thory of labour supply Session 9.1.ppt

The theory of labor supply is an important topic for Economics Students

1. The Theory of Labor Supply
Session 9
By: Lecturer | Yaser Mujaddedi |
Zawul Institute of Higher Education | E4Eco

2. Labour Supply
1. Assumptions of the Model
2. Deriving the Budget Constraint
3. Labour Supply Decision
4. Summary

3. 1. Assumptions of the Model
People have a choice: to work or not to work
If not working, they will remain at home or engage
in leisure
Supply labour if Price (wage) > reservation wage
Reservation wage is the minimum wage needed to
attract a person away from leisure and into work
Represents the opportunity cost of labour

4. Simplify the analysis to a choice between work
and leisure
•Assume seven days of 24 hours available
Can analyse using indifference curve analysis
•Assume labour is homogeneous and waged
Can we model this decision making?
•Assume the wage rate is w

5. Leisure Hours
Income
168
If no work undertaken then 168hours of
leisure taken and income is zero(a)
If worker then decides to work one hour
then leisure decline and income rises to
a
b
ww
One more hour gives income of 2w
c
2w
Work Hours
2. Deriving the Budget Constraint

6. Leisure Hours
Income
168
w
Slope = -w
1
Maximum income is 168w

7. Indifference curve for income-leisure trade off
Leisure Hours
Income
U2
U3
U1
Work Hours

8. 3. Labour Supply Decision
Once someone is working how do they respond to a
change in the wage rate?
Two key elements:
Substitution effect–as wages rise, person works more
and substitutes work for leisure as the opportunity cost
of leisure rises
Income effect–as wages rise, person works less as
his/her income has risen thus allowing him/her to spend
more time in leisure activities

9. Leisure Hours
Income
168
Y1
a
b
c
U2
U1
Y2
Substitution: a to c (wage up, work up)
Income: c to b (income up, work down)

10. For most workers, SUBSTITUTION > INCOME
effects but…...
Y1
Y2
Y3
Y4
Y5
(no I curves shown)
Price consumption curve

11. Hours worked
Wage
W1
H1
BACKWARD BENDING SUPPLY CURVE FOR
LABOUR

12. 3.3.4Summary
•Reservation wages determine the point of entry into
the labour market
•Need to trade-off between leisure and income
•Can analyse using indifference curve approach
•Income effects can outweigh substitution effects to
give a backward bending supply curve
•Implications for tax/benefit policy