Topic 7 Supply of Labor to the Economy - The Decision to Work PDF

10/13/2024 SUPPLY OF LABOR TO THE ECONOMY Trends in the Labor Force Participation Labor Economics...

10/13/2024 SUPPLY OF LABOR TO THE ECONOMY Trends in the Labor Force Participation Labor Economics Labor Force Participation Rate – percentage of a given population that either has a job or is looking for one 1. Increased labor force participation of women, especially married women As recently as 1950, less than SUPPLY OF LABOR TO THE ECONOMY: 25% of married women were in THE DECISION TO WORK the labor force, but by 1980, this percentage has doubled. The labor force participation INSTRUCTOR: rate of married women has reached over 60%, although MARIA CORAZON B. ALBAÑO since 2000, the growth for married women seems to have stopped and the rates for single women have fallen. SUPPLY OF LABOR TO THE ECONOMY SUPPLY OF LABOR TO THE ECONOMY Trends in the Labor Force Participation A Theory of the Decision to Work 2. Decrease in the participation rates of men, especially among the young and The decision to work is ultimately a decision about how to spend time the old.  The most substantial decreases in the United States have been among We shall be characterizing the decision to work as a choice between those 65 and older, from about 42% in 1950 to about half that currently – although since 1990 rates have been Working climbing a bit.  Participation rates for men of “prime Leisure or for Pay age” have declined only slightly since 1950, although among 45- to 64-year- olds, there were sharp decreases in the 1930 and 1970s. If we regard the time spent eating, sleeping, and otherwise maintaining ourselves as more  Clearly, men are starting their work or less fixed by natural laws, then the discretionary time we have (16 hours a day, say) can lives later and ending them earlier be allocated to either work or leisure. It is most convenient for us to begin our analysis of than they were in 1950. the work/leisure choice by analyzing the demand for leisure hours. SUPPLY OF LABOR TO THE ECONOMY SUPPLY OF LABOR TO THE ECONOMY OPPORTUNITY COST OF LEISURE INCOME EFFECT “What is the opportunity cost of leisure” Higher wages means workers will reduce the amount of hours they work because they can maintain a target level of income through fewer hours. Leisure The income effect is based on the simple notion that as incomes rise, holding or leisure’s opportunity cost constant, people will want to consumer more leisure Leisure Working for Pay (which means working less) We say the income effect is Using algebraic notation, we define NEGATIVE. The numerator (ΔH) The cost of spending an hour watching television is basically what one the income effect as the change in and denominator (ΔY) move in could earn if one had spent that hour working. Thus, the opportunity hours of work (ΔH) produced by a opposite directions, giving a change in income (ΔY), holding cost of an hour of leisure is equal to one’s wage rate – the extra wages constant (W): negative sign to the income effect. earnings a worker can take home from an extra hour of work. 1  10/13/2024 SUPPLY OF LABOR TO THE ECONOMY SUPPLY OF LABOR TO THE ECONOMY EXAMPLE OF INCOME EFFECT SUBSTITUTION EFFECT Higher wages means workers will give up leisure to do more hours of work because work has now a higher Leisure reward Working for Pay Receiving an Inheritance The substitution effect occurs because as the cost of leisure changes, income Receiving an inheritance offers an example of the income effect by held constant, leisure and work hours are substituted for each other. itself. The bequest enhances wealth (income) independent of the hours of work. Thus, income is increased without a change in the Using algebraic notation, we We say the substitution effect is compensation received from an hour of work. define the substitution effect as POSITIVE. The numerator (ΔH) and the change in hours of work (ΔH) denominator (ΔW) always move in In this case, the income effect induces the person to consume more induced by a change in wage the same direction, at least in leisure, thereby reducing the willingness to work. (ΔW), holding income constant theory. (Y): SUPPLY OF LABOR TO THE ECONOMY SUPPLY OF LABOR TO THE ECONOMY EXAMPLE OF SUBSTITUTION EFFECT Conserving gasoline program Working for Pay  During the 1980 presidential campaign, candidate John Anderson proposed a program aimed at conserving gasoline. His plan consisted of raising the gasoline tax but offsetting this increase by a reduced Social Security tax payable by individuals on their earnings. The idea was to raise the price of gasoline without reducing people’s overall spendable income.  For the typical worker, it would have created only a substitution effect on labor supply. Social Security Revenues are collected by a tax on earnings, so reductions in the tax are, in effect, increases in the wage rate for most workers.  For the average person, however, the increased wealth associated with this wage increase would have been exactly offset by increases in the gasoline tax. Hence, wages would have been increased while income was held more or less constant.  This program would have created a substitution effect that induced people to work more hours. SUPPLY OF LABOR TO THE ECONOMY Activity: Which is stronger, Income Effect or Substitution Effect? BOTH EFFECTS OCCUR WHEN WAGES RISE The presence of both effects working in opposite directions create ambiguity in predicting the overall labor supply response in many cases. Because the actual labor supply response is the sum of the income and substitution effects, we cannot predict the response in advance; the theory simply does not tell us which effect is stronger. Consider a case of a person who receives a wage increase  If the INCOME EFFECT is  If the SUBSTITUTION EFFECT is stronger, the person will stronger, the person will respond to a wage respond to a wage increase increase by decreasing his by increasing his or her or her labor supply labor supply 2  10/13/2024 SUPPLY OF LABOR TO THE ECONOMY ANALYSIS OF THE LABOR/LEISURE CHOICE Preferences (can be graphed!) The person’s desired hours of Let us assume that there are 2 major categories: LEISURE and MONEY INCOME work increase (substitution  Suppose a thoughtful worker was asked to decide effect dominates) when wages how happy he or she would be with a daily go up as long as wages are low income of $64 combined with 8 hours of leisure (below W*). At higher wages, (Point A). This level of happiness could be called utility level A. however, further increases result  Our worker could no doubt achieve a higher level in reduced hours of work (the of happiness if he or she could combine the 8 income effect dominates); hours of leisure with an income of $100 per day instead of just $64 a day. This higher satisfaction economists refer to such a level could be called utility level B. curve as backward-bending.  The curve connecting the dots is called an INDIFFERENCE CURVE, which connects the various combinations of money income and leisure that yield equal utility, a person is truly indifferent about where on the curve he or she will be. ANALYSIS OF THE LABOR/LEISURE CHOICE ANALYSIS OF THE LABOR/LEISURE CHOICE Specific characteristics of Indifference curves Specific characteristics of Indifference curves 1. Utility level B represents more happiness than level A. (Any curve that lies to the northeast of another one is preferred to any curve to the southwest because the northeastern curve represents a higher level of utility) 2. Indifference curves do not intersect. (If they did, the point of intersection would represent one combination of money income and leisure that yielded two different levels of satisfaction.) 3. Indifference curves are negatively sloped because if either income or leisure hours are increased, the other is reduced in order to preserve the same level of utility. ANALYSIS OF THE LABOR/LEISURE CHOICE ANALYSIS OF THE LABOR/LEISURE CHOICE Specific characteristics of Indifference curves 4. Indifference curves are convex – steeper at the left than at the right. (This shape reflects the assumption that when money income is relatively high and leisure hours are relatively few, leisure is more highly valued (and income less valued) than when leisure is abundant and income relatively scarce. 5. When income is low and leisure is abundant, income is more highly valued. (Losing income would require a huge increase in leisure for utility to remain constant. To repeat, what is relatively scarce is assumed to be more highly valued) 6. Different people have different sets of indifference curves. (People who value leisure more highly, for example, would have had indifference curves that were generally steeper. People who do not value leisure highly would have relatively flat curves) 3