1、Chapter 2,The Theory of Individual Labor Supply,1.The Work-Leisure Decision:Basic Model,Individuals choose between work and leisure.Work is time spent on a paying job.Leisure includes activities where one is not paid.EducationRestWork within the household,Assumptions,Indifference Curve,Leisure Hr,In
2、come/day,24,0,The indifference curve shows work and leisure combinations that yield the same amount of total utility.,More hours of leisure implies fewer hours of work.,24,0,Work Hr,Negative slope To keep the level of utility the same,if one get more leisure,some of income must be given up.Convex to
3、 originWith low hours of leisure,individuals are willing to give up a large amount of income to get 1 more leisure hour.With high hours of leisure,individuals are willing to give up a small amount of income to get 1 more leisure hour.,Indifference Curve Properties,Marginal Rate of Substitution,Leisu
4、re,Income/day,3,4,9,8,24,0,4,1,The marginal rate ofsubstitution(MRS)is the amount of income one must give up to compensate for 1 more hour if leisure.,At 3 hours of leisure(21 hours of work),one must give up 4 units of income to compensate for 1more hour of leisure.,24,0,Work,At 8 hours of leisure(1
5、6 hours of work),one must give up 1 unit of income to compensate for 1 more hour of leisure.,The MRS falls as one moves southeast along an indifference curve.,Indifference Map,Leisure,Income/day,24,0,Curves further from the origin indicate higher utility.,I1,I2,I3,L2,L1,Y2,Y1,Combination L2Y2 is pre
6、ferred to combination L1Y1 since one gets both more income and more leisure.,A person will maximize utility by getting to the highest attainable indifference curve.,Work-Leisure Preferences,Leisure,Income/day,24,0,“Leisure lovers”place a high value on leisure.The have a steep indifference curve.They
7、 are willing to sacrifice a large amount of income to get a small increase in leisure.,I1,I2,“Workaholics”place a low value on leisure.The have a flat indifference curve.They must be given a large increase in leisure to compensate for a small decrease in income.,IA,IB,Budget Constraint,Leisure,Incom
8、e/day,24,0,The budget constraint shows the combinations of income and leisure that a worker could get given a wage rate.,$120,At a wage rate of$5,a worker could get a maximum income of$120 per day($5/hour*24).,At a wage rate of$10,a worker could get a maximum income of$240 per day.,At a wage rate of
9、$15,a worker could get a maximum income of$360 per day.,$240,$360,The slope of the budget constraint iswage rate.,Utility Maximization,Leisure,Income/day,24,0,The optimal or utility maximizing point is where the budget constraint is tangent to the highest attainable indifference curve(U).,$240,I1,I2
10、,I3,16,$80,U,At U,the MRS(slope of the indifference curve)is the equal to the wage rate(slope of the budget constraint),At B,the MRS is greater than the wage rate.The individual values leisure more than the wage rate.,B,A,At A,the MRS is less than the wage rate.The individual values leisure less tha
11、n the wage rate.,Backward Bending Labor Supply Curve,Hours of Work,Wage Rate,24,0,For a given person,hours of work may increase as the wage rate rises.,8,10,$10,$25,If the wage rate rises from$10 to$25 per hour hours of work rises from 8 to 10 hours per day.,Above$25 per hour,hours of work fall.,SL,
12、The backward bending labor supply curve is the result of theincome and substitution effects of a wage change.,Income Effect The change in desired hours of work resulting from a change in income,holding the wage constant.Leisure is a normal good,so higher income implies a desire for more leisure(fewe
13、r hours of work).For a wage increase,income is raised and so the income effect lowers desired work hours.,Income Effect,Substitution Effect The change in desired hours of work resulting from a change in the wage rate,holding income constant.A higher wage rate raises the relative price of leisure.For
14、 a wage increase,the substitution effect raises desired work hours.,Substitution Effect,For Wage Increases If substitution effect income effect,then hours of work rise.If income effect substitution effect,then hours of work fall.For Wage Decreases If substitution effect income effect,then hours of w
15、ork fall.If income effect substitution effect,then hours of work rise.,Net Effect,Income and Substitution Effects,Leisure,Income/day,24,0,At a wage rate of$10/hour,the optimal hours of leisure is 16(8 hours of work)at point U1.,$240,I1,I2,16,U1,If the wage rate rises to$15/hour,the optimal hours of
16、leisure is 15 at point U2.,The income effect(IE)is measured through a parallel shift of the old budget constraint.The IE is from U1 to U2(from 16 to 17 hours of leisure).,The substitution effect(SE)is measured by movement along I2.The SE is from U2 to U2(from 17 to 15 hours of leisure).,17,15,U2,U2,
17、$360,The net effect is an increase of hours of work by 1 hour.,The substitution effect dominates at low wage rates.The MRS is low because income is scarce relative to leisure.The income effect dominates at higher wage ratesThe MRS is high because leisure is scarce relative to income.,Backward Bendin
