non-Participant
U1 U2
Slope = -W0
Income
Market wage W0 less than
the reservation wage
U0
R
Slope= -WR
YN
Optimum is E0
(Corner Solution)
E0
R’
0
T
A=E0
Leisure
40
Case 2:
• In this case, RR’ is steeper than the budget constraint at zero
hours of work.
• MRS at zero hours of work > the market wage rate, →
he/she will NOT participate the labour market.
41
Question 3
Consider the situation of a worker who is ‘at the corner equilibrium’
i.e., he or she is supplying zero hours of work and consuming 16
hours of leisure. With regards to their income-leisure framework,
which of the following statements is false?
a)
The indifference curve is steeper than the budget line
b)
The marginal rate of substitution is greater than the wage
rate in absolute value terms.
c)
The indifference curve is flatter than the budget line
d)
The rate at which the worker is willing to exchange income for
leisure is not equal to the market rate for the exchange of income
for leisure
e)
On the margin, the worker values an hour of leisure more
than she values an hour’s worth of income.
42
Question 4
Why does the budget line slope downwards and to the right?
a) Because the worker has to work in order to earn income.
b) Because the level of non-market income determines the
intercept of the budget line.
c)
Because leisure is a normal good
d) Because the worker has a time endowment, and can only
work for so many hours per time period.
e) Because both income and leisure are valued by the worker
43
Question 5
An increase in non-market income will have which of the
following effects?
a) An upward shift in the income constraint
b) A downward shift in the income constraint
c)
A clockwise rotation in the income constraint, making it
steeper
d) A counter-clockwise rotation in the income constraint,
making it flatter
e) A kink is created in the income constraint
44
Worked Example
Working Part-Time at University
• Jack and Jill attend the same University
• Weekly allowance of $100 from parents
• Market wage rate $10.00 per hour
• Assume rest and eating take 10 hours per day. For every
week, the maximum amount of leisure (i.e. time
endowment) is 98 hours (24×7-10×7=98)
• Jack and Jill value their time differently
46
Jack:
Working
Part-Time at
University
47
Jill: Study Full-Time at University
48
The Effect of an Increase in Non-Labour
Income on Labour Supply (two effects)
1. Labour Participation Effect
❑ If Leisure is a normal good:
Increase in non-labour income leads to increase in
consumption of leisure (some leave the labour market:
decrease in labour supply, and non-participants continue to
remain non-participants)
❑ If Leisure is an inferior good:
Increase in non-labour income leads to reduction of
consumption of leisure (increase in labour supply)
49
2. Hours of Work Effect
Increase in non-labour income results in a parallel outward shift
of the budget constraint
❑ Leisure, Normal good:
▪ more leisure will be consumed resulting in less work hours
❑ Leisure, Inferior good:
▪ less leisure will be consumed resulting in more work hours
49
The Effect of an Increase in Non-Labour Income on
Supply (hours of work)
Buy more leisure
Buy less leisure
50
Change in Wage Rate
Assume the wage rate increases, there are two effects:
1.
Income effect (I.E.)
▪
2.
the worker has more income to buy more goods
including leisure (reduces work hours)
Substitution effect (S.E.)
▪
individual may work more because the returns are
greater substituting away from leisure
52
Income and Substitution Effect of Wage Increase
Income
W1T + YN
W0T + YN
-W1
-W0
E’
E1
E0
U1
U0
Net effect
Income effect
0
l’
Substitution effect
l1 l0
T
Leisure
53
Effect of Wage Increase on
Participation
• The net effect depends on both substitution effect and
income effect
• If income effect dominates, hours of work may decline
• For a non-participant, an increase in wages may either
leave the equilibrium unchanged or induce the individual
to participate
54
The Effect of a Wage Increase on Participation
to a participant
The net effect depends on
both S.E. and I.E.
Here, I.E. outweighs S.E.,
→ this person works less
54
The Effect of a Wage Increase on Participation
to a Non-participant
The consumer chooses to
work at W2 but not at the
lower wage W1 and W0.
55
Individual Supply Curve
 If substitution effect dominates,
- Increase in wages leads to increase in labour supplied
-
wages continue to increase until a point where
substitution effect and income effect offset each other
 Supply curve bends backward when income effect
dominates substitution effect
56
Individual Supply Curve
The individual labour supply curve can be derived by tracing out the
labour supply choices (tangencies) in response to different wages 58
Income effects
dominates, labour
supply decreases
Substitution effects
dominate, labour
supply increases
59
Question 6
Over the backward bending portion of the labour supply
curve
a) The substitution effect of a wage change dominates the
income effect
b) Leisure becomes an inferior good
c)
The wage elasticity of labour demand is inelastic
d) There is no longer a trade-off between income and
leisure
e) The wage elasticity of labour supply is negative
59
Question 7
What would happen to an individual’s labour supply
schedule if leisure were an inferior good?
