Economics 324: Labor Economics
1. For next time, please read Angrist & Evans (AER, 1998)
2.
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For the answer to a question which came up in class last time, see the last bullet point
below. It seems that UI (unemployment insurance) is indeed taxed as regular income.
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Benefits
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* In general, benefits are based on a percentage of an individual's earnings over a
recent 52-week period - up to a State maximum amount.
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* Benefits can be paid for a maximum of 26 weeks in most States.
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* Additional weeks of benefits may be available during times of high unemployment
(see Extended Benefits). Some States provide additional benefits for specific purposes.
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* Benefits are subject to Federal income taxes and must be reported on your
Federal income tax return. You may elect to have the tax withheld by the State
Unemployment Insurance agency.
Source: http://www.workforcesecurity.doleta.gov/unemploy/uifactsheet.asp
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Changing Non-labor Income
• What happens to hours of work when we change V?
– Shock =  V due to bigger dividends, beneficiary in a will, bigger
unemployment insurance check, etc.
• Wage is held constant
• Leisure could be normal or inferior good
• Income effect = impact on the D for leisure of a change in non-labor income,
holding the wage constant
(L/ V) |w > 0 or equivalently, (h/ V) |w < 0 ,
if Leisure is a normal good (which we will assume)
• How does  V affect the reservation wage?
• 2 effects of  V : (1) lowers the probability of working (WRES)
(2) decreases hours worked, if you work
Changing the Wage Rate
• What happens to hours of work when we change w ?
– Shock = w due to a raise at work, perhaps
• Non-labor income (V) is held constant
• Total effect is ambiguous
– Two competing effects
(1) Income effect: higher w  greater purch power  demand more L
(2) Substitution effect: higher w  higher Pleisure  demand less L
• Isolating the Substitution effect:
– Draw the new budget line. Move this new budget line parallel to itself
until it is tangent to the old IC (at point Y)
SE = (L/ w) |U,V < 0
• Isolating the Income effect:
– Draw a new IC tangent to the new budget line at some point.
Individual’s Labor Supply Curve
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Backward-bending Labor Supply curve
(h/ w) |V > 0  SE > IE
(h/ w) |V < 0  SE < IE
SE dominates initially, but IE is stronger
eventually
Empirically, data shows that female
labor supply is backward-bending, while
men generally have a positive slope,
with a short vertical range ($10-20/hour)
Commuting costs and labor supply
curve
– Won’t work 1 hour per week
– Enter LF at h* hours (say 20)
IE > SE
w
SE > IE
Wreservation
0
h*
Hours of work
Which Effect Dominates?
• The size of the income effect
depends on where you start
• bigger at point A than B
• Z is the extreme, IE = 0
C
• Empirically:
Cross-sectional data reveals that
IE and SE are small for men
(estimates for women are
complicated by child care and
household work)
A
B
Z
0
Leisure
Optimal Labor-Leisure Choice example
C
U=?
• Suppose Jack’s utility function is given
by U = L C
(wT+V)
• Find the demand function for leisure
hours, L* = L (w, V, T)
• Assuming  = ¾,  = ¼, V = 0, T = 400 C* = ?
and w = $4 what are the initial optimal
values?
V
• Now suppose welfare program passed
giving $200 of income if you don’t work
at all. As you earn income benefits are
L* = ?
0
scaled back $0.20 per dollar earned.
h* = ?
• What is the break-even point and what
h L
are the effects on labor supply?
Initial
• Decompose, graphically and numerically,
the change in demand due to the subsidy
subsidy
and tax into the substitution and income
Tax: SE
effects.
Tax: IE
• What if U = L¼ C¾ ?
E0
T Leisure
Work
C
U
Labor Supply Elasticity
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Definition
Consensus estimate for prime-aged men is -0.1
+.1 for SE, -.2 for IE
When estimates are negative the income effect dominates
Labor supply for men tends to be inelastic
As time period increases, labor supply becomes more elastic
• Why so many elasticity estimates?
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Measurement error (Whipple effect for hours of work)
tends to overemphasize the importance of the income effect
relevant marginal wage rate for salaried workers
sample selection bias
Nonlabor income
Labor supply of women
• Substantial cross-country differences in women’s labor
force participation rates
• Over time, women’s participation rates have increased
• In most studies on women, substitution effects dominate
income effects
• Reverse causality -- Angrist & Evans (AER, 1998)
Cross-Country Relationship Between Growth in Female Labor Force and the
Wage, 1960-1980
7
Netherlands
Female Participation
Growth Rate of
6
5
A us tralia
J apan
4
Italy
3
S weden
USS R
Is rael
B ritain
S pain
2
Franc e
Germany
1
United States
0
1
2
3
4
5
6
7
8
9
Perc entage Change in Wage
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Source: Jacob Mincer, “Intercountry Comparisons of Labor Force Trends and of Related Developments: An Overview,” Journal of Labor Economics 3 (January
1985, Part 2): S2, S6.