The Labor Supply Decision

1
The Labor Supply Decision

• The advantage to working more hours is
  consumption
• The more hours you work, the more income you
  earn, the more goods and services you can buy
• Price is CPI, or implicit consumption deflator
• The advantage to working fewer hours is leisure
• The fewer hours you work, the more time outside
  work you enjoy
• Leisure includes all non-market activity (school,
  childraising, etc.)
• Price is oppy cost of not working, the nominal
  employee wage.
• Price of leisure relative to consumption is the
  real employee wage.
• Goal is to choose best combo of consumption and
  leisure

2
The Labor Supply Curve

• If the employee wage of a kind of labor
  increases, the quantity of labor demanded may
  increase or decrease.
• If what people receive in exchange for working a
  kind of labor increases, the number of persons
  who wish to work that kind of labor and the
  number of hours they wish to spend working that
  kind of labor may increase or decrease.
• Ambiguity exists because of 3 kinds of effects at
  work
• Substitution Effect
• Entry Effect
• Income Effect

3
The Labor Supply Curve

• Positive Substitution Effect
• Increase in employee wage of a kind of labor
  increases price of leisure relative to
  consumption
• Creates incentive for people to substitute
  consumption for leisure by working more hours and
  earning more income
• Ex. Increase in wage of freelance authors
  increases oppy cost of relaxing on weekends,
  number of hours writers spend freelancing.
• Ex. Increase in wage of young workers increases
  oppy cost of forgoing work to attend college,
  number of high school grads who forgo or postpone
  college to go straight to work.
• Ex. Increase in wage of women increases oppy
  cost of forgoing work to raise children, number
  of women who work instead.

4
The Labor Supply Curve

• Positive Entry Effect
• Increase in employee wage of a kind of labor
  increases its employee wage relative to employee
  wage of other kinds of labor
• Creates incentive for people to work fewer hours
  in other kinds of labor and more hours in the
  kind of labor in question
• Ex. Increase in the employee wage of
  telemarketers may cause data entry workers to
  want to quit to become telemarketers even if they
  have no plans to work longer hours in total
• Ex. Increase in wage of backup singers may cause
  singers with acts of their own to work more hours
  as backup singers, fewer hours on their own act.
• Technically another version of substitution effect

5
The Labor Supply Curve

• Negative Income Effect
• Increase in employee wage of a kind of labor
  allows people who work that kind of labor to
  reduce their hours but still earn more income
  than before, enjoy more leisure and consumption.
• Ex. A plumber who works 50 hours a week at a 15
  wage can consume 50 x 15 750 in goods if
  plumbers wage increases to 18, he can reduce to
  45 hours but can consume 45 x 16 810.
• Economists believe people prefer a balanced mix
  of consumption and leisure, will tend to use a
  wage increase to both increase consumption and
  reduce quantity of labor supplied.
• Ex. An increase in wage of plumbers may be used
  to help afford both more spending and more free
  time.

6
The Labor Supply Curve

• Sum of substitution, entry, and income effects
  determine relationship between employee wage of a
  kind of labor and the quantity supplied of that
  kind of labor.
• If substitution and entry effects dominate income
  effect, relationship between employee wage and
  quantity of labor supplied is positive.
• If income effect dominates substitution and entry
  effects, relationship between employee wage and
  quantity of labor supplied is negative.

7
The Labor Supply Curve

• If substitution and entry effects dominate,
  positive relationship between employee wage and
  quantity of labor supplied.
• Illustrate relationship with upward-sloping labor
  supply curve.
• Tells us what quantity of labor supplied will be
  at each employee wage

W(eme)
L(S)
L(S)
8
The Labor Supply Curve

• If income effect dominates, negative relationship
  between employee wage and quantity of labor
  supplied.
• Illustrate relationship with downward-sloping
  labor supply curve.
• Tells us what quantity of labor supplied will be
  at each employee wage

W(eme)
L(S)
L(S)
9
The Labor Supply Curve

• The labor supply curve is always upward-sloping
  at low employee wages.
• Always some low wage at which no one will work,
  L(S) 0
• Income effect reduces L(S), cannot exist when
  L(S) 0 because L(S) ? 0
• Substitution and entry effects must dominate,
  L(S) must increase with W(eme).

L(S)
W(eme)
Labor supply curve must slope upward
L(S)
10
The Labor Supply Curve

• At higher wages, the income effect may start to
  dominate the substitution and entry effects,
  bending the L(S) curve backwards.
• Or, the substitution and entry effects may
  dominate at all wages, so the L(S) curve always
  slopes upward.

