Labour Economics assignment 1
Chapter Four Labour Supply over the Life Cycle
© 2012 McGraw-Hill Ryerson Ltd.
Prepared by Dr. Amy Peng
Ryerson University
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Learning Objectives
Explain why it is misleading to compare behaviours and outcomes of different-aged individuals, concluding that the observed differences can be attributed to the pure effects of “age.”
Distinguish between the theoretical effects a temporary increase in wage and a permanent increase in wage might have on an individual’s labour supply decision.
Paraphrase, for non-specialists, factors highlighted by economists when considering the question, where do babies come from?
Describe Canada’s three-tier public and private pension system.
Explain using diagrams how changes to Canada’s public pension program can affect the age at which individuals choose to retire and how this can affect retirement incomes.
Chapter 4
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Labour Force Participation Profiles
Chapter 4
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Labour Force Participation Rates
Chapter 4
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Labour Force Participation Rates
Women
Data more complicated to interpret
Society/economic factors influence women’s participation rates
Generally shaped like men’s participation
Slower entry into labour market
Has been rising since 1971
Chapter 4
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Cohort Effect
Refers to the difficulty of separating out age from vintage (or year of birth) at a single point in time.
Best understood in the context of trying to isolate the effect of age, or time, for the evolution of a variable (not necessarily labour supply)
For women, the age-participation profiles have been shifting upward over time, as each subsequent cohort of women is more attached to the labour market than previous ones.
Chapter 4
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Dynamic Life Cycle Model
A model based on the assumption that individuals plan out their lifetime supply of labour given their expected economic environment (specifically wages and other income). Thus, the labour supply decision in any one time period is connected to the decisions made in all time periods.
Chapter 4
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Dynamic Life Cycle Model
Basic Assumptions:
preferences over consumption and leisure today and in the future
maximize utility function
optimize consumption and leisure in each period of time given expected lifetime budget constraint
Chapter 4
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Dynamic Life Cycle Model Utility Function
Using income-leisure model over life time:
u = U( C1, C2, C3,…, CN; l1 , l2 , l3 , …, lN)
Where,
u = Utility function over life time, N
C = Consumption
l = Leisure
Chapter 4
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Dynamic Life Cycle Model Income Constraint
Assume there is only two periods
Where W is wage earnings and H is life time of labour supply
Assume the interest rate is r, then the present value of the income constraint becomes
Replace Hi with li (recall H = T-l), then
Chapter 4
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Dynamic Life Cycle Model and Wage Changes
Substitution and income effects differ depending on
permanent or temporary wage change
anticipated or unanticipated wage change
Labour supply response will differ depending on the source of the wage increase
Chapter 4
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Dynamic Life Cycle Wage Changes
Chapter 4
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Household Production
Households as producers as well as consumers
The household’s allocation of its scarce time resources (pure leisure, household work and other activities to facilitate consumption)
Expanding the consumer demand analysis so that the price of a good includes the time costs of obtaining utility from it
Chapter 4
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Household Production
Basic Framework
Using conventional Utility Maximization Model:
Max. U = f(Z1, Z2, Z3 , …, Zn)
Where: Zi = gi (X1, X1, …, X1; hi),
X = market purchased goods,
h = time spent producing Z with X
“Leisure” is not a purely separate good. It is also and input in producing utility from consumption.
Chapter 4
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Household Production An example
For simplicity, assume u = f(nutrition, rest), where nutrition can be attained either through purchasing precooked food or raw food
The consumer thus has to decide how much precooked and raw food to buy, as well as how much time to spend in one of three activities: work outside the home (at wage W), leisure(rest), and food preparation (h).
Three prices may affect household productions:
Price of Leisure (W)
Price of a unit of nutrition from raw food (PR +Wd )
Price of a unit of nutrition from precooked food (PC )
Chapter 4
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Household Production An example
Chapter 4
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Comparative Statics
A decrease in the price of precooked food, PC
buy and consume more precooked food, have more leisure time , but the effect on raw food is not clear.
A decrease in the price of raw food, PR
buy and consume more raw food, have less leisure time , but the effect on precooked food is not clear.
An increase in the wage rate, W
rising wages will tilt demand away from time-intensive goods
A decrease in preparation time, d
reduce the relative price of home-cooked food, may increase leisure time or labour supply depending on the income and substitution effects.
