1. Labour supply

Question 1

Labour supply

Answer 1

Labour supply is the relationship between desired hours worked and wages

Labour supply is the trade-off between consumption and leisure

Question 2

Indifference curves

Answer 2

Fix an arbitrary level of utility and solve the utility function for the combinations of c (consumption) and l (leisure) that yield the same level of utiltiy

Characteristics of indifference curves:
- do not intersect
-convex
- negatively sloped in c and l (U is increasing in both arguments)

Question 3

Optimal labour supply

Answer 3

Point where indifference curve is tangent to budget constraint

Question 4

Interior solution

Answer 4

Point where indifference curve is tangent to the budget constraint

Question 5

Income effect (IE)

Answer 5

Holding hours constant, if wage increases, income increases - if leisure is a normal good, individuals will choose to work less and consume more leisure

Question 6

Substitution effect (SE)

Answer 6

If wage increases - the price of leisure increases - leisure gets more costly (captured by foregone wage) - so people will work more

Question 7

What determines labour force participation?

Answer 7

Intensive margin - how many hours to work
Extensive margin - decision to participate in the workforce

Question 8

Corner solution

Answer 8

Situation where consumer chooses to consume only one good (here, leisure or consumption)
Occurs at the extremes of the budget constraint
Chosen if there is no interior solution:
-in our case, they choose to consume their “exogenous income” (e.g. unemployment benefits) - and their entire time endowment in leisure

Note: This is still a choice not to work (voluntary) - different from involuntary unemployment

Question 9

Corner Solutions

Answer 9

A situation where worker chooses to ‘consume’ only one of the two ‘goods’: consumption (c) or leisure (l)

If there is no interior solution - then consumers choose their corner solution:
-choose to consumer their “exogenous income” - m (e.g. unemployment benefits) and their entire time endowment in leisure

Note: this is a CHOICE not to work( voluntary) - NOT involuntary unemployment

Question 10

Reservation wage

Answer 10

Wage at which individual is indifferent between working positive hours - or not working and consuming m

Question 11

Aggregate labour supply

Answer 11

Aggregate labour supply curve represents the total number of hours provided by all workers given each possible wage level

Obtain aggregate labour supply curve by adding up the individual labour supply curves - that is, write labour supply with hours on the left-hand side - and add it up

Question 12

Elasticity of labour supply

Answer 12

Slope of labour supply curve is crucial - informs us about how labour markets respond to shocks

Labour supply is very inelastic if labour supply curve is steep:
-there is little response in hours even for large wage changes
Extreme case: vertical line (perfectly inelastic)

Labour supply is very elastic: if labour supply curve is flat
- Even small wage changes have a large effect on hours worked
Extreme case: horizontal line (perfectly elastic)