Labour Economics assignment 1
zaleel503
Chapter02.pptxChapter Two Labour Supply: Individual Attachment to the Labour Market
© 2012 McGraw-Hill Ryerson Ltd.
Prepared by Dr. Amy Peng
Ryerson University
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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.
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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.
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Section One
The Theory of Labour Supply
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Labour Market Terminologies: Labour Force and Labour Force Participation Rate
LF (Labour Force)
Individuals in the eligible population (15 years and older) who participate in labour market activities, either employed or unemployed
LFPR
The fraction of the eligible population that participates in the labour force
LFPR = LF/POP
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Unemployment
To be considered unemployed, a person must be in one of the following three categories:
Without work but has made specific efforts to find a job within the previous four weeks
Waiting to be called back to a job from which he or she has been laid off
Waiting to start a new job within four weeks
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Labour Force Concept
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Hours
Hours-of-work
Hours per day, days per week, weeks per year
It may affect the quantity and the quality of labour supply
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Distribution of Hours Worked Per Week by Sex, January 2011
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Basic Income–Leisure Model
The 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
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Preferences
Two “goods”
consumption
leisure
Represented by indifference curves
(A person is indifferent between various combinations of consumption and leisure on an indifference curve)
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B
B - willing to give up abundance of leisure for consumption
Indifference Curve
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Leisure
0
Consumption
A
A - willing to give up abundance of consumption for leisure
Slope - Marginal Rate of Substitution
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Preferences
Preferences over all conceivable combinations of consumption and leisure
All combinations lie on some indifference curve
Represented by an indifference map
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Indifference Curve Map for an Individual
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Leisure (time) (non-market activity)
Consumption
U0
U1
U2
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Constraints
Constrained are determined by the economic properties of the market, which, in turn, transform consumption-leisure to income-leisure by setting the price of consumption
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Linear Potential Income Constraint
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Leisure
0
T
Income
W1 High wage
W0 Low wage
W1T+YN
W0T+YN
YN
Slope depends on
the wage rate
Non-labour income
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The Consumer’s Optimum
Optimal amount of income and leisure
Utility-maximizing equilibrium
highest indifference curve given the income constraint
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
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Equilibrium of a Participant
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Leisure
0
Income
Market wage exceeds the
reservation wage
T
R
R’
YN
Indifference curve tangent to budget constraint
U1
U2
U0
l0
W0h0+YN
E0
Interior Solution
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Equilibrium of Non-Participant
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Leisure
0
Income
U1
U0
Market wage less than
the reservation wage
T
Slope = -W0
U2
YN
A=E0
Corner Solution
Slope= -WR
R
R’
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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)
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Effect of Non-Labour Income on Labour Supply
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
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The Effect of an Increase in Non-Labour Income on Supply (hours of work)
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Buy more leisure
Buy less leisure
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Change in Wage Rate
Two effects:
Income effect
the worker has more income to buy more goods including leisure (reduces work hours)
Substitution effect
individual may work more because the returns are greater substituting away from leisure
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Income and Substitution Effect of Wage Increase
E0
Leisure
0
Income
U0
T
-W0
l0
E’
l’
Substitution effect
Income effect
Net effect
W0T + YN
W1T + YN
l1
U1
E1
-W1
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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 leave the equilibrium unchanged or induce the individual to participate
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The Effect of a Wage Increase on Participation to a Non-participate
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The consumer choose to work at W2 but not the lower wage W1 and W0.
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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
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Substitution effects dominate, labour supply increases
Income effects dominates, labour supply decreases
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Empirical Evidence
Participation, married women
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Empirical Evidence
Evidence of the Elasticity of Labour Supply
Uncompensated elasticity
Compensated elasticity
Income elasticity
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Section Two
Extensions and Applications
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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.
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Hidden Unemployment
The discouraged worker effect and the problem of hidden unemployment
“Secondary” or “marginal” workers
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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?
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Fixed Hours Constraint
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0
Income
Leisure
Y1
T
C
Lc
Yc
Fixed Hours
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Underemployment and Moonlighting
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0
Income
Leisure
C
Lc
Yc
YT
T
Uc
Ud
D
Yd
Given the wage,
the consumer would rather
choose D, working T - LD
hours. As this exceeds the
available hours of work, the
consumer is underemployed.
Ld
Um
M
Ym
If a second job is available, even one paying a lower wage, the consumer may choose M,
working T - LC on the main
job, and moonlighting on the
second.
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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
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Overemployment and Overtime
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Income
Leisure
C
Lc
Yc
YT
T
Uc
Ud
D
Yd
The consumer would prefer to work at D, at fewer hours than C, though C is still preferred to
not working at all.
Ld
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Overemployment and Overtime
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0
Income
Leisure
C
Lc
Yc
T
Uc
Uo
O
YO
The consumer could be
induced to work more hours,
corresponding to point O, if
offered a higher wage rate
for hours worked after C.
Lo
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Overtime Premium
Substitution effect is larger than the income effect
Price of leisure is higher for overtime hours
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Is Overtime Premium preferred to Straight Line Equivalent?
No!
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
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Overtime Premium versus Straight-Time Equivalent
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0
Y0
C
Y1
T
Uo
Us
The income effect associated with the higher wage received from the first hour worked will lead the consumer to choose fewer hours worked (at S) than
when the higher (overtime premium) is paid only on hours in excess of those at C.
O
S
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Choice in Working Hours
Different groups with different preferences for work-time arrangements
Allowing workers to work desired amount of hours saves on costs
Flex-time and compressed work week
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Gains from Alternative Work Schedules
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0
Uc
T
C
Yt
Yf
F - willing to give up wages
for preferred work schedule
C - some individual are
discontent
Ud
D
D - preferred work schedule
F
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Summary
Two ways of measuring individual attachment to the labour market
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
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