Labour Supply

Question 1

What are an individuals consumption decisions?

Answer 1

Individuals have preference over goods and allocate income to achieve the most preferred combination of goods, given their income and prices they face

Question 2

Theory of consumer choice can be applied more broadly with two applications..?

Answer 2

Modelling labour supply model
Altruistic behaviour

Question 3

What do we assume for individuals when.m talking about labour?

Answer 3

We assume individual has a fixed time endowment and can allocate this time between work and leisure

We assume individual can freely choose the no. Of hours/week to work.

Question 4

What does leisure entail?

Answer 4

Leisure includes all non-labour market activities (leisure, house work, child care)

Question 5

What are the additional simplifiying assumptions?

Answer 5

• individual has 7 days of 24 hours available (Time endowment T = 168)
• individual takes the wage rate, w
  and chooses the no. of hours per week to work
• time spent working generates labour income (no taxes or other expenses associated with work)
• all income (labour + non-labour income) is used to finance consumption
• individuals have preferences over 2 “goods” (leisure + consumption)

Question 6

How does labour supply respond to changes in wages?

Answer 6

We can decompose total change in the no. of hours worked into:

1. Substitution effect - as wages rise, person works more and substitutes leisure for work as the opportunity cost of leisure rises (opp. Cost of NOT working)
2. Income effect - as wages rise, person works less as his/her income has risen thus allowing them to spend more time on leisure activities (leisure is a normal good)

Question 7

If a leisure is a normal good, how do the income and substitution effects work?

Answer 7

In opposite directions.

1. An increase in wage makes leisure more expensive relative to consumption. Substitution effect means individual chooses more consumption and less leisure/more work.
2. Increase in wage makes individual richer. If leisure is a normal good, income effect means that the individual will choose more leisure/less work

Question 8

How can we derive a persons labour supply curve?

Answer 8

By plotting combinations of wages and hours worked into a new diagram

Question 9

What changes the look of the labour supply curve?

Answer 9

Depending on whether the substitution or the income effect of a wage change dominates - we can get a variety of cases

Question 10

What are the cases of labour supply curves?

Answer 10

Upward sloping labour supply
Downward sloping labour supply
Backward bending labour supply

Question 11

Total effect of a change in wage can be decomposed into..?

Answer 11

Substitution effects and income effects

Question 12

What traces out the labour supply curve?

Answer 12

Optimal choices for different wage rates

Question 13

What does the shapes of labour supply curve depend on?

Answer 13

Leisure consumption preferences

Question 14

If MPl < APL…

Answer 14

APL must be falling. Average productivity falls as long as it exceeds marginal productivity