Lecture 4: The Allocation of Time between home & Market Production

TOPIC 1: The Labor Market

Labor Market Graph + Labor Force participation rate + unemployment rate

TOPIC 2: Labor Supply Decision- Labor Leisure Model

What are the 2 activities in the Labor Leisure Model?

• Market production (ie work)

• Non market production (ie leisure, cooking, childcare),

Example: Available time in a day = 16 ours, market wage 7.5 per hour and, non labor income is $70/day. Model this individuals budget constraint

What is a reservation wage (w*)?

The minimum required compensation (hourly) to get a person to enter the labor force (slope of IC between 0 & 1 hours worked, and MRS at zero hours worked).

Example Cont.: On the previously drawn budget constraint model 2 scenarios one where w<w* and another where w>w*

Why is the optimum in this model the point where W= MRS?

The optimum occurs where the slope of the budget constraint (w) equals the slope of the indifference curve (MRS), because at that point the last unit of $ spent on leisure provides the same marginal utility as last unit of $ spent on consumption (equimarginal principle).

TOPIC 3: Comparative Statics

What are comparative statics?

Seeks to establish what would happen to hours worked (H) if there is a change in market wage (W), reservation wage (W*) or income (Y)

What is the income effect triggered by, and model it in the scenario that there is a 50$ increase in NLI.

• the income effect is triggered by a change in NLI

What are both the income AND substitution affect triggered by?

• Triggered by a change in wage

• Graphically: IE (point A to B), SE (point B to C)

Example: Model a case where there is a wage increase, in one graph IE>SE and in another SE> IE

Note: More leisure means IE dominates (with wage increase). Less leisure means SE dominates with wage increase). Modeled by backwards bending labor supply curve.

Backwards bending Labor Supply Curve

What are 2 economic factors that may influence the labor supply decision?

1) Unemployment fluctuations-Leads to 2 effects:

• Added worker effect- other family members will enter the workforce or delay exist if spouse becomes unemployed, this often means the secondary worker is in the labor market and earning a lower wage than their spouse.

• Discouraged worker effect- some may exit the labor force leading to a reduction in household income (more common).

2) Government Policies

• non-labor income and effective labor income (wage-taxes) are affected by policies relating to tax and subsidies.

What are potential factors that influence a womens reservation wage?

• Availability and costliness of market substitutes for home production

• Birth rate (now declining)

• # of children

• Family

• tastes and preferences.