chapter 2 labor supply (static). 2 labor supply why has the lfpr of men declined? why has the lfpr...

Chapter 2

Labor Supply (Static)

2

Labor Supply

Why has the LFPR of men declined?Why has the LFPR of women increased?Why has the length of the workweek decreased?How will changes in the welfare system affect job mobility and/or unemployment spells?Does a change in family structure affect LFP decisions?

3

Measuring the Labor Force

Bureau of Labor Statistics (BLS) Conducts the Current Population Survey

(CPS) which surveys 60,000 households monthly

Workers are considered: Employed:

Unemployed:

Out of the Labor Force:

4

Labor Force Statistics

Labor Force =

Labor Force Participation Rate =

Employment-Population Ratio =

Unemployment Rate (UR) =

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“Hidden Unemployed”

Note that “employment” is not different for full- and part-time workers, so part time workers who want full-time employment are not differentiated.People who give up searching are considered out of the labor force.Using the employment-population ratio would have flaws as well, since unemployed and out of the labor force would be grouped together.

May under-state UR

6

Labor Supply Trends (up to 1990s)

Male LFPR declined Decline in labor market attachment after age 65 10% decline between ages 45 and 64 Decline in LFPR from 46% to 17% men over 65 Decline in LFRP from 97% to 93% for ages 25-44

Female LFPR increased, particularly among married womenHours per week declinedMen (4%) less likely than women (16%) to be employed PTPositive correlation between educational attainment and LFPRacial Differences White men have higher LFPR than black men. White men work more hours than black men.

7

Worker Preferences

Workers choose:

Goal:

U = f (C , L)

8

Indifference Curves

Do not intersectUniqueAll points along an indifference curve represent the same utility level Higher indifference curves represent higher levels of utility

9

Indifference Curves, cont.Downward-sloping

Convex to the origin -

10

Indifference Curves, cont.

Slope =

Move from (L1,C1) to (L2,C2)

Gain + Loss = 0 to maintain Utility = U

runrise

CL MUand MU

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Differences in Tastes

Large slope = Large MRSMUL large relative to MUC

Individual enjoys _______ (willing to sacrifice a large amount of consumption for leisure)

Small slope = Small MRSMUL small relative to MUC

Individual enjoys _______ (willing to sacrifice a large amount of leisure for consumption)

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Budget Constraint

Assumptions: No saving →

where V = non-labor income

(endowment) w = wage H = hours worked

Constant wages (no overtime)

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Budget Constraint, cont.

Solve for slope of BC: C = V + wH = = =

where T = total time available for work and leisure

→ slope =

Interpretation:

runrise

14

Budget Constraint, cont.

Properties: Consumption

bundles below the budget line are

Consumption bundles outside the budget line are

Consumption bundles along the budget line

15

Hours of Work Decision

Choose C* and L* such that utility is maximized, subject to BC

U(C) _ U(A) and U(C) _ U(B), and U3

_______________ Interior solution (H* > 0)

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Hours of Work Decision, cont.

Tangency (between IC and BL) conditions: Slope of indifference curve = Slope of

budget line =

ΔLΔC

LC

wMUMU

C

L C

L MUw

MU

17

Comparative Statics

Comparative Statics: How does individual behavior change when a parameter of the model changes? Suppose V increases, holding w

constant Suppose w increases, holding V

constant

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Comparative Statics, cont.

Suppose V increases, ceteris paribus Individuals have more money to spend

on C (C*↑) Income effect:

If leisure is a normal good, the demand for leisure will __crease (L* ) and the number of hours worked will __crease (H* )

constantw holding

, H,V when0

ΔVΔH

w

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Comparative Statics, cont.

