1. Chapter 2
Labor Supply

2. Measurement and Definition
Labor force (LF) is given by participant either employed (E) and unemployed (U), so LF = E + U.
Labor force participation rate (LFPR) = LF/P
Employment Rate (ER) = E/P
Unemployment Rate (UR) = U/LF
See attachment A.

4. Decision Individual may make a decision about Simple Model So, we need
Work or not work (binary decision)
If they work, how many working hours?
Occupation and Industry
How long to work at this job? Migration?
Simple Model
Trade off between leisure (time to rest) and consumption
leisure = total hour – working hour
work more can generate more income and can consume more
So, we need
Indifferent curve (IC)
Budget Line
Maximization of Satisfaction (utility)

5. Preferences Presented by IC between leisure and consumption Properties
Indifferent curve has negative slope
The higher IC indicates to higher level of utility..
Individual ICs cannot cross.
ICs are convex to origin. Law of diminishing marginal utility

6. Leisure
Consumption
IC1
IC2

7. IC2 IC1 Consumption Inconclusive Superior Inconclusive Inferior
Leisure
Consumption
IC1
IC2
Inconclusive
Superior
Inconclusive
Inferior

8. Slope of IC
Slope of IC
The shape of IC can show the worker’s preference about the degree of loving to work or take leisure.
This show by the slope of IC or MRS, the higher MRS (without considering the negative sign) implies to prefer leisure than consumption whereas the steeper slope of IC means to prefer consumption than leisure.
So, we can classify individual into two groups which are “workaholic” and “leisure lover”.
Important factors to determine the decision are personality, occupation, and individual circumstances.

10. Budget Constraint Decision may have limit on time and income
income = working hour x wage crate + nonlabor income
Select the best combination that maximize the utility subject to budget constraint (optimal work – leisure combination)
Slope of IC = Slope of Budget line

11. Leisure
Consumption
wT+V V T E

12. Solutions There are two type of solutions
Interior solution – decision between consumption and leisure are neither zero unit
Corner solution – either consumption or leisure are zero unit
Explanation for zero working hour
High Reservation wage rate
Very high non-labor income
Preference

13. Consumption
wT+V
w(T- l)+V P E V T l
Leisure

14. Leisure
Consumption
wT+V V T E

16. Consumption
Slope is - 4
196 P
156.8
U = 3.956
U = 3.860
100 E T
l = 9.8
Leisure

17. Change in Non-labor Income
Change in non-labor income when wage rate still constant  Change in leisure hour at wage rate constant  “Income effect”
The increasing/decreasing of non-labor income extends the possible set.
Shift the budget line (slope of budget line constant)
Some government’s program is shifting non-labor income such as pension for older, 2000Bt at April 2009
There are two possibilities
Leisure is normal good (increasing leisure, work less)
Leisure is an inferior good (reducing leisure, work more)

18. Consumption
Leisure is normal good Q C2 P C1 E T l1 l2
Leisure

19. Consumption
Leisure is inferior good C2 Q P C1 E T l2 l1
Leisure

20. Change in Wage rate
Chang in wage rate  change in working hour  change in working hour when maintain income constant  substitution effect
We need to decompose effect of changing in wage rate into substitution effect and income effect
total effect = substitution effect + income effect

21. Increasing of wage rate implies to increasing cost of leisure
If you rest more, you may have more opportunity cost due to wage rate increases.
Leisure = loss of time to work = opportunity cost
If the price of leisure increases, we have to buy less leisure.
In general, price increases  less leisure (work more)
However, if the price if extremely increases, there are possible that income effect may dominate substitution effect.

22. Leisure
Consumption T l1 C1 E P Q C2 l2

23. Decomposing Draw before and after price change situation
Keep wage rate constant (same slope) at the same level of new satisfaction (shift income to new IC)
l1  l2 is total effect
l2  l3 is substitution effect
l1  l3 is income effect

24. C2 C1 l2 l1 l3 T Q R P E Consumption Substitution Effect Dominates
Leisure

25. Consumption
Income Effect Dominates C2 Q R P C1 E l1 T
Leisure l2 l3

26. Effect Dominates There are two possible outcomes
Substitution Effect dominates Income Effect  Work More (Less Leisure) because income effect is not high enough to induce individual to rest more
Income Effect dominates Substitution Effect  Work Less (More Leisure)

27. Reservation wage rate
Theoretically, there are such a wage rate that individual is indifferent between work and rest.
We call this rate as “reservation wage”, if
Offered wage rate > reservation rate  work
Offered wage rate < reservation rate  Not
From figure, reservation wage is w2

28. Consumption w3 w2 P w1 F
IC3 E
IC2
IC1 T
Leisure

29. Individual Supply of Labor
Note Supply is a component of willing to work at specific wage rate
Utility Maximization means that willing to do at optimal point
In some case, we may find the backward shape due to the income effect dominant
Depends on MRS at each point of IC

30. Consumption w4 w3 w2 P Q w1 F
IC3 E
IC2
IC1 T
Leisure

31. Q w4 w3 P E w2 F w1 Wage rate Substitution effect < Income Effect
Working Hours

32. Fact about Labor Supply
Male  Income Effect > Sub Effect , then when wage increase  Take more leisure
Female  Sub Effect > Income Effect  Labor supply curve is steep
Because, men already work of 90% of their time, no housework, then elasticity is low
Leisure are not perfectly substituted product to work

33. Female LFPR is lower than male because the housework
Married women has elastic (highly substitutable) for leisure and work  work for money  use money for house service  full time work
They may have three choices, work in labor market, work in house, leisure
How about high education women?

34. Female reservation wage decrease  more LFP because
Fertility  Number of children and cost of children
Household production-technology change
Demand for female labor
Attitude about female work
Marital status and Stability

35. Children is normal good Rural and Urban
Increasing in income  more children
Rural and Urban
Rural families have more children than urban families
Differential female wage rate between rural and urban
Government policy about fertility
Socioeconomic
Read
Becker, Gary S “A Theory of the Allocation of Time,” The Economic Journal, September, pp

36. Estimation of Elasticity
Elasticity of Supply
The estimation equation

38. Problem of Estimation
What’s happen if there are individuals who didn’t work for long time?, so and doesn’t exist.
For this group, how do you take care of the wage rate?
How do you correctly collect the data about non-labor income?
The unit of hour of work, should it be weekly, monthly, or yearly?
Technical problem
Measurement Error
Exogeneity
Sample Selection  Heckman Selection Method

39. Policy Implication Policy in Text book (Please read your text book)
a) Labor supply of woman
b) Cash Grant
c) The Earned Income tax Credit
d) Transfer 2000 Bt.**
e) Limit working hour
f) Overtime (OT)

40. Transfer 2000 Bt.**
Note that both cases increase consumption that is an objective of government transfer program

41. Limit working hour
Consumption
wT+V F
wH*+V E V T
l =T-H*
Leisure H*

42. Overtime V T l =T-H* w**T+V w*(T-H*)+wH*+V G wT+V F E Consumption
l =T-H*
Leisure

43. Retirement Decision In case of there is no mandatory retirement age
Age at retirement depends on
Wage rate and Pension
Wage rate increase  substitution effect
Pension increase  income and substitution effects