chapter 6: The Supply of Labour Flashcards
the most abundant and important factor of production
labor
a country’s economic performance depends on?
the willingness of its people to work
A person’s discretionary time (16 hours a day) can be spent on?
(a) working for pay to derive income (Y ) for consumption
b) on leisure (L
the demand for good/service depends on:
(1) The opportunity cost of the good = market price
(2) One’s level of wealth
(3) One’s set of preferences
Opportunity Cost of Leisure
is equal to one’s wage rate or the extra earnings a worker can take home from an extra hour of work
what determines the demand for leisure
Wealth and income include:
(a) family’s holdings of bank accounts
(b) financial investments
(c) physical property owned
The effects of increases in income and wages on leisure-work preferences of a person can be categorized as:
(1) Income effect
(2) Substitution effect
the Income Effect
If income (Y) increases, holding wages (W) constant, desired hours of work (H) will go down
demand for leisure hours will increase while the hours of work supplied by a worker to the labor market decreases
Delta H / Delta Y < 0
the Substitution Effect
If income is held constant, an increase in the wage rate will raise the price and reduce the demand for leisure
an increase in the opportunity cost of leisure reduces the demand for leisure
Delta H / Delta W > 0
receiving an inheritance will lead to income or substitution effect?
income effect
a wage increase will lead to income or substitution effect?
increase will involve both an income effect and a substitution effect
and both effects working in opposite directions creates ambiguity in predicting the overall labor supply response in many cases
If the income effect is stronger, the person will respond to a wage increase by decreasing his or her labor supply (the labor supply curve will be negatively sloped)
If the substitution effect dominates, the person’s labor supply curve will be positively sloped
what is the formula for preferences and utility?
U = f (Y, L),
U is utility, an index that measures the level of satisfaction or happiness,
Y is income (wage)
L is leisure.
Higher U means higher levels of utility that will make a person happier
what do the indifference curves show?
curves show the various combinations of money income (or goods and services) and the hours of leisure/work per day that will yield the same level of happiness
Characteristics of the indifference curves
(1) Higher (up and to the right, or northeast) indifference curves represent higher utility
(2) Indifference curves do not intersect.
(3) Indifference curves are negatively sloped
(4) Indifference curves are convex (steeper at the left than at the right) when income is high, leisure hours are relatively few.
(5) Moving down on the indifference curve reflects value (when income is low, leisure hours are abundant)
(6) Indifference curves differ among individuals because of the differences in tastes/preferences or values
what do budget constraints show?
the combinations of money income and the hours of leisure per day that are possible or attainable for the individual
the combinations of attainable consumption goods and services, and the hours of leisure per day that are possible or attainable for the individual
what is the formula for total income?
(1) Y = wH + V
(2) Y = w(T – L) + V
(3) Y = (wT + V) – wL
(wT + V): intercept
V = non labor income
H = number of hours allocated to the labor market
w = hourly wage rate
L = hours of leisure per day
Y = total income defined
T = total discretionary time (16 hours)
formula for total discretionary time (16 hours)
T = H + L
L = hours of leisure per day
H = number of hours allocated to the labor market
The slope of the constraint can be expressed as:
Delta Y / Delta L = - W
Delta Y / Delta H = W
at the point where the budget constraint is tangent, what is the slope representing?
- (Delta Y / Delta L) = - (MUL / MUY) = - W
MRSY,L = W
in case od¡f a wage increase, when is the substitution effect stronger than the income effect?
when a worker increases his or her hours of work to the labor market
in case od¡f a wage increase, when is the income effect stronger than the substitution effect?
when a worker reduces his or her hours of work to the labor market
what defines if a substitution effect or income effect is stronger when wage rises?
the shape of the indifference curves
who experience greater income effects when wage rates change?
people who are working longer hours
a relatively flat set of indifference curves implies what?
a relatively heavy work schedule
a relatively steep set of indifference curves implies what?
hours at work are fewer
key factors a worker takes into consideration in determining whether or not to work in the labor market
Reservation wage and the earning possibilities.
