Chapter 3
Labor Force
Participation
• Review definitions:
– employed: actually holds a paid
job.
– Unemployed: no paid job but
actively seeking work.
– Out of labor force: no job and not
looking.
• LFP: labor force participation.
• Current Population Survey
(CPS): monthly survey of US
households.
Figure 3.1
• Shows LFP trend from 1950 to
1998 for entire population, then
broken down by sex.
• Overall:
• Men:
• Women:
Modeling the Decision
to Work
• Corner Solution: In some
circumstances, with a given
market wage, nonlabor income,
and set of preferences, the
utility-max hours choice will be
zero hours.
• At this corner solution:
• MRS  wage.
Reservation Wage
• Reservation wage = WR = the
wage at which the individual is
indifferent between working
and not working.
• Measure WR :
• LFP rule: mkt W  WR
Effect of Wage on LFP
• Start out of LF: WM  WR.
• As WM  it approaches WR until
it reaches WR, at which time the
person is indifferent between
working and not working.
• So:  WM   probability of
being in the LF.
• Note: this  WM causes a pure
substitution effect so result is
clear (no income effect).
More on W  and LFP
• * LFP more responsive to  W than
hours worked because LFP responds
with pure substitution effect causing
 probability of LFP, while hours
worked has both effects.
– LFP wage elasticity is greater than
hours elasticity.
• * Estimated LFP elasticities always
positive, even for men.
• If start in LF: a  W could cause
person to stop working.
Effect of Y on LFP
• As income es, the point on the
indifference curve where the optimal
point occurs es too, so the MRS is
ing. This means even with no  W,
the MRS can  so that the
comparison between W and MRS
can result in a  in LF state.
• The  Y causes the optimal point to
move up to a steeper portion of the
indifference curve where MRS is
bigger.
• Show on graph by tracking MRS at
different income levels.
Deficiencies in Formal
Labor/Leisure Model
• 1. Ignores family context
• 2. Ignores unpaid work or
nonmarket home time.
• Two trends have  importance
of these deficiencies:
• 1.  female LFP (even married)
• 2.  men’s involvement in
home work activities.
• See the Family Model.
Family or Household
Model
• Key extension: each potential
worker has 3 uses of time:
– market work
– home work
– leisure
• Decision-making unit is the
family.
• Effect of  Y on family’s time
allocation:
–  Demand for leisure, so  hours
in other two categories.
Effect of  Wage on
Labor Supply
• Assume husband and wife:
person 1 and person 2.
• If W of person 1: income and
substitution effects for this
person, plus cross-income and
cross-substitution effects for
spouse very complicated!
• *
• Key is relationship between
husband and wife’s time:
Empirical Evidence
• What do empirical studies tell
us about whether spouses’ time
are substitutes or complements
(I.e., what is sign of the crosseffects): Key is presence of
children in the household.
– No kids:
– Yes young kids:
Relate Back to LFP
Trends
• Remember: over time, male LFP 
while female LFP:
• LFP rule: choose to participate in LF
if Wmkt  WR
• Verbally: each spouse works an extra
hour for pay if Wmkt  than time in
leisure OR home work.
• Men:
• *
• *
• *
Continue
• Women: relatively low wages; few
substitutes for home-produced goods
like meals, cleaning, and childcare.
• Key Point: With a W, men mostly
moving between paid work and
leisure, while women are moving
between paid work, leisure, and
home work.
• So women have bigger substitution
effect  explains why substitution
effect more likely to dominate for
women.
Becker’s Time
Allocation Model
• Key: Final consumption goods are
what give individuals utility; These
final consumption goods can be
produced with some combination of
paid goods and home-produced
goods.
• Time is an input in this process of
producing final consumption goods.
• Final consumption goods include
true leisure activities that generate
utility.
• So: W substitute AWAY from both
home-production and time-intensive
leisure time.
More Detail on  Male
LFP
• Review male LFP trend:
• At same time: real wages grew
about 45%  Y effect has
dominated substitution effect.
• See Figure 3.5: Ageparticipation profiles:
Decompose the  Male
LFP into different age
groups
• This decline seen mostly in:
– 1) young men (ages 16-24)
– 2) prime-aged men (ages 45-64)
– 3) men at retirement age (age 65+).
• Four factors:
–
–
–
–
1)Life-cycle allocation of time
2) Social Security/Private pension plans
3) Growth in disability benefits
4) Decreased demand for low-skilled
workers.
• Some factors specific to a single
age-range; some are broader.
Life-Cycle Allocation of
Time
• More complex model required:
when I decide hours worked today, I
care about hours I hope to work in
the future as well.
• Key is time trend in wages:
– For an individual across a lifetime
• Rewards to work greatest at midlife
– Shifting average profile over time
• Economic growth causes  wages over time
for all ages (shift in entire age-wage
profiles)
Life-Cycle Effect
Broken Down by Age
• For Ages 65+: At some age,
real wages actually 
• For young men: reallocation of
time from work to school
because bulk of job growth in
high-skill jobs (called
investment in human capital)
• Why done early in life?