Suppose w increases, ceteris paribus Substitution effect:

Since the wage rate is the OC of leisure, an increase in w increases the OC of leisure, and workers substitute ______ for __________ (L* & H* )

Income effect: An increase in w is an increase in wealth, which

will _________ the demand for leisure (L* & H*

)

0 ΔwΔH

V

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Income and Substitution Effects

Case 1: Both C* and L* __crease, so leisure must be a ________ good

Suppose V increases Budget line _______ up

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Case 2: C* __creases and L* __creases, so leisure must be an _________ good

Suppose V increases Budget line _______ up

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Case 1: L* __creases, so the ____________ effect dominates

Suppose w increases Budget line ________ up

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Case 2: L* __creases, so the __________ effect dominates

Suppose w increases Budget line _______ up

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Isolating the Income and Substitution Effects

To isolate the income effect, draw a hypothetical budget line with same slope as old budget line and tangent to new indifference curve

Income Effect: _ to _ Substitution Effect: _ to _

_________ Effect dominates H*↑ when w↑

Suppose w increases Budget line rotates up

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Isolating the Income and Substitution Effects

To isolate the income effect, draw a hypothetical budget line with same slope as old budget line and tangent to new indifference curve

Income Effect: _ to _ Substitution Effect: _ to _

________ Effect dominates H* when w

Suppose w increases Budget line rotates up

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Decision to Work (H*>0 or H*=0)

Can obtain U0 if H*=0Trade leisure for consumption by entering labor market? If w = wlow, U* _ U0

(cannot reach a higher IC) H* _ 0

If w = whigh, UH _ U0 (higher IC) H* _ 0

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Reservation Wage

Individuals with high wage offers choose to work (H*>0); individuals with low wage offers do not work (H*=0)There exists a wage at which the individual is indifferent between H*=0 and H*>0, the reservation wage

w~

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Reservation Wage Characteristics

When w < , do not workWhen w > , workHigh less likely to enter labor market depends upon tastes for work (slope of the indifference curve) ↑ as V↑ (when V↑, L*↑, so the wage required to induce labor market participation increases)For a given , a high wage offer increases the probability of working (↑ LFPR when w↑)There is a positive relationship between wages and the probability of working (the higher the wage, the more likely it is to exceed the reservation wage) – no income effect for non-workers, so there are not competing income and substitution effects when considering how many hours to work

w~

w~w~

w~w~

w~

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Individual Labor Supply Curve

Recall: Work if reservation wage

< wage offer; otherwise H*=0

Work more when wage ↑ if substitution effect dominates

Substitution effect always dominates (income effect DNE) for non-workers LFPR ↑ when wage ↑

Work less when wage ↓ if income effect dominates (only true for workers)

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Market Labor Supply Curve

Workers have unique preferences, reservation wages, indifference curves, and thus optimal hours of work decisions

Market supply curve =

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Elasticity of Labor Supply

How responsive is labor supply to changes in wages?

Interpretation:

Elastic (______ responsive) when |σ|_ 1 Inelastic (______ responsive) when |σ|_ 1

dominateseffect incomewhen 0

dominateseffect onsubstituti when 0

w%H%

σ

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Elasticity of Labor Supply: Example

Suppose:

Interpretation:

___________ labor supply Note: Since hours worked increased with

wages, the ____________ effect dominates

H1 = 2000 W1 = $15

H2 = 2200 W2 = $17.50

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Elasticity of Labor Supply Estimates

Prime-Age Men: α ≈ -0.1

(1% increase due to substitution effect, and 2% decrease due to income effect)

May explain decline in the length of the workweek (men now earn more in real terms, so more leisure is demanded)

Elasticity estimate not significantly different from zero (most prime-age men work full-time, full-week jobs)

Different estimate for younger and older men, as well as women

Much variation in empirical estimates

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Problems with estimates Hours of work

Per year? Per month? Per week? (α ≈ -0.1calculated using hours of work per year)

Hours of work likely more inelastic for shorter time periods

Measurement error, especially for salaried workers Wages

For salaried workers, wage definition

likely measured with error Wages should measure price of leisure as the

marginal wage for an additional hour of work, which is not likely average wage (may include overtime, etc.)

hoursannual omeannual inc

"wage"

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Problems with estimates, cont. Wages, cont.

