chapter6

chapter6 - The Basic Neoclassical Model of Labor Supply The...

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    The Basic Neoclassical Model  of Labor Supply The labor-leisure tradeoff
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    Assumptions: there are only two possible uses of time:  labor and leisure, each individual selects the combination  of hours of work and leisure that  maximizes his or her level of  satisfaction (utility).
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    Opportunity costs For individuals who are working, the  opportunity cost of an additional hour of  leisure time is the wage rate. Individuals choose not to work if the  value of leisure time exceeds the  market wage.
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    Change in the wage A change in the wage generates: a substitution effect, and an income effect
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    Substitution effect the opportunity cost of leisure time rises as the wage rate increases. as leisure time becomes more costly, individuals consume less leisure time and spend more time at work. this is the substitution effect resulting from a higher wage.
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    Income effect as the wage rate rises, an individual’s real income rises. this leads to an increase in the consumption of all normal goods. if leisure is a normal good, the higher wage rate will induce the individual to consume a larger quantity of leisure time (and reduce hours of work). This is the income effect resulting from a wage increase.
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    Net effect If leisure is a normal good, an increase  in the wage rate will cause the quantity  of labor supplied to: increase if the substitution effect is larger  than the income effect, and decrease if the income effect is larger than  the substitution effect.
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    Backward-bending labor  supply curve Quantity of Labor Supplied wage w o S income effect effect subs. > income effect effect subs. <
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    Indifference curves An  indifference curve  is a graph of  alternative combinations of goods that  provide a given level of   satisfaction   (utility).
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    Utility function It is assumed that the individual’s  utility level is a function of two  goods: real income (Y), and leisure  time (L).  In mathematical terms, this utility  function may be expressed as: U=U(Y,L)
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    Indifference curve U=Uo Y L
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    Indifference curve (cont’d.) Y L An indifference curve is downward sloping since an individual is willing to give up some income to receive additional leisure (or vice versa).
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    Indifference curves (cont’d.) Y L A U=Uo A point that lies above an indifference curve provides a higher level of utility than a point on the curve.
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    Indifference curves (cont’d.) Y L A U=Uo U=U' (U’ > Uo) An indifference curve passes through each point in the diagram.
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    Constrained maximization Individuals attempt to attain the  highest possible level of utility. The choice among alternative 
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chapter6 - The Basic Neoclassical Model of Labor Supply The...

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