– Wage lower
– HK investment has more years to
get payoff.in higher wage.
Effect of Social Security
and Private Pensions
• Trend:  coverage and 
benefits for both plans.
• Effect of SS:
• SS changing over time: age is 
• Private Pensions: Two types:
– Defined Benefit:
– Defined Contribution:
Decline LFP of PrimeAged Men
• Two reasons:
– 1) growth in disability benefits
– 2)  demand for low-skilled jobs
• Disability Benefits: Part of SocSec:
SSDI; Big  # recipients and
monthly benefit.
• Demand for low-skilled jobs: hits
older workers worse since no time
for substantial HK investment. Lost
Y from not working has fallen.
• Differences by race:
– African-Americans hit harder by
disability and disproportionately
represented in low-skill jobs.
Female LFP Rates
• Remember the big increase over
time in female LFP rate:
• Percentage of total US labor force
that is female:
– *
– *
– *
• Today, more than 50% of mothers
with preschool children are in paid
LF
To Note in Figure 3.7
• Age-LF Participation profiles
for women in 3 years:
• Two major features:
– 1)  female LFP for all age
groups up to 65
– 2) ing LFP pattern for women in
childbearing years.
• Currently:: still bit of peak at
age 24, but then stays fairly
high.
6 Reasons for  Female
LFP
• 1. Rising real wages.
• 2. es in fertility patterns.
• 3. es in educational
attainment.
• 4. ing living standards.
• 5.  job opportunities.
• 6. ing social attitudes.
Details for the 6 Reasons
• Reason #1:  real wages: for
females, substitution effect is
dominant, causing  LFP.
• Reason #2: Fact: having young
children increases value of
nonmarket time.
• What has ed?
• (i) #kids per mother has
declined. Why?
Continue with #2:
• (ii) postponement of
childbirth for many women:
• *
• *
• Key: hard to establish career
while also having young
children. So some have kids
later; some have no kids at all.
– 1992 survey of female executives:
42% had no kids
continue
• Third component of changing
fertility patterns:
• More women continue to work
even when children are young
• *
• *
• One result: dramatic increase in
utilization of non-maternal child
care
Education Changes
• This is reason #3:
• Changes in Educ. Attainment:
Big increase in women getting
4-year college degree.
• Anyone with college degree:
more likely to be in paid LF;
why?
–*
–*
–*
Continue
• High divorce rates tend to 
education as means to economic
independence.
• Also: es in Field of Study:
• *
• *
• *
Reason #4: Living
Standards
• Theory:  female LFP so that
family can maintain a good
standard of living, even though:
– Male wage growth for collegeeducated workers declined in 70s
and 80s;
– For unskilled workers, real wages
actually fell.
Reason #5: Increased
Job Opportunities
• In past 50 years, “female”
jobs have experienced aboveaverage job growth.
• In 1997, over half of working
women in 6 occupations:
–
–
–
–
–
–
Administrative support
Food preparation services
Sales clerks in retail trade
Teachers
Secretaries and typists
Nurses
More on Reasons
• Also:some females moving
into previously maledominated occupations.
• *
• *
• Reason #6: Changing social
attitudes:
– If wife works, no longer conclude
that husband is a failure.
– More acceptance of child care.
All 6 Factors Related
• Not possible to know what
caused what.
• Were the rising real wages most
important?
• Did more women working
cause the shifting in social
attitudes?
• One way to disentangle
different factors is to compare
LFP trends across countries.
From Figure 3.8
• Four industrialized countries.
• Sweden similar to U.S.: big 
female LFP.
• Germany and Japan : some
fluctuation but no overall .
• Average female real wage grew
much in all four countries;
suggests other factors have
some importance too.
Japan and Germany
• Japan: decline in agriculture, a
“female” occupation.
• Germany: LFP patterns differ for
different subgroups ( young single
women;  for married women).
• Social attitudes very different:
– Japan: explicit discriminatory hiring
policies
– Germany: unlike U.S., did not use
females to combat acute labor shortage
in defense industry in WWII
Bargaining Model of
Female Labor Supply
• More institutional version of the
HH model.
• Key factor: family decisions reflect
family’s power structure: if husband
earns all money, he has all power.
• As better job market opportunities
opened up for women and social
attitudes changed, their LFP  and so
power in family shared more
equally.
LF During Recessions
• Issue: During recession, does LF
expand or contract? Two forces
work in opposite directions.
• Added Worker Effect: temporary
entrance into LF of “secondary”
workers in response to
unemployment of primary household
worker. (Due to Y effect.)
• Discouraged Worker Effect: laid
off worker leaves LF. Real LFP
decision rule is: compare WR and
expected wage, where E(W) is less
than actual WM due to low chance of
getting job. Dominant effect in
recession.