Application 1: Labor supply

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Presentation transcript:

Application 1: Labor supply

Review Model of choice We know preferences and we find The two differences – net demands Buying, selling?

Geometry x2 w2 w1 x1

Three Applications 1. Labor Supply (Labor-Leisure Choice) 2. Intertemporal Choice (Consumption-Savings Choice) 3. Uncertainty (Insurance) (Consumption across states of the world)

Labor Supply Model (One day) Two “goods”: leisure time, R, and consumption, C A worker is endowed with time 24h Consumption good’s price is pc. w is the wage rate in $ New: Labor supply

Translation:

Budget set The worker’s budget constraint is where C, R denote gross demands for the consumption good and for leisure. This can be rewritten as

Budget set C 24 R

Budget set C 24 R

Quiz: Real Price Budget set depends on wage and price only through ratio Ratio is called a real wage rate Q: Real wage rate is a “price” of time in terms of $ time in terms of commodity commodity in terms of $ commodity in terms of time

Preferences C 24 R

Labor supply Curve: Definition 24

Cobb Douglass: Optimal Choice

Cobb Douglass: Labor Supply 24 R

Cobb Douglass: Labor supply

Empirical Evidence: Inelastic Backward-Bending Labor supply

Solution: overtime wage First 8 hours of work: w The following hours: w’>w w’ is an overtime wage rate

Overtime wage rate: Budget set