Lecture 3 Labor supply.pdf - International Labour Markets Spring 2018 Peter Jensen Department of Economics and Business Aarhus University Labor supply

Lecture 3 Labor supply.pdf - International Labour Markets...

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1 International Labour Markets Spring 2018 Peter Jensen Department of Economics and Business Aarhus University Labor supply Literature: Chapters 6 and 7 in “Modern Labor Economics” Analysis of labor supply Policy applications: income maintenance programs Refinements of the labor supply model
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2 Trends in labor force participation Simple model of labor supply Basic neoclassical model (microeconomics), where individuals are assumed to face a trade-off between work and leisure time Only two possible uses of time : work and leisure Each individual is assumed to select the mix of leisure time and purchased goods that maximizes his or her level of satisfaction (utility) The model can help to understand the work- incentive effects of wages and incomes taxes income maintenance programs
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3 Opportunity costs The decision to work depends on 3 factors: Opportunity costs (wage) Wealth Preferences Leisure contributes to well-being Working contributes to producing goods and services The opportunity cost of an additional hour of leisure time is the wage payment (W) that is given up by choosing to not work Optimal allocation of time The individual chooses to not work an additional hour if the value of leisure time exceeds the market wage rate The individual will work an additional hour if the value of the products that can be purchased with the wage exceeds the benefits of an additional hour of leisure time
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4 Effects of a wage change Two effects on an individual’s labor supply: a substitution effect an income effect As the wage rate rises, the opportunity cost of leisure time rises Thus, individuals consume less leisure time and spend more time at work = substitution effect due to higher wage An increase in the wage, however, also raises an individual’s real income which leads to an increase in the consumption of all normal goods (including leisure) A higher wage will generally induce individuals to consume more leisure time = income effect due to higher wage Effects of a wage change Note: The SE and IE act simultaneously and in opposite directions Total effect = SE + IE = ? Assuming that leisure is normal good, an increase in the wage will cause the quantity of labor supplied to Increase if SE>IE (low level of wages) Decrease if IE>SE (high level of wages) Thus, an individual’s labor supply curve may be backward-bending In practice, it appears that most labor supply curves are either upward-sloping or vertical
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5 Backward-bending labor supply curve income effect > substitution effect substitution effect > income effect Analysis of labor/leisure choice
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