slides_econ20a_labor_market

That is the value of the extra consumption to the

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Unformatted text preview: -Leisure Tradeoff ◮ The optimal choice occurs where the tradeoff between consumption and leisure equals the real wage. ◮ That is, the value of the extra consumption to the person from working a little more just has to be equal to value of the lost leisure that it takes to generate the consumption. ◮ The real wage, w , is the amount of consumption that this person can purchase if she gives up an hour of leisure. Real wages and labor supply ◮ At an intuitive level, it may not seem reasonable that an increase in the wage rate would always lead to an increase in the supply of labor. If my wage becomes very high I might spend some of extra income consuming leisure. ◮ An increase in the real wage has offsetting income and substitution effects ◮ Substitution effect: Higher real wage encourages work, since reward for working is higher ◮ Income effect: Higher real wage increases income for same amount of work time, so person can afford more leisure, so will supply less labor The Substitution Effect ◮ A pure substitution effect: a one-day rise in the real wage ◮ A temporary real wage increase has just a pure substitution effect, since the effect on wealth is negligible ◮ Higher real wage encourages work, since the reward for working is higher. ◮ Another way to think about this is that when the wage rate rises the leisure become more expensive, which by itself leads people to want less of it. ◮ If leisure is a normal good, we would then predict that an increase in the wage rate would lead to a decrease in the demand for leisure – and thus an increase in the supply of labor. ◮ A normal good must have a negatively sloped demand curve. If leisure is a normal good, then the supply curve of labor must be positively sloped. ◮ But our story is not over... The Income Effect ◮ A pure income effect: winning the lottery ◮ ◮ Winning the lottery does not have a substitution effect, because it does not affect the reward for working But winning...
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