EC306 Labour Economics
• Chapter 2#• Labour Supply
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Chapter objectives • Terminology/measurement#• Review consumer choice theory#• Basic model of labour supply (individuals)#
– Intensive and extensive margins#• Income and substitution effects#• Extensions and applications
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Labour Force • LF (Labour Force)
– Individuals in the eligible population (15 years and older) who participate in labour market activities, either employed or unemployed
• LFPR – The fraction of the eligible population that
participates in the labour force – LFPR = LF/POP
3
4
5
0
10
20
30
40
50
60
70
80
90
100
1976 1980 1984 1988 1992 1996 2000 2004 2008
Part
icip
atio
n R
ate Men 25-54 Men 55+
Women 25-54 Women 55+
Source: Labour Force Survey, Cansim Table 282-0002, using estat.
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7
8
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Unemployment
• To be considered unemployed, a person must be in one of the following three categories:
• Without work but has made specific efforts to find a job within the previous four weeks
• Waiting to be called back to a job from which he or she has been laid off
• Waiting to start a new job within four weeks
Employment and unemployment rates
• UR = U/LF
• ER=E/POP. ( working age )
10
0
2
4
6
8
10
12
1976 1980 1984 1988 1992 1996 2000 2004 2008
Une
mpl
oym
ent R
ate
Men 25-54 Women 25-54
Source: Labour Force Survey, Cansim Table 282-0002, using estat.
Review: Consumer choice
12 X
Y M=PxX+PyY
Yes, you need to do the math...
Review:consumer choice theory
• Slope of budget constraint
• Slope of indifference curve
• Diminishing marginal rate of substitution
• Solve the utility maximization problem - review derivatives if necessary
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Example
Review: consumer choice theory
• Substitution effects - changes in relative prices
• Income effects - overall ability to purchase goods
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• The choice of hours worked given opportunities and value of non-market time – preferences and constraints – individuals choose the feasible outcomes
which yield the highest level of satisfaction
Basic Income–Leisure Model
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• Two “goods” – consumption – leisure
• Represented by indifference curves (A person is indifferent between various combinations of consumption and leisure on an indifference curve)
Preferences
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Indifference Curve
Leisure 0
Con
sum
ptio
n
Slope - Marginal Rate of Substitution
A. Willing to give up an abundance of consumption for leisure
B. Willing to give up an abundance of leisure for
consumption
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• Constrained are determined by the economic properties of the market, which, in turn, transform consumption-leisure to income-leisure by setting the price of consumption
Constraints
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Relationship between Wages, Earnings, Compensation, and Income
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Leisure
0 T
Income
W1 High wage
W0 Low wage
Linear Potential Income Constraint
W1T+YN
W0T+YN
YN
Slope depends on #the wage rate
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The Consumer’s Optimum
• Optimal amount of income and leisure • Utility-maximizing equilibrium
– highest indifference curve given the income constraint • Compare MRS with the Market Wage Rate
– MRS: measures the willingness to exchange leisure for consumption (or income)
– Market Wage Rate: measures the ability to exchange leisure for income
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Equilibrium of a participant
Leisure 0 T
Income
W0T+YN
YN
Interior solution: market wage exceeds reservation wage
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Equilibrium of a non-participant
Leisure 0 T
Income
W0T+YN
YN
Corner solution: reservation wage exceeds market wage
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Reservation wage of a participant
Leisure 0 T
Income
W0T+YN
YN
Interior solution: market wage exceeds reservation wage
The utility maximization problem
• Given all prices (consumer goods and leisure), choose the feasible amount of consumption and leisure that maximizes your utility
• Yes, you need to do the math
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Example
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The Effect of an Increase in Non-Labour Income on Labour Supply (two effects)
1. Labour Participation Effect If Leisure is a normal good:
Increase in non-labour income leads to increase in consumption of leisure (some leave the labour market: decrease in labour supply, and non-participants continue to remain non-participants)
If Leisure is an inferior good: Increase in non-labour income leads to reduction of
consumption of leisure (increase in labour supply)
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Effect of Non-Labour Income on Labour Supply
2. Hours of Work Effect #Increase in non-labour income results in a
parallel outward shift of the budget constraint – Leisure, Normal good:
• more leisure will be consumed resulting in less work hours
– Leisure, Inferior good: • less leisure will be consumed resulting in more
work hours
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The Effect of an Increase in Non-Labour Income on Supply (hours of work)
Consume more leisure Consume less
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Change in Wage Rate
Two effects: 1. Income effect
– the worker has more income to buy more goods including leisure (reduces work hours)
2. Substitution effect – individual may work more because the returns are
greater substituting away from leisure
32 Leisure
0 T
Income
Income and substitution effects for increase in wage.
W1T+YN
W0T+YN
YN
A B
C
Find substitution effects first
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Effect of Wage Increase on Participation
• The net effect depends on both substitution effect and income effect
• If income effect dominates, hours of work may decline
• For a non-participant an ↑ W may leave the equilibrium unchanged or induce the individual to participate
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Individual Supply Curve
• If substitution effect dominates, "– ↑ wage leads to ↑ labour supplied – wages continue to ↑ until a point where
substitution effect and income effect offset each other#
• Supply curve bends backward when income effect dominates substitution effect
Deriving the individual supply curve
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Deriving the individual supply curve
Deriving the individual supply curve
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Extensions and Applications of the Model
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Moonlighting, Overtime, Flexible Work Hours
• Why do some people moonlight at a second job at a wage less than their market wage on their first job?
• Why do some people require an overtime premium to work more?
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Fixed hours constraints
Leisure 0 T
Income
W0T+YN
YN
Fixed hours constraints lead to moonlighting (B)
A
B
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Overtime and Overemployment
• Workers prefer to work fewer hours at the going wage rate
• Workers are induced to work more hours through an overtime premium
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Overtime
Leisure 0 T
Income
W0T+YN
YN
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Overtime Premium
• Substitution effect is larger than the income effect
• Price of leisure is higher for overtime hours
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Is Overtime Premium preferred to Straight Line Equivalent? Why?
• No! Because: • Worker would not remain at overtime
equilibrium • New (Straight Line) equilibrium on a higher
utility curve • Income effect outweighs the substitution effect
causing the person to supply less work
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Choice in Working Hours
• Changing work force • Different groups with different
preferences for work-time arrangements • 1985: two-thirds of the work force was
discontent with work-time arrangements
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Gains from Alternative Work Schedules
Leisure 0 T
Income
W0T+YN
YN
A
B
C
C. Willing to accept lower wage for preferred work schedule
A. Constrained B. Preferred
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Solution
• No difference in utility between A and C even though C implies a lower wage rate
• Allowing workers to work desired amount of hours saves on costs
• Flex-time • Compressed work week
Reading and references • Required #
– BGLR Ch. 2#• Suggested#
– Guide to the Labour Force Survey 2011(http://www.statcan.gc.ca/pub/71-543-g/71-543-g2011001-eng.htm )#
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