1. CHAPTER 2: THE SUPPLY OF LABOR

2. MICROECONOMIC CONCEPT OF LABOR SUPPLY INDIVIDUAL LABOR SUPPLY

3. WORK - LEISURE DECISION: BECKER’S MODEL
Time is scarce / limited. Choice depends on either WORK or LEISURE:
How much time is allocated for work and leisure.
2 sets of information are needed to determine the optimal distribution of time between work and leisure:
Psychological information – concerning the individual’s work-leisure preferences.
Look at INDIFFERENCE CURVE
Objective market information
Look at BUDGET CONSTRAINT

4. INDIFFERENCE CURVE
Shows various combinations of REAL INCOME (y-axis) and LESURE TIME (x-axis) that yield specific level of UTILITY or SATISFACTION to the individual.
All points on the same IC represents SAME LEVEL OF SATISFACTION.
Slope of IC = Marginal rate of substitution (MRS)
Refer to my lecture in class for more details.
Features of IC:
Negative slope – negative relationship between work and leisure.
Convex to the origin. Why convex? Individual becomes increasingly reluctant to give up income as it becomes scarce.
Indifference map – number of ICs
Different work-leisure preferences (different IC for each individual)
Workaholic – willing to sacrifice an hour of leisure for SMALL increase in income.
Leisure lover – willing to sacrifice an hour of leisure for LARGE increase in income.
Utility function
U = f (Y, L) Y = income from working L = leisure

6. LEISURE LOVERS vs WORKAHOLICS

7. BUDGET CONSTRAINT
Assume: The only source of income is WORK. No borrowing, no saving.
Budget constraint = shows all various combinations of income and leisure that a worker might realize (given the wage rate)

8. UTILITY MAXIMIZATION
Maximize utility by attaining the highest possible indifference curve.
Optimal / utility maximizing combination:
BUDGET CONSTRAINT IS TANGENT TO THE HIGHEST ATTAINABLE IC.
Optimal work-leisure position:
SLOPE OF IC (MRS L,Y) = SLOPE OF BUDGET LINE (wage rate)

10. INCOME EFFECT Let say we have this situation… Same wage rate
An individual receives other income (non-labor incomes) such as dividend, transfer payment, rental collection, inheritance, etc.
Question: Does an individual work MORE or FEWER HOURS?
Answer:
More income – more budget – budget line shifts upward
More income - more satisfaction – IC shifts upward.
Different level of optimal utility maximization.
Therefore, more non-labor incomes lead to
More hours of leisure
Fewer working hours
Income effect = change in the desired hours of work resulting from a change in income (holding the wage rate constant)

11. SUBSTITUTION EFFECT Let say we have this situation…
Hours of work per day: 8
Hours of leisure per day: 16
Initial wage rate per day: RM 10
Question: What if a worker is being offered a higher wage rate (RM 15 per day)?
Answer:
Individual is prompted to work more hours – due to the offer.
More hours of work, less leisure.
Substitution effect: the change in the desired hours of work resulting from a change in the wage rate, keeping the income constant.

13. NET EFFECT If substitution effect DOMINATES income effect:
People will WORK MORE HOURS when the wage rate increases.
If income effect DOMINATES substitution effect:
People will WORK LESS HOURS even when the wage rate increases.
If income effect EQUAL to substitution effect:
No change in working hours when the wage rate increases.
Refer to my lecture in class for more details.

14. BACKWARD BENDING INDIVIDUAL SUPPLY CURVE
Normally, when wage rate increases, a labor may opt for extra working hours.
But, when the wage rate is keep increasing, both substitution effect and income effects alter the utility-maximizing position.
But beyond certain wage rate, an individual will choose to have more hours of leisure and less work – leads to BACKWARD BENDING SUPPLY CURVE.

15. NON-PARTICIPANT & RESERVATION WAGE
Those individuals who choose NOT TO TAKE PART in the labor force. Why? Probably because of
Low wage rate
Receives social security benefits
Dedicates ALL of their times for LEISURE only.
No substitution between WORK and LEISURE.
Results in REDUCTION OF MONEY INCOME but an INCREASE in LEISURE.
They will only participate in the labor force when the WAGE RATE is HIGH ENOUGH.
Reservation wage: lowest wage rate to induce an individual to work.

16. EXAMPLE: NON-PARTICIPANT
Examples of non-participant:
Full time college or universities’ students
Mother who wants to take care of preschool children
Pensioners
Etc..

17. STANDARD WORKDAY Malaysia case: 8 hours (8.00 am – 5.00 pm)
Based on government legislation.
Private sector may differ – based on the nature of the business or companies.
2 terms
Overemployment
Facing with standard workday (8 hours a day) – deny added leisure
An employee may compensate it by:
Engaging in absenteeism
Having more leisure ‘between jobs’
Underemployment
Facing with longer working hour as opposed to the standard workday. Why?
Value less leisure, love to work
Might take a second job, even though the wage rate for the 2nd job is less than the 1st job.

18. OVER-EMPLOYMENT
Facing with standard workday (8 hours a day) – deny added leisure
An employee may compensate it by:
Engaging in absenteeism
Having more leisure ‘between jobs’

19. UNDER-EMPLOYMENT
Facing with longer working hour as opposed to the standard workday. Why?
Value less leisure, love to work
Might take a second job, even though the wage rate for the 2nd job is less than the 1st job.

20. PREMIUM PAY vs STRAIGHT TIME
Does a worker receives the same wage rate regardless of number of working hours?
NO – based on the legislation, the employer needs to pay PREMIUM WAGE to workers who work for extra time.
Motivate the employees to do overtime work – more conducive

21. INCOME MAINTENANCE PROGRAM
Purpose: Provide minimum level of income to all families and individuals.
Examples (in US):
Supplementary security income
Temporary assistance for needy families
Food stamps
Medicaid
Basic features:
Income guarantee or basic benefit
Receive by individuals if they have no income
Benefit reduction rate = “implicit tax rate”
As income increases, the basic benefit is reduced.
Breakeven level of income
Income receives by an individual without any subsidy payment / if he is dropped from the income maintenance program.

22. ILLUSTRATION – INCOME MAINTENANCE PROGRAM
S = B – tY
S = actual subsidy payment
B = basic benefit
t = benefit reduction rate
Y= income
Assume an individual is working, receives US$ 500 per month as a salary.
The amount of basic benefits received is US$ 500, t = 0.2.
The actual subsidy payment (S) is: US$400
To calculate the breakeven income (when no subsidy is received):
Formula: Yb = B / t
= 500 / 0.2 = US$ 2,500
Conclusion: If this individual’s income is US$2,500, he will not receives any subsidy – drop from income maintenance program.

24. CONTROVERSY OF THE INCOME MAINTENANCE PROGRAM
Objectives:
1. reduce poverty level
2. maintain incentives to work
3. achieve 1 & 2 at reasonable cost
Issue: High cost to maintain this program. Why?
To achieve (1) – can do it by increasing the basic benefit – costly!
To achieve (2) – can do it by reducing the benefit reduction rate. Effects:
Increase net wage
Motivate non-participants to work – due to higher wage
Any examples of income maintenance program in Malaysia?