L(S)
W(eme)
Labor supply curve may bend backward
Labor supply curve must slope upward
L(S)
11
The Labor Supply Curve

• The magnitude of the response of L(S) to W(eme)
  also differs
• At low wages, an increase in W(eme) causes a
  large increase in L(S)
• At higher wages, an increase in W(eme) causes a
  small increase in L(S)
• At yet higher wages, an increase in W(eme) causes
  a decrease in W(eme)

L(S)
W(eme)
L(S)
12
The Elasticity of Labor Supply

• Response of the quantity of labor supplied to the
  employee wage is quantified with the elasticity
  of labor supply.
• Several ways to think of the elasticity of labor
  supply
• change in L(S) / change in W(eme)
• change in L(S) caused by a 1 increase in
  W(eme)
• 1 / slope of labor supply curve x W(eme) / L(S)
• Change in L(S) / Change in W(eme) x W(eme) /
  L(S)
• If e of labor supply gt 1, labor supply is
  elastic.
• If e of labor supply 1, labor supply is unit
  elastic.
• If 0 lt e of labor supply lt 1, labor supply is
  inelastic.
• If e of labor supply lt 0, labor supply is
  negative elastic.

13
The Elasticity of Labor Supply

• Labor supply curves may have an elastic range
• response of L(S) to W great
• L(S) curve flat
• and/or an inelastic range
• response of L(S) to W slight
• L(S) curve steep
• and/or a negative elastic range
• response of L(S) to W neg.
• L(S) curve backward sloped

L(S)
W(eme)
L(S) neg. elastic
L(S) inelastic
L(S) elastic
L(S)
14
The Elasticity of Labor Supply
W(eme)

• A popular labor supply curve in macro is the
  perfectly inelastic labor supply curve
• Income effect perfectly cancels out substitution
  and entry effects
• Elasticity of L(S) is zero
• Another is the perfectly elastic labor supply
  curve
• Elasticity of L(S) is infinite

L(S)
L(S)
W(eme)
L(S)
L(S)
15
Other Determinants of L(S)

• Nonlabor income of workers
• Negative income effect Increase in income from
  nonlabor sources (capital, transfer payments)
  allows both increase in consumption and
  reduction of work hours
• Ex. Extra 100 allows person earning 5/hr. to
  reduce work hours by 10 and still increase
  consumption by 50 (100 - 5 x 10 50)
• People prefer a balanced mix of consumption and
  leisure, will tend to do as above, reduce
  quantity of labor supplied

16
Other Determinants of L(S)

• Employee wage of other kinds of labor
• Negative entry effect Increase in employee wage
  of other kinds of labor creates incentive to work
  more at other kinds of labor and less at kind of
  labor in question
• Ex. Increase in employee wage of retail workers
  will cause fast-food workers to want to quit jobs
  in fast food and acquire jobs in retail,
  decreasing quantity of labor supplied of
  fast-food workers
• Ex. Increase in employee wage of weekday work
  creates incentive for workers who work both
  weekdays and weekends to work more hours on
  weekdays and fewer hours on weekends, decreasing
  quantity of labor supplied of weekend work.

17
Other Determinants of L(S)

• Preference for consumption over leisure
• Positive substitution effect increase in
  relative preference for consumption over leisure
  creates incentive to substitute consumption for
  leisure by working more hours and earning more
  income, increasing quantity of labor supplied.
• Ex. Labor-saving devices such as microwave,
  electric washer and dryer decreases need for time
  for household tasks, increases preference for
  consumption over leisure, increases quantity of
  labor supplied.
• Ex. Change from winter to summer weather
  improves quality of leisure time, decreases
  preference for consumption over leisure,
  decreases quantity of labor supplied.

18
Other Determinants of L(S)

• Preference for kind of work over others
• Positive entry effect increase in relative
  preference for a kind of labor over other kinds
  of labor creates incentive to work fewer hours at
  other kinds of labor and more at kind of labor in
  question, increases quantity of labor supplied of
  kind of labor in question.
• Ex. Improvement in factory worker safety
  standards increases preference for factory work
  over other kinds of work, increases quantity of
  labor supplied of factory work.
• Ex. Increase in terrorism decreases preference
  for airline work over other kinds of work,
  decreases quantity of labor supplied of airline
  labor.

19
Shifts in Labor Supply

• When the quantity of labor supplied increases for
  some reason other than a change in the employee
  wage, the labor supply curve shifts right.
• Expresses the fact that the quantity of labor
  supplied increases regardless of the wage.

L(S)
L(S)
W(eme)
L(S)
20
Shifts in Labor Supply

• When the quantity of labor supplied decreases for
  some reason other than a change in the employee
  wage, the labor supply curve shifts left.
• Expresses the fact that the quantity of labor
  supplied decreases regardless of the wage.

L(S)
L(S)
W(eme)
L(S)