labor-leisure choice – indifference curves graph by harcourt, inc. just like the indifference...

Labor-Leisure Choice – Indifference Curves

Graph by Harcourt, Inc.

Just like the indifference curves used to derive consumer demand.

Tradeoff is between leisure and all other goods measured in dollars (i.e. income).

Slope is marginal rate of substitution.

Different Preferences for Leisure

Graph by Harcourt, Inc.

Since MRS = MUL/MUY, steeper curve enjoys leisure more and flatter curve enjoys leisure less.

So Person B requires more money to be willing to give up leisure than Person A does.

Different Budget Constraints

Graph by Harcourt, Inc.

Hours not spent at leisure can be spent in market work earning money to buy other goods, so wages are represented by slope – a higher wage is a steeper slope.

Non-labor- market income results in a shift up of the budget line.

Optimal Number of Hours Worked

Graph by Harcourt, Inc.

Individuals maximize utility subject to their budget constraint, so optimal hours worked is total hours available minus chosen hours of leisure.

A Pure Income Effect

Graph by Harcourt, Inc.

An increase in income with no change in the wage (pure income effect) shifts out the budget constraint and implies demanding more normal goods, including leisure. Move from X to Z and hours of work decline.

A Wage Increase (Substitution Effect Dominate)

Graph by Harcourt, Inc.

A wage increase has both income (budget line moves out) and substitution (budget line’s slope changes) effects. Income effect -> work less (Z), Substitution effect -> work more (X). Overall effect is move from V to X (sub > inc).

A Wage Increase (Income Effect Dominate)

Graph by Harcourt, Inc.

A wage increase has both income (budget line moves out) and substitution (budget line’s slope changes) effects. Income effect -> work less (Z), Substitution effect -> work more (X). Overall effect is move from V to X (inc > sub).

The Reservation Wage

Graph by Harcourt, Inc.

At this wage, it is not worth giving up leisure. The slope of the indifference curve at B is the reservation wage. Only participate in the labor market when W > reservation wage.

The Participation Decision – Wage Change

Graph by Harcourt, Inc.

When the wage increases beyond the reservation wage, begin to participate in the labor market (move from B to X).

The Participation Decision – Income Change

Graph by Harcourt, Inc.

As income rises, tangency is at a steeper and steeper sections of the indifference curves, until the current wage is the reservation wage and individual drops out of the labor market.

Policy Analysis – Welfare Program

Graph by Harcourt, Inc.

$200 guarantee, reduced as earn income. Program has both inc effect (budget out) -> work less (Z), and sub effect (flatter budget) -> work less (X). Clear work disincentive from this program.

Policy Analysis – Social Security

Graph by Harcourt, Inc.

Change time frame to year. Can earn a small amount with no loss of benefits, then are reduced as earn more until completely phased out. Here pure income effect, but if worked more without program, will also be substitution effect. Both imply work less.

Policy Analysis – Progressive Income Tax

Graph by Harcourt, Inc.

Proportional tax is just a wage change, but progressive tax adds curvature to the budget line. The more one works, the less of each extra dollar earned one gets to spend. Income effect is to work more (Z), but strong substitution effect to work less (X).

Fixed Hours of Work Available

Graph by Harcourt, Inc.

Person A would like to work 50 hours, Person B would like to work 30 hours. If only jobs with 40 hours are available at this wage, both will be worse off – working more or less than is optimal.

Fixed Costs of Working

Graph by Harcourt, Inc.

Fixed time costs reduce the time available for either work or leisure so budget line moves in. Less income, less leisure, likely also less work (more commuting).

Fixed monetary cost is pure income effect, so budget line moves in. Less income, less leisure, more work.

Graph copyright © 2003 by Pearson Education, Inc.

Household Production

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HH Opportunity Frontier & Individual Budgets

The husband has a higher wage, so he works first to get market goods and the wife is first to produce household goods. As a household they can have more of everything.

Different HH Divisions of Labor

In A the husband specializes in the market sector and the wife splits her time. In B the husband specializes in the market sector and the wife specializes in the HH sector. In C the husband splits his time and wife specializes in the HH sector

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