chap16.pdf - Lecture notes on labor supply

# Chap16- - Labor Supply Labor supply is an application of the model of individual choice Individual chooses between consumption(C and hours of

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1 1 Labor Supply Labor Supply Labor supply is an application of the model of individual choice Individual chooses between consumption (C) and hours of leisure (H), where H is hours spent not working C and H are composite goods - C reflects utility gain by consuming a variety of goods and services - H reflects all nonmarket uses of time A composite commodity is a bundle of goods for which prices vary proportionately - the goods can be lumped together and treated as a single commodity - Individual allocates funds to consumption and leisure activities and then makes choices within these categories 2 Utility Is Maximized Subject to Two Utility Is Maximized Subject to Two Constraints Constraints Time constraint H + L = T, where T is total amount of available time and L is hours of labor (work) Budget constraint C = wL + N, where wL is earnings and N is nonwage income (transfers, gifts, interest income)

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2 3 Budget and Time Constraints Are Budget and Time Constraints Are Combined into Full Income Combined into Full Income Constraint Constraint Substituting the time constraint into the budget constraint, we have C = w(T-H) + N Full income constraint: C + wH = Tw + N LHS shows prices times quantities (the price of C is normalized to 1) RHS shows the total resources available (endowment), if individual worked fulltime Opportunity cost of H is w: for each hour of leisure, the individual foregoes w in wages 4 Labor Supply Decision Is Standard Labor Supply Decision Is Standard Utility Maximization Problem Utility Maximization Problem Lagrangian multiplier: = U(C,H) + λ (C+wH-Tw-N) / C = U/ C + λ = 0 / H = U/ H + λ w = 0 Therefore, MRS(H for C) = MU H /MU C = w Utility maximization requires the individual to equate the ratio of marginal utilities to the ratio of prices
3 5 Graph of Labor Supply Problem Graph of Labor Supply Problem

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## This note was uploaded on 05/26/2008 for the course ECON 101 taught by Professor Buddin during the Winter '08 term at UCLA.

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Chap16- - Labor Supply Labor supply is an application of the model of individual choice Individual chooses between consumption(C and hours of

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