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Fertility and Childbearing
Important in understanding women’s labour supply
Variables affecting fertility decision
income
cost of child
price of related goods
tastes and preferences
technology advances
Chapter 4
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Fertility and Childbearing
Income
Positive relationship between income and the desired number of children
Contraceptive knowledge and the cost of having children tend to be related to the income variable
Difficult to separate the pure effect of income on decision
Chapter 4
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Fertility and Childbearing
Price and Cost of Children
The demand for children is negatively related to the price or cost of having children
The main cost is income foregone by spouse
Increase in potential earnings can have both an income (positive) and substitution (negative) effect on decision to have children
Chapter 4
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Fertility and Childbearing
Price of Related Goods
Dramatic changes in private costs can impact the decision to have children
A rise in the price of complementary goods (medical, daycare, education, etc.) would reduce desired number of children
Fall in price (public subsidies) could encourage larger family sizes (e.g. public education, daycare subsidies, free or subsidized health care, family allowance, child tax credits)
Chapter 4
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Fertility and Childbearing
Tastes and Preferences
Women’s liberation movements
Family planning
Change in values
Cultural/background/religious effects
Recently encouraged smaller family size (improvement in quality vs. quantity of having children)
Chapter 4
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Retirement Decisions and Pensions
An area of increasing concern
Retirement could imply:
leaving the labour force
reducing hours worked
moving to a less difficult job
Impacts social policy
Concerns of solvency of pension funds
Chapter 4
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Retirement Decisions and Pensions
Effects of Retirement:
Private savings
Unemployment
Size of labour force
National income implications
Chapter 4
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Retirement Decisions and Pensions
Theoretical Determinants of Retirement:
Mandatory retirement age
Wealth and earnings
Health and the nature of work and the family
Public and private pension plans
Chapter 4
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Retirement Decisions and Pensions
Mandatory Retirement Age:
Compulsory Retirement Age:
Requires retirement at certain age but allows continuation of service usually on a year to year basis.
Automatic Retirement Age:
Requires retirement, no longer allowed to provide the service
Chapter 4
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Retirement Decisions and Pensions
Wealth and Earnings
Increase in Wealth: Income effect, hence more leisure
Increase in Earnings: Both income and substitution effects—the effect on leisure/retirement indeterminate
Health, the Nature of Work, and Family
Poorer Health: Induces early retirement
Hard Physical Work: Induces early retirement
Family: Two vs. one income earner effect
Chapter 4
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Canada’s Public and Private Pension
Universal Old Age Security Pension
Social Insurance: CPP/QPP
Employer-Sponsored Occupational Pension Plan
Other Arrangements:
Private savings, privately arranged pensions, RRSPs
Chapter 4
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Canada’s Public and Private Pension
Universal Old Age Security Pension
Financed by general tax revenue
Demogrant or flat amount paid to all persons over age 65
May be supplemented by means-tested “Guaranteed Income Supplement,” based on need
Chapter 4
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Canada’s Public and Private Pension
Social Insurance Pension: CPP/QPP
Financed by compulsory employee and employer contributions
Benefits related to contributions based on payroll tax applied to past earnings
Universal participation
Chapter 4
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Canada’s Public and Private Pension
Employer-Sponsored Occupational Pension Plan
Financed by employer, sometimes with employee contributions
Benefits on type of plan:
Flat benefit plan
Earning-based benefit plan
Defined-contribution plan
Chapter 4
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Formal Income-Leisure Model Application to Pension
Yp = B + W (T - l) – pW(T - l) – tW(T - l), or
Yp = B + (1 – p – t)W(T - l)
Where:
Yp = Income of a pension receiver
B = Pension
W = Wage rate
T = Time
l = leisure, thus (T - l) = hours of work
P = payroll tax rate
t =implicit tax (clawback)
Chapter 4
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Budget Constraint under Social Insurance Pensions (assume p=0)
Chapter 4
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YM
YB
EP
EO
B
T
Case a:
No Retirement Test, t = 0
(e.g. CPP/QPP)
(retirement)
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Budget Constraint under Social Insurance Pensions (assume p=0)
Chapter 4
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YM
YB
B
T
Case b:
Full Retirement, t = 100%
(retirement)
0
Y
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Budget Constraint under Social Insurance Pensions (assume p=0)
Chapter 4
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YM
YB
B
T
Case c:
Partial Retirement Test,
T=0 and then t = 50%
(retirement)
0
Y
C
D
C
d
YB
YB
T = 50%
T = 0
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Other Provisions of Pension Plans
Backloading
Early/special retirement provisions
Postponed retirement provisions
Chapter 4
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Other Provisions of Pension Plans
Backloading
Benefits get larger as seniority-based wage increases
Young workers have an incentive to stay with the firm
Older workers have an incentive not to retire too soon
Chapter 4
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Other Provisions of Pension Plans
Early/special retirement provisions:
Typically at age 55 with at least 10 years’ service
In most earning-based plans
May be unsubsidized due to reduced number of years of service compared to the normal retirement age
Special Provisions:
Typically at age 60–62 with at least 20 years of service.
Covers about 30% of earning based private pensions.
Extensively subsidized.
Chapter 4
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Other Provisions of Pension Plans
Postponed retirement provisions
Typically involves pension penalties for postponing the retirement past the retirement age.
Chapter 4
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Summary
Systematic patterns of labour supply as individuals age
Age-labour force participations of men vs. women
Life-cycle model and intertemporal labour supply
Present value of life time income
Present value of life time consumption
Household production and preferences
Non-market time
Economics of family
Retirement decision and labour supply
Chapter 4
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