Labor Supply Decisions for Physicians

1
Labor Supply Decisions for Physicians
2
There are different dimensions of labor supply of
doctors
1) decision to become a doctor

• hours worked per time period, given
• participation

3) decision to specialize
3

• Decision to Become a DoctorHuman Capital Model

• The decision should be made by comparing the
  costs and benefits (higher earnings) of earning a
  medical degree.
• Costs of obtaining a medical degree
• The direct costs are the cost of tuition, fees,
  and books.
• Room and board are not included since they are
  needed regardless of whether you go to med
  school.
• The indirect cost is the forgone earnings you
  give up while you obtain the degree.

4
Age-Earnings With and Without Medical Degree

• The HH curve is the age- earnings profile if a
  person does not become a doctor.

Annual Earnings

• The CC curve is the cost- earnings profile if
  one becomes a doctor.

C

• The total cost of medical school is the
  sum of the direct costs (area 1) plus indirect
  costs (area 2).

Incremental Earnings (3)
H

• The benefit of medical school is the increase
  in earnings due to the medical degree (area 3).

Indirect Costs (2)
H

• Whether it is rational to attend medical
  school depends on whether the present value of
  the benefits exceeds the present value of the
  costs.

Age
65
22
26
C
Direct Costs (1)
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Present Value

• Discounting converts the value of future dollars
  into todays dollars through the interest rate.

• The present value (Vp) of a payment received one
  year from now is

• Def

100.00
6
Present Value

• The present value of a future stream of
  incremental earnings or costs (E)

E0

• Costs are represented as negative values of E.
• A person should attend medical school if the net
  present value (Vp) is greater than 0.

7
Internal Rate of Return

• The internal rate of return, r, is the rate of
  return at which Vp 0

E0

0

• A person should attend medical school if the rate
  of return (r) exceeds the market interest rate
  (i).

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Generalizations

• Length of income stream
• The longer the stream of positive incremental
  earnings, the more likely the net present value
  will be positive.
• As a result, younger people are more likely to
  attend attend medical school
• Costs of attending medical school
• The lower the cost of attending medical school,
  the more likely the net present value is
  positive.
• Older people have a higher opportunity cost of
  attending medical school, less likely to attend.

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2) Hours Worked per Time Period, Given
Participation
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Assumptions

• Individuals choose between work and leisure.
• Work is time spent on a paying job.
• Leisure includes activities where one is not
  paid.
• Rest
• Work within the household

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Indifference Curve
Income/day

• The indifference curve shows work and leisure
  combinations that yield the same amount of
  total utility.

• More hours of leisure implies fewer hours of
  work.

0
Leisure Hr
24
24
0
Work Hr
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Indifference Curve
Wage 10/hour
Income/day

Convex to origin With low hours of leisure,
individuals are willing to give up a large
amount of income to get 1 more leisure
hour. With high hours of leisure, individuals
are willing to give up a small amount of income
to get 1 more leisure hour. (diminishing MRS)
100
40
20
14
0
Leisure Hr
24
24
0
Work Hr
13
Marginal Rate of Substitution
Income/day

• The marginal rate of substitution (MRS) is
  the amount of income one must receive to
  compensate for 1 less hour of leisure.

4

• At 4 hours of leisure (20 hours of work), one
  must receive 4 units of income to compensate
  for 1 less hour of leisure.

1

• At 8 hours of leisure (16 hours of work), one
  receive 1 unit of income to compensate for 1
  less hour of leisure.

• The MRS falls as one moves southeast along an
  indifference curve.

3
4
9
8
0
Leisure
24
24
0
Work
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Indifference Map
Income/day

• Curves further from the origin indicate higher
  utility.

• A person will maximize utility by getting to
  the highest attainable indifference curve.

Y2
I3
Y1
I2
I1
0
Leisure
24
L2
L1
15
Work-Leisure Preferences
Income/day

• Leisure lovers

I1

• Workaholics

I2
4
3
0
Leisure
24
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Budget Constraint
Income/day

• The budget constraint shows the combinations
  of income and leisure that a worker could get
  given a wage rate.

360

• At a wage rate of 5, a worker could get a
  maximum income of 120 per day (5/hour 24 ).

240

• At a wage rate of 10, a worker could get a
  maximum income of 240 per day.

120

• At a wage rate of 15, a worker could get a
  maximum income of 360 per day.

Leisure
24
0

• The slope of the budget constraint is wage
  rate.

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Utility Maximization
Income/day

• The optimal or utility maximizing point is
  where the budget constraint is tangent to the
  highest attainable indifference curve (U).

• At U, the MRS (slope of the indifference
  curve) is the equal to the wage rate (slope of
  the budget constraint)

240
B
U

• At B, the MRS is greater than the wage rate.
  The individual values leisure more than the
  wage rate.

I3
80
I2
I1
A

• At A, the MRS is less than the wage rate. The
  individual values leisure less than the wage
  rate.

Leisure
24
0
16
18
Wage Effect
Income/day

• A change in the wage can have two effects

240

• Income effect and substitution effect.

U
Leisure
24
0
16
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Income Effect

• Income Effect
• The change in desired hours of work resulting
  from a change in income, holding the wage
  constant.
• Leisure is a normal good, so higher income
  implies a desire for more leisure (fewer hours of
  work).
• For a wage increase, income is raised and so the
  income effect lowers desired work hours.

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Substitution Effect

• Substitution Effect
• The change in desired hours of work resulting
  from a change in the wage rate, holding income
  constant.
• A higher wage rate raises the relative price of
  leisure.
• For a wage increase, the substitution effect
  raises desired work hours.

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Net Effect

• For Wage Increases
• If substitution effect gt income effect, then
  hours of work rise.
• If income effect gt substitution effect, then
  hours of work fall.
• For Wage Decreases
• If substitution effect gt income effect, then
  hours of work fall.
• If income effect gt substitution effect, then
  hours of work rise.

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Backward Bending Labor Supply Curve
Wage Rate

• For a given person, hours of work may increase
  as the wage rate rises.

SL

• If the wage rate rises from 10 to 25 per
  hour hours of work rises from 8 to 10 hours per
  day.

25

• Above 25 per hour, hours of work fall.

10

• The backward bending labor supply curve is the
  result of the income and substitution effects of
  a wage change.

0
Hours of Work
24
8
10
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Backward Bending Labor Supply Rationale

• The substitution effect dominates at low wage
  rates.
• The MRS is low because income is scarce relative
  to leisure.
• The income effect dominates at higher wage rates
• The MRS is high because leisure is scarce
  relative to income.

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3) The Decision to Specialize

• The decision to specialize can be analyzed in the
  context of the human capital model by
  determining
• the additional number of required years of
  training
• the benefits as measured by increased
  earnings from specialization