60
Answer:
• If leisure were an inferior good, there would be no
backward-bending portion of the labour supply curve,
even at high wage levels.
• This is because a wage increase would lead to both a
stronger substitution effect (working more as leisure
becomes more expensive) and a reinforcing income effect
(working more because higher income reduces the
demand for leisure).
• As a result, the labour supply curve would be consistently
upward-sloping, since higher wages would always lead to
more hours worked and less leisure consumed.
61
Empirical Evidence
Testing the Model of Labour Supply
Two Research Questions
Does labour supply behaviour conform
to the predictions of economic theory?
How responsive is labour supply to
changes in the wage?
62
63
Section Two
Extensions and Applications
Added and Discouraged Worker Effects
Discouraged worker effects
• In periods of high unemployment, people may become
discouraged from looking for work and drop out of the
labour force
Added worker effects
• In periods of high unemployment, some may enter the
labour force to supplement family income that may have
deteriorated with the unemployment of other family
members.
70
Hidden Unemployment
THE DISCOURAGED
WORKER EFFECT AND
THE PROBLEM OF
HIDDEN
UNEMPLOYMENT
“SECONDARY” OR
“MARGINAL”
WORKERS
71
• Secondary or marginal worker (vs. breadwinner, primary
worker):
- persons who have a loose attachment to the labour force, moving
in and out in response to changing economic conditions
- have other family income to rely on
- e.g. married women, teenagers
• Discourage workers are considered as hidden
unemployment.
- “Secondary” or “marginal” workers constitute a large portion of
discouraged workers
72
Moonlighting, Overtime, Flexible
Work Hours
• Why 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?
73
Fixed Hours Constraint
(e.g. work 8 hours per day and 40 hours per week)
Income Y1
Face two constraints:
• the usual budget constraint TY1
• fixed workday of T-Lc hours: one cannot
take more leisure than 0Lc.
Fixed Hours
Yc
0
C
Lc
T
Leisure
74
Underemployment &
Moonlighting
Point C: a fixed hours & income package.
Given the wage, the consumer would
choose D, working T – LD hours.
As this exceeds the available hours of work
(i.e. T – LC), he is underemployed.
Income YT
N
Yd
If a second job is available, even one paying
a lower wage, the consumer would choose
M, working T - LC on the main job, and
moonlighting on the second.
D
Ym
M
Ud
C
Yc
0
Um
Uc
Ld
Lm
Lc
T Leisure
70
Notes:
In this graph:
• Without restriction of fixed hours: the income constraint is
TYT
• With restriction of fixed hours: must be at point C
• With moonlighting: the income constraint is CN
• The moonlighting wage applies only to hours of work beyond
T-Lc.
71
Overtime and Overemployment
• Workers prefer to work fewer hours at
the going wage rate
• Workers are induced to work more
hours through an overtime premium
77
Overemployment and Overtime
Income
The consumer would prefer to
work at D, at fewer hours than
C, though C is still preferred to
not working at all (i.e. point T).
YT
C
Yc
D
Yd
Uc
0
Lc
Ld
Ud
Leisure
78 T
Overemployment and Overtime
Income
The consumer could be
induced to work more hours,
corresponding to point O, if
offered a higher wage rate
for hours worked after C.
Yd
YT
O
With overtime premium, the
income constraint is CYd
C
YO
Yc
Uo
Uc
0
Lo
Lc
T
Leisure
For overtime hours:
Overtime
Premium
• The opportunity cost of leisure increases
• The substitution effect is larger than the
income effect
80
• No!
81
Is Overtime
Premium
preferred to
Straight Line
Equivalent??
• Worker would not remain
at overtime equilibrium
• New (Straight Line)
equilibrium on a higher
utility curve
• Income effect outweighs
the substitution effect
causing the person to
supply less work
Overtime Premium versus Straight-Time
Equivalent
The income effect associated with the higher
Yd
O
wage received from the first hour worked will
lead the consumer to choose fewer hours
worked (at point S) than when the higher
(overtime premium) is paid only on hours in
excess of those at C.
S
Us
C
Uo
0
T
77
Choice in Working Hours
▪ Different groups would have different preferences for worktime arrangements
▪ Allowing workers to work desired amount of hours saves on
costs
▪ Solution: Flexible-time and compressed work week
78
Gains from Alternative Work Schedules
C - some individual are
discontent
Yt
C
D - preferred work schedule
Yf
F - willing to give up wages
for preferred work schedule
D
F
Ud
Uc
0
T
84
• Two ways of measuring
individual attachment to the
labour market (i.e.,
participation and hours)
Summary
• Use of consumer choice theory
and income-leisure model to
explain labour supply behaviour
• Reservation wage; income and
substitution effects
• Labour supply curve
• Extension of the income-leisure
model to explain moonlighting,
overtime, and flexible working
hours
85