© 2002 McGraw-Hill Ryerson Ltd.Chapter 2-1 Chapter Two Labour Supply: Individual Attachment to the Labour Market Created by: Erica Morrill, M.Ed Fanshawe College

© 2002 McGraw-Hill Ryerson Ltd.Chapter 2-2 Chapter Focus  Labour market attachment  Labour Force Participation Rate  Labour supply  Changes in market wage  Overtime premiums

© 2002 McGraw-Hill Ryerson Ltd.Chapter 2-3 Labour Supply  How individuals earn a living by selling labour services through the labour market.  Question:  Is labour supply an upward sloping function of the wage rate?

© 2002 McGraw-Hill Ryerson Ltd.Chapter 2-4 Quantifying Labour Market Attachment  Labour Force Participation  the decision to participate in paid labour market activities  influences the size and composition of our labour force  impacts the economy

© 2002 McGraw-Hill Ryerson Ltd.Chapter 2-5 Labour Force Participation Rate  LFPR  the fraction of the eligible population that participates in the labour force  LFPR=LF/POP  LF (Labour Force)  individuals in the eligible population who participate in labour market activities either employed or unemployed

© 2002 McGraw-Hill Ryerson Ltd.Chapter 2-6 Figure 2.2 Labour Force Participation Rates by Sex,

© 2002 McGraw-Hill Ryerson Ltd.Chapter 2-7 Hours of Work  Variety of dimensions  Institutional arrangements  Affects quantity and quality of labour supply  Short run hours appear fixed  altered by the need for flexible hours, part time and working structures

© 2002 McGraw-Hill Ryerson Ltd.Chapter 2-8 Basic Income - Leisure Model  The choice of hours worked given opportunities and value of nonmarket time.  preferences and constraints  individuals choose the feasible outcomes which yield the highest level of satisfaction

© 2002 McGraw-Hill Ryerson Ltd.Chapter 2-9 Preferences  Two “goods”  consumption  leisure  Represented by indifference curves  Indifferent between various combinations of consumption and leisure

© 2002 McGraw-Hill Ryerson Ltd.Chapter 2-10 Figure 2.4a Indifference Curve Leisure 0 Consumption B B-abundance of leisure willing to give up for consumption C-consumption and leisure are substitutable C A-abundance of consumption willing to give up for leisure A Slope - Marginal Rate of Substitution

© 2002 McGraw-Hill Ryerson Ltd.Chapter 2-11 Figure 2.4b MRS Of Two Different Consumers Leisure 0 Consumption U10U10 U20U20 A l0l0 C0C0 l1l1 C21C21 C11C11

© 2002 McGraw-Hill Ryerson Ltd.Chapter 2-12 Preferences  Preferences over all conceivable combinations of consumption and leisure  All combinations lie on some indifference curve  Represented by an indifference map

© 2002 McGraw-Hill Ryerson Ltd.Chapter 2-13 Figure 2.4 c Indifference Curve Map For an Individual Leisure 0 Consumption U0U0 U1U1 U2U2

© 2002 McGraw-Hill Ryerson Ltd.Chapter 2-14 Constraints  Constrained by economic properties of the market  Transform consumption-leisure to income-leisure by setting the price of consumption

© 2002 McGraw-Hill Ryerson Ltd.Chapter 2-15 Figure 2.5 a Simple Full-Time/Part- Time Choice Leisure 0 Income T YNYN A YNYN No Paid Work LPLP I P +Y N B IPIP Part-time LFLF I F +Y N C IFIF Full-time hPhP hFhF

© 2002 McGraw-Hill Ryerson Ltd.Chapter 2-16 Leisure 0T Income W 1 High wage W 0 Low wage Figure2.5 b Linear Potential Income Constraint W 1 T+Y N W 0 T+Y N YNYN Slope depends on Individual’s wage rate

© 2002 McGraw-Hill Ryerson Ltd.Chapter 2-17 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 time for income  Market Wage Rate - measures the ability to exchange leisure for income

© 2002 McGraw-Hill Ryerson Ltd.Chapter 2-18 Leisure 0 Income U1U1 U0U0 Figure 2.6 a Equilibrium of Nonparticipant R Market Wage less than the reservation wage T Slope=-W 0 U2U2 YNYN A=E 0 Corner Solution Slope= -W R R R’

© 2002 McGraw-Hill Ryerson Ltd.Chapter 2-19 Figure 2.6 b Equilibrium of a Participant Leisure 0 Income Market wage exceeds the reservation wage T R R’ YNYN Indifference curve tangent To budget constraint U1U1 U2U2 U0U0 l0l0 W 0 h 0 +Y N E0E0 Interior Solution

© 2002 McGraw-Hill Ryerson Ltd.Chapter 2-20 Figure 2.7 The Effect of an Increase in Nonlabour Income on Supply Consume more Consume less