Nonworkers? Wage ≠ 0, but no reported wage (only know wage offer < reservation wage); these workers have low wage offers or high reservation wages, and are not a “random sample” of the population

Non-labor income Workers with much non-labor income probably

earned a lot in the past and saved earnings (which are now wealth) If these workers continue to work a lot now, there will be a positive relationship between V and H (suggests leisure is inferior).

When tastes for work are accounted for, evidence of a negative income effect is found.

36

Female Labor Supply

Different LFPRs across countries (for ages 25-54) Italy: 50%; US: 75%; Sweden: 90%

Elasticity of Labor Supply α ≈ 0.2 after correcting for the decision to work

(substitution effect dominates) Women more responsive (in terms of LFP) to

changes in wages than men, less responsive in terms of H*

Responsiveness to husband’s wages LFP elasticity with respect to whusband = 0.53

H* elasticity with respect to whusband = 0.17

37

Female Labor Force Participation

LFPR↑ considerably since 1960 As a cohort ages, LFPR↑ As time has passed, LFPR↑ Why?

Theory: The increase in real wages over time (between 2.1% per year and 6.2% per year) has ___________ the probability of working (wages more likely to exceed reservation wage) The increase in LFPR may be due to _________________________ _____________________________________ (Because of ↓ fertility? Or has the number of children ↓ because women now work more?)

38

Policy Application: Welfare

AFDC, TANF, etc.Personal Responsibility and Work Opportunity Reconciliation ActTake-it-or-leave-it offer Assume V = 0 w/o

benefits Lump sum benefits = 0

if individual works L1 _ L2 _ T – leave labor

force with benefits Why?:

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Policy Application: Welfare

Cash Grants Assume V = 0 w/o

benefits Full benefits if

individual does not work endowment ↑

For workers, cash grant is reduced for each dollar earned working BL flatter

Net wage < actual wage OC of leisure ↓ so L*_

Note:

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Policy Application Summary: Welfare

Welfare programs __crease LFPR (an increase in non-labor income increases a worker’s reservation wage) and __crease the demand for leisure (a decrease in net wages is a decrease in the OC of leisure)Empirical evidence Negative income tax experiment: Cash grants

were 95% or 140% of the poverty line, and the tax rate on labor earnings was 50% or 70%)

Prob(work)↓ by 3% for husbands and 7% for wives H*↓ by 5% for men, 21% for women

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Policy Application: Earned Income Tax Credit (EITC)

Began in 1975By 1990s, $25 billion distributed to low income familiesDependent upon income, number and ages of childrenProgram Up to Max Y ($8890), credit

= 40% of earnings (net wage = 1.4w, up to $3556

Between $8890 and $11,160, receive max credit ($3556)

For earnings in excess of $11,160, benefits are reduced by 21.06¢ per dollar earned

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Effects of EITC on labor supplyCase 1: Income < $8890 Steep indifference curve

strong preference for ______

Choose H* _ 0 w/o benefits EITC induces

Recall: income effect does not exist for non-workers, so LFPR must _ when w_

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Effects of EITC on labor supply

Case 2: $8890 < Income < $11,160 Choose H* _ 0 w/o

benefits EITC induces

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Effects of EITC on labor supply

Case 3: Income > $11,160 Choose H* _ 0 (many

hours) w/o benefits EITC induces

_________ effect likely dominant for those who work many hours

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Policy Application Summary

EITC __creases LFPR for non-workers (only a substitution effect exists) and __creases hours worked (either because of a pure income effect or because the individual is already working many hours) Evidence: 2.4% increase in LFPR

Cash grants _______ work incentives (LFPR ), but EITC subsidizes work and __creases work incentives (LFPR )

chapter 2 labor supply (static). 2 labor supply why has the lfpr of men declined? why has the lfpr...

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