chapter 6: The Supply of Labour

Question 1

the most abundant and important factor of production

Answer 1

labor

Question 2

a country’s economic performance depends on?

Answer 2

the willingness of its people to work

Question 3

A person’s discretionary time (16 hours a day) can be spent on?

Answer 3

(a) working for pay to derive income (Y ) for consumption

b) on leisure (L

Question 4

the demand for good/service depends on:

Answer 4

(1) The opportunity cost of the good = market price
(2) One’s level of wealth
(3) One’s set of preferences

Question 5

Opportunity Cost of Leisure

Answer 5

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

Question 6

Wealth and income include:

Answer 6

(a) family’s holdings of bank accounts
(b) financial investments
(c) physical property owned

Question 7

The effects of increases in income and wages on leisure-work preferences of a person can be categorized as:

Answer 7

(1) Income effect

(2) Substitution effect

Question 8

the Income Effect

Answer 8

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

Question 9

the Substitution Effect

Answer 9

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

Question 10

receiving an inheritance will lead to income or substitution effect?

Answer 10

income effect

Question 11

a wage increase will lead to income or substitution effect?

Answer 11

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

Question 12

what is the formula for preferences and utility?

Answer 12

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

Question 13

what do the indifference curves show?

Answer 13

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

Question 14

Characteristics of the indifference curves

Answer 14

(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

Question 15

what do budget constraints show?

Answer 15

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

Question 16

what is the formula for total income?

Answer 16

(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)

Question 17

formula for total discretionary time (16 hours)

Answer 17

T = H + L

L = hours of leisure per day

H = number of hours allocated to the labor market

Question 18

The slope of the constraint can be expressed as:

Answer 18

Delta Y / Delta L = - W

Delta Y / Delta H = W

Question 19

at the point where the budget constraint is tangent, what is the slope representing?

Answer 19

• (Delta Y / Delta L) = - (MUL / MUY) = - W

MRSY,L = W

Question 20

in case od¡f a wage increase, when is the substitution effect stronger than the income effect?

Answer 20

when a worker increases his or her hours of work to the labor market

Question 21

in case od¡f a wage increase, when is the income effect stronger than the substitution effect?

Answer 21

when a worker reduces his or her hours of work to the labor market

Question 22

what defines if a substitution effect or income effect is stronger when wage rises?

Answer 22

the shape of the indifference curves

Question 23

who experience greater income effects when wage rates change?

Answer 23

people who are working longer hours

Question 24

a relatively flat set of indifference curves implies what?

Answer 24

a relatively heavy work schedule

Question 25

a relatively steep set of indifference curves implies what?

Answer 25

hours at work are fewer

Question 26

key factors a worker takes into consideration in determining whether or not to work in the labor market

Answer 26

Reservation wage and the earning possibilities.

Commute time per day (fixed costs of working)

Question 27

reservation wage (WR)

Answer 27

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

Question 28

the choices workers make with respect to the desired hours of work depends on:

Answer 28

Wealth

Wage rate

Leisure-income preferences

Question 29

who has greater responsiveness to wage changes, men or women?

Answer 29

women

Question 30

what are the overall observed substitution effects and income effects for men?

Answer 30

the observed substitution effects are positive

observed income effects are negative

Question 31

why use the labor supply theory?

Answer 31

to analyze the work-incentive effects of various social or income maintenance programs because they create budget constraints for their recipients

Question 32

Budget Constraints with “Spikes”

Answer 32

The social insurance compensation programs

Question 33

The social insurance compensation programs

Answer 33

compensate workers for work-related injuries

replaces most of the earnings/incomes lost by workers due to injuries

Question 34

when are social insurance compensations paid?

Answer 34

as long as the worker is off work and disabled

Question 35

when do social insurance compensations stop?

Answer 35

when worker supplies only one hour of labor

Question 36

why do social insurance compensations affect the work-incentives of workers?

Answer 36

since the returns associated with the first hour of work are negative

reduced income for returning to work for 1 hour

Question 37

where on a graph will a worker be happiest with a the post-injury budget constraint?

Answer 37

there at the top of the spike

with H = 0 and L = 16

Question 38

What can policymakers do to minimize the effects of income maintenance programs that create spikes and severe work disincentive problems?

Answer 38

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

Question 39

Programs with Net Wage Rates of Zero

Answer 39

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

Question 40

in a Welfare Subsidy, how does the welfare agency determine the income needed (Yn) by an eligible person?

Answer 40

family size,

area living costs (CPI)

local welfare regulations

Question 41

in a subsidy, why does an extra hour of work yielded no net increase in income?

Answer 41

because the extra earnings resulted in an equal reduction in welfare benefits

price of leisure was zero

Question 42

what is a negative point of a subsidy program?

Answer 42

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

Question 43

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

Answer 43

worker’s utility would be maximized by choosing to work instead of receiving welfare

Question 44

what did the Personal Responsibility and Work Opportunities Reconciliation Act (PRWORA) do?

what for?

Answer 44

gave states more authority on how to design their own welfare programs

(1) encourage work,
(2) reduce poverty, and
(3) move people off welfare

Question 45

how long are the lifetime limits created by PRWORA?

Answer 45

five-year lifetime limit on recipients

Question 46

effect of five-year lifetime limit on recipients created by PRWORA

Answer 46

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

Question 47

PRWORA work requirements rules (1996)

Answer 47

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

Question 48

what will the work-incentive effects of the work requirement depend on?

Answer 48

on whether the indifference curves are steeply sloped or flatly sloped

Question 49

effects of the work requirement?

Answer 49

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

Question 50

Earned Income Tax Credit (EITC)

Answer 50

income maintenance program designed by the federal government

functions as an earnings (cash) subsidy, which goes only to those who work

Question 51

tax credit offered by the EITC programs depends on what?

Answer 51

one’s earnings and the number of dependent children

Question 52

what could EITC recipients could experience?

Answer 52

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)