Chapter 2-1 Chapter Two Labour Supply

Chapter 2-2 Chapter 2© 2007 McGraw-Hill Ryerson Ltd.2 Learning Objectives  Labour Market Attachment  Labour Force Participation  Measurement and Trends  Hours of Work  Basic Income-Leisure Model  Utility Maximizing Behaviour  Labour Supply  Factors Influencing the Supply of Labour

Chapter 2-3 Chapter 2© 2007 McGraw-Hill Ryerson Ltd.3 Learning Objectives, cont’d  Changes in the Wage Rate and the Labour Supply  Extensions and Applications  Added and Discouraged Worker Effects  Hidden Unemployment  Moonlighting, Overtime, and Flexible Hours

Chapter 2-4 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

Chapter 2-5 Chapter 2© 2007 McGraw-Hill Ryerson Ltd.5

Chapter 2-6 Figure 2.2 Labour Force Participation Rates by Sex,

Chapter 2-7 Chapter 2© 2007 McGraw-Hill Ryerson Ltd.7

Chapter 2-8 Chapter 2© 2007 McGraw-Hill Ryerson Ltd.8

Chapter 2-9 Chapter 2© 2007 McGraw-Hill Ryerson Ltd.9

Chapter 2-10 Chapter 2© 2007 McGraw-Hill Ryerson Ltd.10 Unemployment  To be considered unemployed, a person must be in one of the following three categories: 1. Without work but has made specific efforts to find a job within the previous four weeks 2. Waiting to be called back to a job from which he or she has been laid off 3. Waiting to start a new job within four weeks

Chapter 2-11 Basic Income - Leisure Model  Max U(C,L) s.t. (1) P*C=wH+v and (2) T=H+L.  The maximization with fixed endowment  The choice of hours worked given opportunities and value of nonmarket time.  preferences U and constraints (income and time)  individuals choose the feasible outcomes which yield the highest level of satisfaction

Chapter 2-12 Preferences  Two “goods”  consumption (C)  leisure (L)  Represented by indifference curves, U  Indifferent between various combinations of consumption and leisure

Chapter 2-13 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

Chapter 2-14 Figure 2.4b MRS Of Two Different Consumers Leisure 0 Consumption U10U10 U20U20 A l0l0 C0C0 l1l1 C21C21 C11C11

Chapter 2-15 Preferences  Preferences over all conceivable combinations of consumption and leisure  All combinations lie on some indifference curve  Represented by an indifference map

Chapter 2-16 Figure 2.4 c Indifference Curve Map For an Individual Leisure 0 Consumption U0U0 U1U1 U2U2

Chapter 2-17 Constraints  Constrained by economic properties of the market  Transform consumption-leisure to income-leisure by setting the price of consumption

Chapter 2-18 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

Chapter 2-19 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

Chapter 2-20 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

Chapter 2-21 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’

Chapter 2-22 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

Chapter 2-23 Figure 2.7 The Effect of an Increase in Nonlabour Income on Supply Consume more Consume less

Chapter 2-24 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

Chapter 2-25 Change in Wage Rate  Two effects  Income effect  the worker has more income to buy more goods including leisure (reduces work hours).  The effect is positive on leisure if leisure is normal, I.e., dL/dv>0.  Substitution effect  individual may work more because the returns are greater substituting away from leisure  it is negative, I.e., dL/dw<0 (where d represents “change”)

Chapter 2-26 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

Chapter 2-27 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  Other institutional constraints such as fix working hours may affect the result

Chapter 2-28 Effects of an Increase in Nonlabour Income on Participation  Opposite to wage increase  Pure income effect  May cause participants to leave the labour force (which occurs when nonlabour income is sufficiently high)  Examples include transfer payments from government (incentives are reduced)

Chapter 2-29 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

Chapter 2-30 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 labor supply 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)

Chapter 2-31 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?

Chapter Income Leisure Y1Y1 T C Lc Yc Figure 2.11 a Fixed Hours Constraint

Chapter Income Leisure C LcLc YcYc YTYT T UcUc UdUd Figure 2.11 b Underemployment D LdLd YdYd

Chapter 2-34 Overtime and Overemployment  Prefer to work fewer hours at the going wage rate  Induced to work more hours through an overtime premium

Chapter 2-35 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

Chapter 2-36 Overtime Premium  Substitution effect is larger than the income effect  Price of leisure is higher for overtime hours  Examples include medical doctors working overtime  People in safe cities often work overtime (relative to those in unsafe cities)

Chapter 2-37 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

Chapter 2-38 L 0 I UcUc T C YtYt 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

Chapter 2-39 Comparison:  No difference in utility between C and F even though F implies a lower wage rate  Allowing workers to work desired amount of hours can improve utility as long as w> T Y f line

Chapter 2-40 End of Chapter Two