Labor Economics Ch. 2

Work-Leisure Model Assumptions
Individuals choose between work and leisure
Time spend on a paying job
activities where one is not paid
ex. education, rest, work within the household
Every Point on an indifference curve yields what?
The same level of total utility
Utility definition
Happiness, satisfaction, utility
Marginal Rate of Substitution
The amount of income one must give up to compensate for 1 more hour of leisure

MRS Falls as you move down and right on an indifference curve
What do leisure lover indifference curves look like and why?
Steeper. These people require a large increase in income for them to give up an hour of leisure.

Put a high value on leisure
What do workaholic indifference curves look like and why?
Flatter. Will give up an hour of leisure for only a small increase in income. They don't value leisure as much.

Place a low value on leisure
Indifference curve properties
Negative slope (to keep utility the same, one must give up income to gain leisure)
Convex to origin (with low hours of leisure, individuals will give up a lot more income to gain leisure)
Budget Constraint
Shows the combinations if income and leisure that a worker could get given a wage rate.

Book: Shows all various combinations of income (goods) and leisure that a worker might realize or obtain, given a wage rate.
Slope of the budget line
Wage Rate
How to read the x axis on Labor Supply curve:
It says hours of leisure

Hours of work=(24-Hours of leisure)
Assumptions for Indifference Curves
1) Each point belongs to 1 indifference curve
2) Indifference curves never cross
Utility Maximization
Where the budget line in tangent to the Indifference curve

MRS=Wage Rate
Backward bending labor supply curve

It comes to a point for some people (with their personal indifference curve) where they work less as the wage increases (causing a backward bend)

You Plot the wage rate on graph.

X-axis: Hours worked
Y-axis: Wage rate
Income Effect (Definition)
The change in desired hours of work resulting from a change in income, holding wage constant
Income Effect on Leisure
Leisure is a normal good.
Higher income implies a desire for more leisure

Fewer hours worked
Want more leisure
Any Change in wage rate will produce:
Both an income and a substitution effect
Income Effect with Wage Increase
wage increase: income is raised and so the income effect lowers desired work hours

Increase wage=increase income=want more leisure
Substitution Effect (definition)
The change in desired hours of work resulting from a change in the wage rate, holding income constant
Substitution Effect on Leisure
A higher wage rate raises the relative price of leisure
Substitution Effect on wage increase
Wage Increase: Substitution effect raises desired work hours

Wage increase=want to work more
Income vs Substitution Effect
Income: wage raises, you work less
Substitution: wage raises, you work more
Which effect dominates (larger in absolute value) at low wage rates?
Substitution effect,

The MRS is low because income is scarce relative to leisure.
What effect dominates (larger at absolute value) at higher wages?
Income Effect.

The MRS is high because leisure is scarce relative to income.
Do men and women respond the same way to an increase in wages?
Men work less with higher wages.

Women work more with higher wages.
What does men's labor supply curve look like?
Backward bending.

Income effect is greater than the substitution effect.
What does women's labor supply curve look like?
Positive slope.

Substitution effect is greater than income effect.
Women substitute between work at home and market work more than men.
Elasticity of Labor Supply (Definition)
measures the responsiveness of desired hours of work to the wage rate
Elasticity of Labor Supply (Formula)
Elasticity of Labor Supply=
(% change in quantity of labor supplied)/(% change in wage rate)
Perfectly Inelastic
Elasticity = 0
Backward Bending Elasticity
Elasticity is negative
Relatively inelastic
Elasticity is positive and less than 1
Relatively elastic
Elasticity is positive and greater than 1
Non-labor income
will produce ONLY an Income Effect. No substitution effect.

With non-labor income individual will want to work LESS.
Hours of work will fall.
Reservation Wage
Lowest wage necessary to induce someone to work
Income Guarantee (B)
Benefit received if individual/family has no earned income
Benefit Reduction Rate (t)
Rate by which the benefit is reduced as income is increased
Break-Even Level of Income (Yb)
The level of earned income at which the individual/family receive no benefit.
Actual Subsidy payment (S)
S = B - tY
Break Even Level of Income (Yb)
Yb = B/t
What restrictions on welfare recipients were instituted in 1996?
1) 2 year time limit on receiving assistance.
2) 5 year lifetime time limit for collecting assistance.
3) Help enforce collection of child support from fathers.
What impact have these restrictions had on the number of welfare recipients?
Large reduction in caseloads since 1996