Lecture 4 - Agenda The Supply of Labor Productivity,...

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1 4-1 Productivity, Output, and Employment, Part 2 4-2 Agenda • The Supply of Labor • Labor Market Equilibrium • Unemployment • Okun’s Law 4-3 The Supply of Labor • Supply of labor is determined by individuals: ¾ Aggregate labor supply is the sum of individuals’ labor supply. ¾ The labor supply of individuals depends on their labor-leisure choices. 4-4 The Supply of Labor • The income-leisure trade-off: ¾ Utility depends on consumption and leisure. ¾ • Costs: Loss of leisure time. • Benefits: More consumption because of higher income. ¾ Utility maximizing individuals will: • Work another day if the benefits exceed the costs and • Keep working additional days until benefits equal costs.
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2 4-5 The Supply of Labor • Real wages and labor supply: ¾ An increase in the real wage has 2 effects: A substitution effect : A higher real wage increases the reward for working so more labor is supplied. An income effect : A higher real wage increases income for same amount of work time so a person can afford more leisure and will supply less labor. 4-6 The Supply of Labor • Real wages and labor supply: ¾ A pure substitution effect : a one-day rise in the real wage. • A temporary real wage increase has a pure substitution effect because the effect on wealth is negligible. • Consequently, an increase in labor supply. 4-7 The Supply of Labor • Real wages and labor supply: ¾ A pure income effect : winning the lottery. • Winning the lottery doesn’t have a substitution effect, because it doesn’t affect the reward for working. • But it makes a person wealthier, so a person will both consume more goods and take more leisure. • Consequently, a reduction in labor supply. 4-8 The Supply of Labor • Real wages and labor supply: ¾ The substitution effect and the income effect together: a long-term increase in the real wage. • The reward to working is greater so there is a substitution effect toward more work. • With higher wage, a person doesn’t need to work as much to consume the same basket of goods and services so there is an income effect toward less work.
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3 4-9 The Supply of Labor • Real wages and labor supply: ¾ The substitution effect and the income effect together: a long-term increase in the real wage. • The longer the high wage is expected to last, the
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Lecture 4 - Agenda The Supply of Labor Productivity,...

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