CHAPTER 2 THE SUPPLY OF LABOR MICROECONOMIC CONCEPT
+ CHAPTER 2: THE SUPPLY OF LABOR
+ MICROECONOMIC CONCEPT OF LABOR SUPPLY INDIVIDUAL LABOR SUPPLY
+ 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: 1. Psychological information – concerning the individual’s work-leisure preferences. • Look at INDIFFERENCE CURVE 2. Objective market information • Look at BUDGET CONSTRAINT
+ 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: 1. Negative slope – negative relationship between work and leisure. 2. Convex to the origin. Why convex? Individual becomes increasingly reluctant to give up income as it becomes scarce. 3. Indifference map – number of ICs 4. 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
+ LEISURE LOVERS vs WORKAHOLICS
+ 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)
+ 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)
+ 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)
+ 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.
+ 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.
+ 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.
+ NON-PARTICIPANT & RESERVATION WAGE Non-participant: • 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.
+ EXAMPLE: NON-PARTICIPANT Examples of non-participant: • Full time college or universities’ students • Mother who wants to take care of preschool children • Pensioners • Etc. .
+ 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 2 nd job is less than the 1 st job.
+ 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’
+ 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 2 nd job is less than the 1 st job.
+ 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
+ INCOME MAINTENANCE PROGRAM Purpose: Provide minimum level of income to all families and individuals. Examples (in US): 1. Supplementary security income 2. Temporary assistance for needy families 3. Food stamps 4. Medicaid Basic features: 1. Income guarantee or basic benefit • Receive by individuals if they have no income 2. Benefit reduction rate = “implicit tax rate” • As income increases, the basic benefit is reduced. 3. Breakeven level of income • Income receives by an individual without any subsidy payment / if he is dropped from the income maintenance program.
+ ILLUSTRATION – INCOME MAINTENANCE PROGRAM S = B – t. Y 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.
+ 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?
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