© 2002 McGraw-Hill Ryerson Ltd.Chapter 2-21 The Effect of an Increase in Nonlabour Income on Labour Supply  Normal goods  income leads to  consumption of leisure (decrease in labour supply)  Inferior goods  income leads to  consumption of leisure (increase in labour supply)

© 2002 McGraw-Hill Ryerson Ltd.Chapter 2-22 Effect of Non-labour Income on Hours of Work   in nonlabour income results in a parallel shift outward of the budget constraint  normal good-if leisure is a normal good more will be consumed resulting in less work hours  inferior good- if leisure is an inferior good less will be consumed and more work hours are spent

© 2002 McGraw-Hill Ryerson Ltd.Chapter 2-23 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

© 2002 McGraw-Hill Ryerson Ltd.Chapter 2-24 E0E0 leisure 0 Income U0U0 T -W 0 Figure 2.8 Income and Substitution Effect of Wage Increase l0l0 E’ l’ Substitution effect Income effect Net effect W 0 T=Y N W 1 T=Y N l1l1 U1U1 E1E1 -W 1

© 2002 McGraw-Hill Ryerson Ltd.Chapter 2-25 Effect of Wage Increase on Participation  Both substitution effect and income effect  If income effect dominates hours of work may decline (not withdraw )  For a nonparticipant an  W may leave the equilibrium unchanged or induce the individual to participate

© 2002 McGraw-Hill Ryerson Ltd.Chapter 2-26 Effects of an Increase in Nonlabour Income on Participation  Opposite to wage increase  Pure income effect  May cause participants to leave the labour force

© 2002 McGraw-Hill Ryerson Ltd.Chapter 2-27 Individual Supply Curve  Substitution effect > income effect   wage leads to  labour supplied  As wages continue to    there is a point where substitution effect and income effect offset each other  Supply curve bends backward when income effect > substitution effect

© 2002 McGraw-Hill Ryerson Ltd.Chapter 2-28 Elasticity of Labour Supply  Responsiveness of labour supply to changes in the wage rate  Uncompensated elasticity  % change in labour supply from a 1% increase in wage (indeterminate)  Income elasticity  % change in wages from a 1% increase in nonlabour income (negative)  Compensated elasticity  % increase in labour supply from a 1% increase in wage after compensating for increased income (positive)

© 2002 McGraw-Hill Ryerson Ltd.Chapter 2-29 Added and Discouraged Worker  Discouraged worker- in high unemployment drop out of the labour force  Hidden Unemployment- unemployment underestimated due to amount of discouraged workers not counted  Added worker- enter the labour force to supplement family income in high unemployment

© 2002 McGraw-Hill Ryerson Ltd.Chapter 2-30 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?

© 2002 McGraw-Hill Ryerson Ltd.Chapter Income Leisure Y1Y1 T C Lc Yc Figure 2.11 a Fixed Hours Constraint

© 2002 McGraw-Hill Ryerson Ltd.Chapter Income Leisure C LcLc YcYc YTYT T UcUc UdUd Figure 2.11 b Underemployment D LdLd YdYd

© 2002 McGraw-Hill Ryerson Ltd.Chapter 2-33 Overtime and Overemployment  Prefer to work fewer hours at the going wage rate  Induced to work more hours through an overtime premium

© 2002 McGraw-Hill Ryerson Ltd.Chapter 2-34 YtYt YtYt Figure 2.12 Overemployment and Overtime 0 I TtTt L 0 I udud UcUc L T YoYo C UcUc UdUd LcLc C YcYc LdLd D YdYd O

© 2002 McGraw-Hill Ryerson Ltd.Chapter 2-35 Overtime Premium  Substitution effect is larger than the income effect  Price of leisure is higher for overtime hours

© 2002 McGraw-Hill Ryerson Ltd.Chapter 2-36 Overtime Premium vs Straight Line Equivalent  worker would not remain at overtime equilibrium  New equilibrium on a higher utility curve  Income effect outweighs the substitution effect causing the person to supply less work

© 2002 McGraw-Hill Ryerson Ltd.Chapter 2-37 Choice in Working Hours  Changing work force  Different groups with different preferences for work-time arrangements  two thirds of the work force was discontent with work-time arrangements

© 2002 McGraw-Hill Ryerson Ltd.Chapter 2-38 L 0 I UcUc T C YtYt Figure 2.14 Gains for Alternative Work Schedules F YfYf F- willing to give up wages for preferred work schedule C-some individual are discontent UdUd D D- preferred work schedule

© 2002 McGraw-Hill Ryerson Ltd.Chapter 2-39 Solution  No difference in utility between C and F even though F implies a lower wage rate  Allowing workers to work desired amount of hours saves on costs  Flex-time  Compressed work week

© 2002 McGraw-Hill Ryerson Ltd.Chapter 2-40 End of Chapter Two