Commute time per day (fixed costs of working)
reservation wage (WR)
the wage below which a person will not work in the labor market
WR represents the value placed on an hour of lost leisure time
the choices workers make with respect to the desired hours of work depends on:
Wealth
Wage rate
Leisure-income preferences
who has greater responsiveness to wage changes, men or women?
women
what are the overall observed substitution effects and income effects for men?
the observed substitution effects are positive
observed income effects are negative
why use the labor supply theory?
to analyze the work-incentive effects of various social or income maintenance programs because they create budget constraints for their recipients
Budget Constraints with “Spikes”
The social insurance compensation programs
The social insurance compensation programs
compensate workers for work-related injuries
replaces most of the earnings/incomes lost by workers due to injuries
when are social insurance compensations paid?
as long as the worker is off work and disabled
when do social insurance compensations stop?
when worker supplies only one hour of labor
why do social insurance compensations affect the work-incentives of workers?
since the returns associated with the first hour of work are negative
reduced income for returning to work for 1 hour
where on a graph will a worker be happiest with a the post-injury budget constraint?
there at the top of the spike
with H = 0 and L = 16
What can policymakers do to minimize the effects of income maintenance programs that create spikes and severe work disincentive problems?
Set no-work benefits at some fraction of pre-injury earnings
Set an upper limit on the weeks each unemployed worker can receive the no-work benefits
If extensions are to be granted in some cases, set up a panel (medial or judicial board) to review such cases
Programs with Net Wage Rates of Zero
Program benefits are paid based on the difference between one’s actual earnings (Ya) and one’s needs (Yn)
Payment of benefits based on the difference between actual earnings and needs creates a net wage rate of zero
in a Welfare Subsidy, how does the welfare agency determine the income needed (Yn) by an eligible person?
family size,
area living costs (CPI)
local welfare regulations
in a subsidy, why does an extra hour of work yielded no net increase in income?
because the extra earnings resulted in an equal reduction in welfare benefits
price of leisure was zero
what is a negative point of a subsidy program?
creates an income effect
tends to reduce labor supply
causes the wage to effectively drop to zero
because every dollar earned is matched by a dollar reduction in welfare benefits
what if, graphically, the subsidy is not tangent to a point in the indifference curve (in this case, at L = 16 and H = 0)
it would not be tangent because the indifference curve is higher than the max amount (spike) of the subsidy
worker’s utility would be maximized by choosing to work instead of receiving welfare
what did the Personal Responsibility and Work Opportunities Reconciliation Act (PRWORA) do?
what for?
gave states more authority on how to design their own welfare programs
(1) encourage work,
(2) reduce poverty, and
(3) move people off welfare
how long are the lifetime limits created by PRWORA?
five-year lifetime limit on recipients
effect of five-year lifetime limit on recipients created by PRWORA
Reduce how long families could be on welfare
Increase work incentives by eliminating income subsidy
Potential welfare recipients must choose when to receive the subsidy and when to “save” their eligibility in the event of a future need
PRWORA work requirements rules (1996)
requiring 6 hours of work per day (or at least 30 hours per week) after a recipient has been on welfare for two years
Enrollment in education and training programs count toward work requirement
what will the work-incentive effects of the work requirement depend on?
on whether the indifference curves are steeply sloped or flatly sloped
effects of the work requirement?
get a max amount of welfare after 6 hours of work per day
If work requirement is exceeded, income remains the same because of dollar for dollar substitution
if earnings rise above max amount of welfare benefits, he/she will no longer be eligible for welfare
Earned Income Tax Credit (EITC)
income maintenance program designed by the federal government
functions as an earnings (cash) subsidy, which goes only to those who work
tax credit offered by the EITC programs depends on what?
one’s earnings and the number of dependent children
what could EITC recipients could experience?
Income effect that pushes them in the direction of less work (those whose annual income falls between $13,090 and $41,952)
Substitution effect that pushes the recipients in the direction of more work, thus the labor force participation of low-income workers will increase (those whose annual income is less than $13,090)
