1. ECO370 LABOR ECONOMICS Ch2: Labor Supply Borjas textbook, Ch 2 Slides

2. INTRODUCTION TO LABOR SUPPLY Labor facts Working men: steady labor force participation at around 70 % between 2000 and 2015 Working women: rise in labor force participation from 28% in 2000 to 35% in 2015 Work hours fell from 52 to 48 hours per week between 2006 and 2015

3. MEASURING THE LABOR FORCE Household Labor Force Surveys (hLFS) in Turkey, ( The Current population survey (CPS) in the US) Labor Force = Employed + Unemployed LF = E + U Size of LF does not tell us about “intensity” of work Labor Force Participation Rate LFPR = LF/P P = civilian adult population 16 years or older not in institutions Employment: Population Ratio (percent of population that is employed) EPR = E/P Unemployment Rate UR = U/LF

4. MEASUREMENT ISSUES Labor Force measurement relies on subjectivity and likely understates the effects of a recession Hidden unemployed: persons who have left the labor force, giving up in their search for work EPR is a better measure of fluctuations in economic activity than the UR

5. FACTS OF LABOR SUPPLY More women than men work part-time More men who are high school drop outs work than women who are high school drop outs

6. WORKER PERFORMANCE Framework used to analyze labor supply behavior is the Neo-Classical Model of Labor-Leisure Choice Utility Function – measure of satisfaction that individuals receive from consumption of goods and leisure (a kind of good) U = f(C, L), where U is an index Higher U means happier person

7. INDIFFERENCE CURVES Downward sloping (indicates the trade off between consumption and leisure) Higher curves = higher utility Do not intersect Convex to the origin (indicating that opportunity costs increase)

8. INDIFFERENCE CURVES Consumption ($) 500 450 400 40,000 Utils 25,000 Utils Hours of Leisure 150 125100+

9. INDIFFERENCE CURVES DO NOT INTERSECT U0U0 U1U1 Y Z 0 Leisure Consumption ($)

10. DIFFERENCES IN PREFERENCES ACROSS WORKERS Steep and flat indifference curves: U0U0 U0U0 U1U1 U1U1 Consumption ($) Hours of Leisure

11. THE BUDGET CONSTRAINT C = wh + V Consumption equals labor earning (wages × hours) plus nonlabor income (V) Because of time, rewrite as C = w(T – L) + V Budget constraint sets boundaries on the worker’s opportunity set of all the consumption baskets the worker can afford

12. DEPICTING THE BUDGET CONSTRAINT T E V wT+V 0 Hours of Leisure Consumption ($) Budget Line

13. THE HOURS OF WORK DECISION Individual will choose consumption and leisure to maximize utility Optimal consumption is given by the point where the budget line is tangent to the indifference curve At this point the Marginal Rate of Substitution between consumption and leisure equals the wage rate Any other bundle of consumption and leisure given the budget constraint would mean the individual has less utility

14. OPTIMAL CONSUMPTION AND LEISURE $1100 $1200 A Y $500 P U1U1 $100 U0U0 U*U* E 110 40 70 0 0 Hours of Work Hours of Leisure

15. TWO EFFECTS Increase in nonlabor income allows worker to “jump” to higher indifference curve, indicating the Income Effect Leisure can be treated as a normal good or as an inferior good As wages change holding real income constant, changes in consumption-leisure bundle indicate the Substitution Effect

16. THE EFFECT OF A CHANGE IN NONLABOR INCOME ON HOURS OF WORK An increase in nonlabor income leads to a parallel, upward shift in the budget line, moving the worker from point P0 to point P1. If leisure is a normal good, hours of work fall. F1F1 P1P1 $200 U1U1 U0U0 E1E1 E0E0 P0P0 7080 110 F0F0 $100 Hours of Leisure Consumption ($)

17. THE EFFECT OF A CHANGE IN NONLABOR INCOME ON HOURS OF WORK An increase in nonlabor income leads to a parallel, upward shift in the budget line, moving the worker from point P0 to point P1. If leisure is an inferior good, hours of work increase. F1F1 P1P1 $200 U1U1 U0U0 E1E1 E0E0 P0P0 70 60 110 F0F0 $100 Consumption ($)

18. AMBIGUOUS RELATIONSHIP: HOURS WORKED AND WAGE RATES If the Substitution Effect is greater than the Income Effect, then hours of work increase when the wage rate rises If the Income Effect is greater than the Substitution Effect, then hours of work decreases when the wage rate rises.

19. MORE LEISURE AT A HIGHER WAGE When the Income Effect dominates: G U1U1 Q D D R P U0U0 V F E 8575 110 0 70 Hours of Leisure Consumption ($)

20. MORE WORK AT A HIGHER WAGE When the Substitution Effect dominates: G D D F E U1U1 Q R P U0U0 V 80 70 110 0 65 Hours of Leisure Consumption ($)

21. TO WORK OR NOT TO WORK? Are the “terms of trade” sufficiently attractive to bribe a worker to enter the labor market? Reservation wage: the minimum increase in income that would make the person indifferent between working and not working Rule 1: if the market wage is less than the reservation wage, then the person will not work Rule 2: the reservation wage increases as nonlabor income increases

22. THE RESERVATION WAGE H Y G X UHUH E U0U0 Hours of Leisure T 0 Has Slope -w high Has Slope -w  Consumption ($)

23. LABOR SUPPLY CURVE Relationship between hours worked and the wage rate At wages slightly above the reservation wage, the labor supply curve is positively sloped (the substitution effect dominates) If the income effect begins to dominate, hours of work decline as wage rates increase (a negatively sloped labor supply curve) Labor supply elasticity % change in hours worked/% change in wage rate Labor supply elasticity less than 1 means “inelastic”

24. ESTIMATES OF LABOR SUPPLY ELASTICITY When estimates are negative the income effect dominates Labor supply tends to be inelastic As time period increases, labor supply becomes more elastic Measurement error tends to overemphasize the importance of the income effect

25. LABOR SUPPLY CURVE Example of backward bending labor supply: Hours of Work 0 Wage Rate ($) 40 2030 10 20 25

26. LABOR SUPPLY OF WOMEN Substantial cross-country differences in women’s labor force participation rates Over time, women’s participation rates have increased In most studies on women, substitution effects dominate income effects

27. DERIVATION OF THE MARKET LABOR SUPPLY CURVE FROM THE SUPPLY CURVES OF INDIVIDUAL WORKERS

28. CROSS-COUNTRY RELATIONSHIP: GROWTH IN FEMALE LABOR FORCE AND THE WAGE, 1960-1980 Source: Jacob Mincer, “Intercountry Comparisons of Labor Force Trends and of Related Developments: An Overview,” Journal of Labor Economics 3 (January 1985, Part 2): S2, S6.

29. POLICY APPLICATION: WELFARE PROGRAMS AND WORK INCENTIVES Cash grants reduce wage incentives Welfare programs create work disincentives Welfare reduces supply of labor by granting nonlabor income, which raises reservation wage

30. EFFECT OF A CASH GRANT ON WORK INCENTIVES A take-it-or-leave-it cash grant of $500 per week moves the worker from point P to point G, and encourages the worker to leave the labor force. F Consumption ($) 500 Hours of Leisure 0 110 70 G U1U1 U0U0 P

31. EFFECT OF A WELFARE PROGRAM ON HOURS OF WORK Hours of Work $500 U0U0 U1U1 G E P F R Q H D D 0 110 100 70 slope = -$5 slope = -$10 Consumption ($)