18、g Labor Supply Rationale,The labor supply curve is slightly backward bending for men.The income effect is slightly greater than the substitution effect.The labor supply curve is positive for women.If substitution effect is greater than the income effect.Women substitute between work at home and mark
19、et work more than men.,Empirical Evidence,The elasticity of labor supply measures the responsiveness of desired hours of work to the wage rate.,Elasticity of Labor Supply,Elasticityof Labor Supply,=,If the elasticity is zero,it is perfectly inelastic.If the elasticity is negative,it is backward bend
20、ing.If the elasticity is positive and less than 1,it is relatively inelastic.If the elasticity is positive and more than 1,it is relatively elastic.,Elasticity of Labor Supply,1.Show the effect of a wage decrease on an individuals income-leisure choices.Isolate the income and substitution effects.Is
21、 the worker on the forward-rising or backward bending portion of the labor supply curve?,Questions for Thought,2.Indicate in each of the following instances whether specified events would cause a worker to want to work more or fewer hours:,(a)The wage rates rises and the substitution effect is great
22、er than the income effect.,(b)The wage rate falls and the income effect is greater than the substitution effect.,2.Applying and Extending the Model,Non-Labor Income,Leisure,Income/day,24,0,At a wage rate of$10/hour with no other income,the optimal hours of leisure is 16(8 hours of work)at point U1.,
23、If the person gets an inheritance that generates$60 a day of non-labor income,the budget constraint has a parallel shift.,The optimal hours of leisure rises to 17 at point U2.,$300,With an increase in non-labor income,only the income effect occurs and so hours work must fall.,Non-Participants,Leisur
24、e,Income/day,24,0,If a person has a low wage rate(WN is flat),higher non-labor income(NH),or steep indifference curves(I1),he is less likely to participate in the labor force(U1).,H,N,W,If a person has a high wage rate(HW),low non-labor income(0),or flat indifferencecurves(I2),she is more likely to
25、participate(U2).,I1,I2,U2,U1,W,The reservation wage is the lowest wage necessary to induce someone to work.,10,College students are less likely to participate in the labor force than other persons.Why?,Over-Employment,Leisure,Income/day,24,0,If an individual is free to choose the number of hours of
26、work,shewould choose point U1,with 18 hours of leisure and 6 hours of work.,H,N,W,U1,If the individual is constrained to work a standard workday of 8 hours or not all,she will choose point U2.,U2,16,18,At U2,her MRS is more than the wage rate and so she feels overemployed.,What is a potential soluti
27、on to her overemployment situation?,Under-Employment,Leisure,Income/day,24,0,If an individual is free to choose the number of hours of work,shewould choose point U1,with 14 hours of work and 10 hours of leisure.,H,N,W,U1,If the individual is constrained to work a standard workday of 8 hours or not a
28、ll,she will choose point U2.,U2,16,10,At U2,her MRS is less than the wage rate and so she feels underemployed.,What is a potential solution to her underemployment situation?,There are a variety of income maintenance programs such as food stamps,Medicaid,Temporary Assistance to Needy Families.We will
29、 examine the work incentives of such programs.,Income Maintenance Programs,Income Guarantee(B)Benefit received if individual/family has no earned income.Benefit Reduction Rate(t)Rate by which the benefit is reduced as income is increased.At t=.50,benefits are reduced by$.50 for every dollar earned.B
30、reak-Even Level of Income(Yb)The level of earned income at which the individual/family receives no benefit.,Income Maintenance Program Features,The actual subsidy payment S illustrates these concepts as shown below.,Benefit Example,S,=B tY,If B=$80,t=.5,earned income(Y)=$60 then.,S=$80-.5*$60=$50,Th
31、e break-even level of income formula is shown below:,Benefit Example,Yb,=B/t,If B=$80,t=.5,then Yb=$160,Income Maintenance Program,Leisure,Income/day,24,0,At a wage rate of$10/hour,the optimal hours of leisure is 16(8 hours of work)at point U1.,$240,I1,I2,16,U1,If there is a welfare program is start
32、ed with a B of$80 a day,t=.5,then Yb=$160.,The income effect(IE)is measured through a parallel shift of the old budget constraint.The IE is from U1 to U2(from 16 to 18 hours of leisure).,The substitution effect(SE)is measured by movement along I2.The SE is from U2 to U2(from 18 to 22 hours of leisur
33、e).The tax lowers the“price”of leisure.,18,22,U2,U2,In contrast to a wage change,both the IE and SE reduce desired hours of work.,$160,$80,The main elements of the 1996 Welfare Reform Act are:Two-year time limit for receiving assistance.Five-year lifetime time limit for collecting assistance.Provisions to help enforce the collection of child support payments from fathers.There has been a large red
