Labour Economics

1
Labour Economics

• Dr Hamish Low
• Lecture 2

2
Outline Labour Supply (cont)

• Explaining hours of work / participation
• Life-cycle model of labour supply
• Uncertainty
• Hours of work may affect wage rate

3
Explaining Hours of work
Increase in wage rate
y

• Substitution effect
• (relative price has changed leisure is more
  expensive)
• Income effect
• (income has increased)

B
A
A
l
H
4
Slutsky Equation
??
Hicksian Substitution Effect - ve
ve (normal good)
Need estimates of SE and IE specifically,
estimates of income elasticity of labour supply
and the compensated wage elasticity.
5
What data to use? Variation in wages across
individuals? Variation over time for the same
individual?
Two problems 1. what does it mean to say a
wage increase 2. hours of work may affect the
wage rate
6
What does it mean to say a wage increase

• Static model opportunity set has expanded.
• Life-cycle context
• wage has increased along expected trajectory
• wage is higher than expected

7
?Hours of work High IES
2.25
2
Log wage
?Hours of work Low IES
1.75
1.5
1.25
1
30
40
50
60
Age

• Choice of when to work in life-cycle reflects
  willingness and ability to substitute hours of
  work intertemporally
• There is no income effect associated with a
  movement along the wage curve

8
Implications for consumption
Are consumption and hours of work substitutes or
complements? Substitutes consumption is low
when hours of work are high (no leisure time to
enjoy earnings?) Complements consumption is
high when hours of work are high (have to spend
more to make the most of few hours of leisure!)
2.25
Log Consumption (Subst)
2
Hours of work
1.75
1.5
Log Consumption (Compl)
1.25
Log wage
1
30
40
50
60
Age
9
2.25
Actual Log consumption
Actual hours of work
2
Log wage
1.75
1.5
1.25
1
30
40
50
60
Age

• Hard to explain the downturn in hours after age
  50
• What does this imply for hours and consumption
  being substitutes?

10
Uncertainty

• unexpected changes to wages may be permanent or
  transitory
• permanent large wealth effect, small opportunity
  for intertemporal substitution
• transitory small wealth effect, large
  opportunity for intertemporal substitution
• Bushs tax cuts temporary or permanent?

11
2.25
2
1.75
Log wage
1.5
1.25
1
30
40
50
60
Age
Increase in hours associated with temporary cut
in tax rate Decrease in hours associated with
permanent tax cut
12
First-order conditions
Uncertainty means individuals want to defer
utility (precautionary reasons)
13
Precautionary Motive
So, greater uncertainty increases expected
marginal utility. This induces a shift of
resources to the future (when expected marginal
utility is high)
14
Uncertainty means work harder when young, but
also defer consumption until old.
15
Hours of work may affect the wage rate

• High wage rate when old is only realised because
  of hours worked when young
• no option to defer work until wage rises
• On-the-job learning (and depreciation when
  unemployed)
• Implications for helping get individuals back
  into labour force
• (Working Tax Credit, Earned Income Tax Credit)

16
Conclusions

• Life-cycle model of labour supply
• work when wages are high
• key parameter is Intertemporal Elasticity of
  Substitution
• need care in interpreting static estimates of
  elasticities
• Uncertainty over wages
• transitory vs permanent wage shocks
• Returns to experience
• wage is affected by hours of work / participation
  (careful in regression analysis)