Labor Supply

• Employment Rate - Gives the fraction of the population that is employed $E/P$
• Gives the fraction of the labor force participants who were unemployed (U/LF)?

  Unemployment Rate
• size of the labor force(E+U)?

  Labor Force
• gives the fraction of the population that is in the labor force (LF/P)?

  Labor Force Participation Rate
• any work that has pay, even self-employed workers are considered employed?

  Employed
• no job but looking for a job and is willing to get a job?

  Unemployed
• working age population is 15-64 years old?

  Population
• no job and they are not looking for a job?

  Out of the labor force
• Hidden employment - discouraged to find a job, should be considered as out of the labor force
• Shifts in labor force participation rates are likely to be accompanied by sizeable decline in average hours of work per week.
• Neoclassical labor-leisure choice -framework that economists typically use to analyze labor supply behavior
• Two factors that a person receives satisfaction from:

  1. consumption of goods and services
  2. consumption of leisure
• Utility function equation is given by:

  $U=$$f(C,L)$
• Indifference Curve - shows the combination of two factors that give the worker equal utility/or happiness and is therefore indifferent on different possible combinations along this curve.
• Properties of indifference curve:

  1. downward sloping
  2. higher IC indicates higher utility
  3. do not intersect
  4. convex
• Marginal Utility of Leisure (MU_L) - change in utility resulting from an additional hour devoted to leisure activities. Holding constant the amount of goods consumed.
• change in utility if the individual consumes one more dollars' worth of goods, holding constant the number of hours devoted to leisure activities?

  marginal utility of consumption
• Marginal Rate of Substitution (MRS) - measures the rate at which a person is willing to give up some leisure time in return for additional consumption, while holding utility constant.
• Ratio of Marginal Utilities - the absolute value of the slope of the IC.
• Convexity implies that the slope of an indifference curve is steeper when the worker is consuming a lot of goods and little leisure.
• The curve is flatter when the worker is consuming few goods and a lot of leisure.
• IC is different for different workers because of interpersonal differences in preferences.
• Budget Constraint - a person's consumption of goods and leisure is constrained by her time and by her income.
• Budget constrain formula is:

  $C=$$wh+$$V$
• The budget line delineates the frontier of the worker's opportunity sets, i.e., the set of all the consumption baskets that a particular worker can afford to buy.
• Optimal consumption of goods and leisure - point where the budget line is tangent to the indifference curve (interior solution)
• Equation of MRS

  $MRS =$$-MU_L/MU_C =$$-w$
• True - the MRS must equal the wage rate
• An increase in nonlabor income, holding wage constant leads to

  • a parallel upward shift in the budget line
  • expands the workers' opportunity sets
  • allows the worker to jump on a higher indifference curve
• If leisure is a normal good an additional nonlabor income increases both expenditure on consumption of goods and number of leisure hours. Length of work hours fail.
• If leisure is an inferior good an additional nonlabor income reduces demand for leisure hours, increasing the length of work hours.
• An increase in nonlabor income raises demand for leisure hours and thus reduces hours of work.
• An increase in nonlabor income, holding the wage rate constant, reduces hours of work.
• Consider a wage increase, holding income constant. Thus, the budget line will rotate around the endowment point
• Two possible outcomes on effect of a change in wage on hours of work:

  1. Increase hours of leisure (hence lower hours of work) - at the new equilibrium, the worker consumes more leisure hours so that hours of work fall.
  2. Reduce leisure hours (hence increase hours of work) - at the new equilibrium, the worker consumes less leisure hours so that hours of work increase.
• An increase in wage, holding nonlabor income constant can have two possible outcomes:

  1. Reduce hours of work (Income Effect)
  2. Increase hours of work (Substitution Effect)
• If income effect dominates (IE > SE) - decrease in hours of work generated by the income effect exceeds the increase in hours of work associated with the substitution effect. Leads to a negative relationship between wage rate and hours of work.
• If substitution effect dominates (SE > IE) - increase in hours of work generated by the substitution effect dominates the decrease in hours of work. Leads to a positive relationship between wage rate and hours of work.
• If wage rate is low, individual moves to a lower IC and becomes better off not working.
• If wage rate is high, any point on the budget line would increase utility. A person is better of working.