Economics 324: Labor Economics

1
Economics 324 Labor Economics

• For next time, please read Angrist Evans (AER,
  1998)
• For the answer to a question which came up in
  class last time, see the last bullet point below.
  It seems that UI (unemployment insurance) is
  indeed taxed as regular income.
• Benefits
• In general, benefits are based on a
  percentage of an individual's earnings over a
  recent 52-week period - up to a State maximum
  amount.
• Benefits can be paid for a maximum of 26
  weeks in most States.
• Additional weeks of benefits may be
  available during times of high unemployment (see
  Extended Benefits). Some States provide
  additional benefits for specific purposes.
• Benefits are subject to Federal income
  taxes and must be reported on your Federal income
  tax return. You may elect to have the tax
  withheld by the State Unemployment Insurance
  agency.
• Source http//www.workforcesecurity.doleta.gov/un
  employ/uifactsheet.asp

2
Changing Non-labor Income

• What happens to hours of work when we change V?
• Shock ? V due to bigger dividends, beneficiary
  in a will, bigger unemployment insurance check,
  etc.
• Wage is held constant
• Leisure could be normal or inferior good
• Income effect impact on the D for leisure of a
  change in non-labor income, holding the wage
  constant
• (?L/ ?V) w gt 0 or equivalently, (?h/ ?V) w
  lt 0 , if Leisure is a normal good (which we
  will assume)
• How does ? V affect the reservation wage?
• 2 effects of ? V (1) lowers the probability of
  working (?WRES) (2) decreases
  hours worked, if you work

3
Changing the Wage Rate

• What happens to hours of work when we change w ?
• Shock ?w due to a raise at work, perhaps
• Non-labor income (V) is held constant
• Total effect is ambiguous
• Two competing effects
• (1) Income effect higher w ? greater purch power
  ? demand more L
• (2) Substitution effect higher w ? higher
  Pleisure ? demand less L
• Isolating the Substitution effect
• Draw the new budget line. Move this new budget
  line parallel to itself until it is tangent to
  the old IC (at point Y) SE (?L/ ?w) U,V
  lt 0
• Isolating the Income effect
• Draw a new IC tangent to the new budget line at
  some point.

4
Individuals Labor Supply Curve

• Backward-bending Labor Supply curve
• (?h/ ?w) V gt 0 ? SE gt IE
• (?h/ ?w) V lt 0 ? SE lt IE
• SE dominates initially, but IE is stronger
  eventually
• Empirically, data shows that female labor supply
  is backward-bending, while men generally have a
  positive slope, with a short vertical range
  (10-20/hour)
• Commuting costs and labor supply curve
• Wont work 1 hour per week
• Enter LF at h hours (say 20)

IE gt SE
w
SE gt IE
Wreservation
h
0
Hours of work
5
Which Effect Dominates?

• The size of the income effect depends on
  where you start
• bigger at point A than B
• Z is the extreme, IE 0
• Empirically
• Cross-sectional data reveals that IE and SE are
  small for men (estimates for women are
  complicated by child care and household work)

C
A
B
Z
0
Leisure
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Optimal Labor-Leisure Choice example

• Suppose Jacks utility function is given by U
  L? C?
• Find the demand function for leisure hours, L
  L (w, V, T)
• Assuming ? ¾, ? ¼, V 0, T 400 and w
  4 what are the initial optimal values?
• Now suppose welfare program passed giving 200 of
  income if you dont work at all. As you earn
  income benefits are scaled back 0.20 per dollar
  earned.
• What is the break-even point and what are the
  effects on labor supply?
• Decompose, graphically and numerically, the
  change in demand due to the subsidy and tax into
  the substitution and income effects.
• What if U L¼ C¾ ?

7
Labor Supply Elasticity

• Definition
• Consensus estimate for prime-aged men is -0.1
• .1 for SE, -.2 for IE
• When estimates are negative the income effect
  dominates
• Labor supply for men tends to be inelastic
• As time period increases, labor supply becomes
  more elastic
• Why so many elasticity estimates?
• Measurement error (Whipple effect for hours of
  work)
• tends to overemphasize the importance of the
  income effect
• relevant marginal wage rate for salaried workers
• sample selection bias
• Nonlabor income

8
Labor supply of women

• Substantial cross-country differences in womens
  labor force participation rates
• Over time, womens participation rates have
  increased
• In most studies on women, substitution effects
  dominate income effects
• Reverse causality -- Angrist Evans (AER, 1998)

9
Cross-Country Relationship Between Growth in
Female Labor Force and the Wage, 1960-1980

• Source Jacob Mincer, Intercountry Comparisons
  of Labor Force Trends and of Related
  Developments An Overview, Journal of Labor
  Economics 3 (January 1985, Part 2) S2, S6.