CH 6. SUPPLY OF LABOR TO THE ECONOMY: THE DECISION TO WORK

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CH 6. SUPPLY OF LABOR TO THE ECONOMY THE
DECISION TO WORK

• Trends in Labor Force Participation Rates.
• In both the U.S. and other industrialized
  countries,
• womens labor force participation rates have
  increased since 1900, particularly among married
  women
• mens labor force participation rates have
  decreased since 1900, particularly among older
  men.
• Trends in hours worked per week.
• In both the U.S. and other industrialized
  countries, since 1950
• unskilled workers (high school or less) have
  reduced hours per week.
• skilled workers (college graduates) have had
  relatively stable hours per week.

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Labor Supply Theory

• Labor supply can be thought of as the inverse of
  the demand for leisure.
• When a person purchases more leisure, they work
  fewer hours.
• The price of leisure is the wage rate.
• Effect of a wage increase
• income effect holding the wage rate constant,
  an increase in income will lead a person to
  purchase more leisure (work fewer hours).
• substitution effect holding income constant, an
  increase in the wage rate will lead a person to
  substitute market goods for leisure (work more
  hours).
• net effect depends on whether income effect or
  substitution effect dominates.

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Labor Supply Theory

• Individual labor supply curve is backward
  bending.
• At low wages, substitution effect dominates.
• Eventually, income effect dominates.

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Labor Supply Theory

• Indifference Curves

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Labor Supply Theory

• Properties of indifference curves
• person is indifferent between any two points on
  a given indifference curve.
• I-curves slope down (a person is willing to give
  up leisure if compensated with additional
  income).
• I-curves are bowed toward the origin(law of
  diminishing marginal utility)
• All points above and to the right of an I-curve
  are preferred to those on an I-curve.
• All points below and to the left of an I-curve
  are less preferred to those on an I-curve.
• I-curves further from the origin are preferred to
  those close to the origin.
• I-curves never intersect (implied by D and E)

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Labor Supply Theory

• A persons willingness to substitute money for
  leisure is reflected in her indifference curve.

• How would young children affect I-cuve?
• How would improvements in home technology
  affect I-curve?

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Labor Supply Theory
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Labor Supply Theory
Utility maximization
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Labor Supply Theory

• THE DECISION TO WORK.

The person with the preferences illustrated would
choose not to work at the wage rate of
8/hour. if the wage rate was increased
sufficiently, the budget constraint would become
sufficiently steep as to induce the person to
begin working.
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Labor Supply Theory

• The reservation wage is the minimum wage rate
  at which a person would begin to work. If the
  wage rate is below the reservation wage, the
  person will not work.
• The reservation wage is given by the absolute
  value of the slope of the indifference curve at
  zero hours of work.
• A person with a steeper indifference curve has a
  higher reservation wage.
• Children
• Other sources of income

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Labor Supply Theory

• INCOME AND SUBSTITUTION EFFECTS OF A WAGE
  INCREASE.
• Income Effect Higher wealth, purchase more
  leisure (work less).
• Example of a pure income effect inheritance,
  lottery
• Substitution Effect
• Price of leisure has increased, substitute market
  goods for leisure by working more.
• Example of a pure substitution effect reduce
  tax rate on wages, but add a lump sum tax that
  keeps total tax payments constant if persons
  work hours remained unchanged.
• Net effect of a wage increase is ambiguous.

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Labor Supply Theory
Pure income effect
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• WILL THE INCOME OR SUBSTITUTION EFFECT DOMINATE?
• If number of hours working originally is small,
• IE is small and SE will be more likely to
  dominate.
• As number of hours working originally rises,
• IE larger and more likely to dominate.
• This is the source of the backward bending labor
  supply curve.
• These results help explain why womens hours
  worked per week have increased over time whereas
  mens have decreased.

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• Effect of Eliminating Social Security
• Retirement Earnings Test.
• January 2000 Retirement Earnings Test was
  eliminated for individuals age 65-69. It remains
  in effect for ages 62 through 64. A modified test
  applies for the year an individual reaches age
  65. (The Senior Citizens' Freedom To Work Act of
  2000, signed into law by President Clinton on
  April 7, 2000.)
• Prior to 2000
• One dollar in benefits withheld for every 3 in
  earnings above 17,000 year for workers aged
  65-69
• No earnings test for workers age 70 over.
• After 2000
• No earnings test for workers age 65 over.

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• Assume SS benefits10,000 year if 0 of labor
  earnings.
• No other nonlabor income.
• Up to 2500 hours of leisure/labor (50 weeks 50
  hours)
• Wage rate 20/hour
• The effects of eliminating the earnings test.

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• Income

Leisure
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Ohios unemployment insurance system.

• An applicant's "weekly benefit amount" is the
  dollar amount he/she may receive for a week of
  total unemployment.
• The "weekly benefit amount" is approximately 50
  of the applicant's average weekly wage during the
  base period.
• The "weekly benefit amount" cannot exceed the
  state's maximum payment for each dependency
  classification.
• The law allows an applicant to earn up to 20
  percent of the weekly benefit amount before
  deducting earnings from benefits. All earnings
  must be reported.

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Ohios unemployment insurance system.
Dependency Classification Number of Allowable Dependents If the applicants weekly base was was Maximum weekly benefit amount is
A 0 578 or more 289
B 1 or 2 700 or more 350
C 3 or more 778 or more 389
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Ohios unemployment insurance system.

• Example The weekly benefit amount is 100.00,
  and weekly earnings are 50.00.
• To calculate the earnings deduction
• Total earnings in week 50.00Minus earnings
  exemption(20 of 100.00) - 20.00Equals
  earnings deduction 30.00
• To calculate amount of benefits paid
• Weekly benefit amount 100.00Minus earnings
  deducted - 30.00Equals benefits amount paid
  70.00

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Ohios unemployment insurance system.

• Budget line for Ohio UI
• Assume 40 hours per week at 10/hour prior to
  unemployment
• No nonlabor income, other than UI.
• Whats budget line for UI system assuming 0
  dependents worker has opportunity to take new
  job at 10/hour?
• What hours would be irrational for a worker to
  choose if on UI?

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• Income

Leisure