Chapter 2 Labor Supply Its true hard work

Chapter 2 Labor Supply It’s true hard work never killed any body, but I figure, why take the chance? —Ronald Reagan

2. 1 Some stylize facts about labor supply Measuring the labor force (LF): BLS CPS l The employed—E, a worker must have been at a job with pay for at least 1 hours, or worked at least 15 hours on a non-paid job such as the family farm The unemployed—U, a worker must either be on a temporary layoff from a job, or have no job but be actively looking for work in the 4 week period prior to the reference week The population—P l

2. 1 Some stylize facts about labor supply l l LF (labor force)=E+U Labor force participation rate=LF/P The participation rate of men declined from nearly 90 percent in 1900 to 76 percent by 1990. An ever-larger fraction of men choose to retire earlier. The huge increase in the labor force participation rate of women. A sizable decline in average hours of work per week prior to 1940.

2. 1 Some stylize facts about labor supply l Employment rate=E/P l Unemployment rate=U/LF The official unemployment rate understated the real condition of unemployment. Discouraged workers, hidden unemployed.

2. 2 The worker’s preferences and budget constraints l Utility function: U=U(C, L) C—consumption of goods L—consumption of goods l Indifference curve

2. 2 The worker’s preferences and budget constraints Four important properties of indifference curve l Indifference curves are downward sloping. l Higher indifference curves indicate higher levels of utility. l Indifference curves do not intersect. l Indifference curves are convex to the origin.

2. 2 The worker’s preferences and budget constraints Marginal utility l Marginal rate of substitution in consumption l l Time constraints: T=L+h l Budget constraints: C=wh+V V—non-labor income l C=(wh+V)-w. L budget line the boundary of the worker’s opportunity set w—slope L—leisure time h—work time

2. 3 To work or not to work? The hours of work decision Reservation wage which makes her indifferent between working and not working l A higher reservation wage makes it less likely that a person will enter the labor force. In addition, for given tastes and non-labor income (that is , for given reservation wage), a person with a higher market wage is more likely to work. l Commuting costs increase the reservation wage l

2. 3 To work or not to work? The hours of work decision l Tangency condition: the slope of the indifference curve equals the slope of the budget line. l Labor supply function h*=h (w, V) l Leisure is a normal good: Non-labor income increase and hours of work (fall), reservation wage (rise) l Income effect

2. 3 To work or not to work? The hours of work decision l An interior Solution to the labor-leisure Decision

2. 3 To work or not to work? The hours of work decision Hours of work when the wage changes: An increase in the wage rate generates both income effect and substitution effect. The income effect reduces hours of work, while the substitution effect increases hours of work. l Substitution effect illustrates what happens to the optimal consumption bundle as the wage increases, holding utility constant. l

2. 3 To work or not to work? The hours of work decision The labor supply curve gives the relationship between the wage rate and hours of work. The upward-sloping segment of the curve implies that substitution effects are stronger initially; the backward-bending segment implies that income effects dominate eventually. l The relationship between hours of work and wage rates for women in U. S has a classic backwardbending shape. l Labor supply elasticity l Commuting costs and hours of work. It is unlikely that a person will want to work for just a few hours. l

2. 4 Welfare programs and work incentives A take-it-or-leave it cash grant l The newer programs often permit the welfare recipient to work, but reduce the amount of the grant by some specified amount for every dollars earned in the labor market. Taxing the welfare recipient l Welfare programs reduce labor supply, both in terms of employment probabilities and in terms of hours worked. l

2. 5 The non-market sector: household production l Much of what we call ”leisure” is really a form of work. l Women allocate more hours to the nonmarket sector than men. l Household production function l The household’s opportunity frontier l A division of labor in a houisehold

2. 5 The non-market sector: household production l Difference in the market wage rate and marginal product in the household sector l The increase in the real wage of women, technological changes in household production also reduce the difference in marginal products between husband wife.

2. 6 Estimates of the labor supply elasticity l hi=βωi+γVi+ other variable l Pwomen=aω+b. V+cwelfare+dchild+d. Whusband+ other variable Other variable includes culture factors and the institutional framework.

2. 6 Estimates of the labor supply elasticity Women participate more not because they have fewer children; rather, they have fewer children because the rising wage induces them to reduce their time in the household sector and enter the labor market. l Participation rates are very responsive to changes in the wage. Hours of work not l Most studies of female labor supply find a positive relationship between a woman’s hours of work and her wage rate. l

2. 7 Labor supply over the life cycle Present value l Lifetime utility l Marginal utility of hour leisure in second year l The ratio of marginal utilities equals the ratio of prices (wage) l A person will work few hours in those periods of the life cycle when the wage is low and will work many hours in those periods when the wage is high. l Wages is relatively low for young workers, increases as the worker matures and accumulates human capital, and then may decline slightly for older workers.

Summary The reservation wage is the wage that makes a person indifferent between working and not working. A person enters the labor market when the market wage rate exceeds the reservation wage. l Utility-maximizing workers allocate their time so that the last dollar spent on leisure activities yields the same utility as the last dollar spent on goods. l An increase in nonlabor income reduces hours of workers. l

Summary An increase in the wage generates both an income and a substitution effect among persons who work. The income effect reduces hours of work; the substitution effect increases hours of work. The labor supply curve, therefore, is upward sloping if substitution effects dominate and downward sloping if income effects dominate. l An increase in nonlabor income reduces the likelihood that a person enters the labor force. An increase in the wage increases the likelihood that a person enters the labor force. l

Summary l The labor supply elasticity is on the order of-0. 1 for men and +0. 2 for women. l Welfare programs create work disincentives because they provide cash grants to participants as well as tax those recipients who enter the labor market. In contrast, credits on earned income create work incentives and draw many nonwokers into the labor force.