ECON 3027 Labour Economics

Labour Supply: Further Topics

Introduction

• In reality the basic model of a trad-off between consumption and leisure neglets various factors that affect labour supply

Household production

Life cycle

• (intertemporal labour supply)

Household production

• Leisure includes many forms of non-market work, including work around the home

• Why do some household members specialize in the market sector and other members specialize in the household sector? – Comparative advantage/return to skills

• Consider a two-person household: Jack and Jill, a married couple – Their household opportunity set is greater than when

they were not married: each specialize in the sector where they are relatively more productive

Jack and Jill – unmarried opportunity sets

200

100 Household

Goods ($)

150

250 Household

Goods ($)

Market

Goods ($) Market

Goods ($)

Budget Lines and Opportunity Frontier of a Married Couple

At point E, Jack and Jill allocate all their time to the household sector. If they wish to buy market goods, Jack gets a job because he is relatively more productive in the labor market, generating segment FE of the opportunity frontier. After he uses up all his time in the labor market, Jill can then enter the labor force, generating segment GF of the frontier.

G 350

F 200

Jack’s

Jill’s

E

250 100 350 Household

Goods ($)

150

Who Works Where?

Market

Goods ($)

Market

Goods ($)

Household

Goods ($)

Household

Goods ($)

Market

Goods ($)

Household

Goods ($)

P

U

U

P

U

P

Division of Labor in the Household

• (a) Jill specializes in the household sector and Jack divides his time between the labor market and the household.

• (b) Jack specializes in the labor market and Jill divides her time between the labor market and the household.

• (c) Jack specializes in the labor market and Jill specializes in the household sector.

An Increase in the Wage Rate or Household Productivity Leads to Specialization

Household

Goods ($)

Market

Goods ($)

P

U

U P

An increase in Jack’s wage moves the household from point P to point P, and Jack now completely specializes in the labor market.

An Increase in the Wage Rate or Household Productivity Leads to Specialization

An increase in Jill’s marginal product in the household sector moves the household from point P to point P, and Jill now completely specializes in the household

sector.

Household

Goods ($)

Market

Goods ($)

U

P P

U

Labor Supply over the Life Cycle

• Wage rates change over the worker’s life (over the life cycle). – Wages are low when young.

– Wages rise with time and peak around age 50.

– Wages decline or remain stable after age 50.

• The changes in wages over the life cycle are “evolutionary” wage changes that alter the price of leisure.

Theoretical Issues of Evolutionary Wages

• A person will work more hours when wages are higher .

• The profile of hours of work over the life cycle will have the same shape as the age-earnings profile.

• Intertemporal substitution hypothesis: people substitute their time over the life cycle to take advantages of changes in the price of leisure.

• In a similar way we can describe a link between wages and labour force participation rates.

The Life Cycle Path of Wages and Hours for a Typical Worker

Age

Wage

Rate

50 Age

Hours of

work

50

Only substitution effect

Hours of Work over the Life Cycle for Two Workers with Different Wage Paths

Age

Jack

t * Age t *

Joe

Wage Rate Hours of

Work

Jack

Joe (if substitution effect

dominates)

Joe (if income effect

dominates)

Joe’s wage exceeds Jack’s at every age. Although both Joe and Jack work more

hours when the wage is high, Joe works more hours than Jack if the substitution

effect dominates. If the income effect dominates, Joe works fewer hours than Jack.

Substitution and income effect

Labor Force Participation Rates over the Life Cycle in 2005

30

40

50

60

70

80

90

100

15 25 35 45 55 65

Age

Lab

or

forc

e p

art

icip

ati

on

rate

Male

Female

Hours of Work over the Life Cycle in 2005

500

1,000

1,500

2,000

2,500

15 25 35 45 55 65

Age

An

nu

al h

ou

rs o

f w

ork

Male

Female

Labor Supply Over the Business Cycle Cyclic changes in participation rates

• Added-worker effect. – So-called “secondary” workers currently out of the

labor market are affected by a recession because the main breadwinner becomes unemployed or faces a wage cut.

– A secondary worker may choose to enter the labor force during these bad times

– The labor force participation rate of secondary workers (i.e., the added worker effect) is counter-cyclical.

Labor Supply Over the Business Cycle Cyclic changes in participation rates

• Discouraged worker effect. – Unemployed workers find it very difficult to find jobs

during a recession, so they give up searching.

– Discouraged workers exit the labor force during bad times.

– The labor force participation rate of discouraged workers is pro-cyclical.

• What actually happens to participation rates over the

business cycle? The discouraged worker effect dominates the added-worker effect, especially during recessions.

Conclusion

• Household production allocation

• Static and dynamic labour supply

• Labour supply and the business cycle

• Other factors affecting labour supply

– Demographic factors (fertility rate)

– Labour mobility and migration policies (to be covered later).