Supply of Labour

7/27/2019 Supply of Labour

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Supply of Labour Market:Theoretical Framework

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Background

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Economics deals with the resources that are scarce in nature

Market generates efficient outcomes

Various market structure

AssumptionsPerfect information

Uniform price for homogeneous goods

No perfect information

Stigler (1962)

Asymmetric information

Two types of Asymmetric information ex-ante and ex-post

Hidden information problemAkerlof (1970)

Purchase of used motor vehicles example

Social structure

Example


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Background - Job shopping problem

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Stigler (1962) As Stigler (1962) put it:

The information a man possesses on the labour market is capital: it wasproduced at the costs of search, and it yields a higher wage rate than onaverage would be received in its absence (p.154)

Strategy for shopping

Dispersion in wage offers

Stiglers study of 44 graduates

Major limitations Decision is based on optimal sample size problem Cost of job search appears to be zero

Wage offers are given- Individuals are to make choices on offers thatthey received

Pragmatically, wage distribution is known, but which firm offers thatwage is unknown

Search


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Neo-classical model of labour-leisure choice

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Time allocation between the labour market and leisure

Ignore household activities

ObjectiveMaximize the utility; higher the utility, higher

the happiness Both C and L are goods

Utility maximization depends on the particular combination

of C and L

the locus of many points representing the combinations ofC and L generate a particular level of utility, called IC

Characteristics of indifference curve

( , )U f C L


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The time and budget constraints

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Constraints imposed by time and budget

Time constraint

Two types of income: Labour income and non-labour income

Budget constraint ( C = wh+V)

wh is the labour earnings and v is the non-labour income

Assumption: same hourly wage regardless of how many hours he/sheworks

Rewrite budget constraint C = wh+v

C = w (T-L) +v

= wT-wL+V

C + wL = wT+V

Right hand side: full time income generates from devoting full time tothe labour market (labour earnings + non-labour earnings)

The left hand side: the way in which income is being spent, betweenconsumption goods and leisure activities (wL is the forgone earningsassociated with consuming leisure activities)

T L h


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Figure 4

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Point E is the endowment point

Numerical example

wT+v

v E

Hours of leisure


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Factors motivate a person to enter the labour market

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Reservation wage

Reservation wage is greater than offer wage

Reservation wage is less than offer wage

Non-labour income and the reservation wage

Being leisure a normal good, the reservation wage tend to rise as non-labour income increases

There are two distinct effects on work incentives

Reduces the chances of being employed in the labour market

Reduces the number of hours allocate in the labour market


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Do people respond to incentives?

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One of the fundamental economic principles An incentive is something that induces a person to act

Rational people respond to incentives

Example: when wages start rising, people decide to participate

in the labour market

A tax on gasoline encourages people to drive smaller and more

efficient cars

Implementing speed governors


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Backward bending supply curve

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Backward bending supply curve is one of the many possible supply curves

The link between wage rates and hours of work

Rs 10 is the reservation wage, below which the workers does not enter the Labourmarket

The worker enters the labour market, only if wage is greater than RS 10

There are two segments: Upward and backward bending

The upward slope indicates that the substitution effects dominate the income effects

the backward bending segment represents that income effect dominates the substitution

effect

Wage rate

Hours of work

Labour supply curve


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Theory at work The laffer curve

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Relation between tax rates and tax revenue

Increase in the income tax rate initially increases tax revenues. Aftersome tax rate of t per cent tax system is confiscating labourearnings and further increase on tax rates shackle the creativity andproductivity of the labour force and reduce tax revenue

When income effects dominate, an increase in the tax rate leads toincrease hours of work, because the decrease in income encourages

workers to consume less leisure. An increase in the income tax rateincreases tax revenue, and gives rise to the upward sloping portion

this does not support the argument that income tax cuts couldincrease tax revenues in the United States


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Household production function

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A simple model that represents two married persons A and B

Maximize utility, which in effect depends on the value of the

goods from the market place and commodities that they

produce in the household

Time available for both activities = 10 hours (Labour market

and household)

Allocation of weekly hours (remaining 14 hours for personal

care and leisure)

The labourmarket

Thehousehold

sector

Personalcare

Passiveleisure

Other


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Household production function

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Interesting question-allocation of 10 hour betweenlabour market and non-market sector?

Three different feasible conditions

Condition 1: Both decide to allocate all of their time to

the household Condition 2: B (Wife) specializes in the labour market

and A (Husban) specializes in the household sector

Condition 3: A specializes in the labour market, and B

divides her time between household and labour market


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Men Women

1965 1981 1965 1981

Labour market 51.6 44.0 18.9 23.9

Household work 11.5 13.8 41.8 30.5

Leisure 36.7 41.8 35.4 41.9

Personal care 68.2 68.2 71.9 71.6

The allocation of time- empirical evidence


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Labour supply elasticity

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Percentage change in hours of work due to

percentage change in wage rate. Or, the responsiveness of hours of work to changes

in the wage rate

It gives the percentage change in hours of workassociated with a 1 percent change in the wage rate.

The sign of the labour supply elasticity depends on theupward and downward slope of the labour supplycurve

The labour supply elasticity is positive when the

substitution effects dominates, and is negative whenincome effect dominates

Example


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Thank you

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Supply of Labour

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