ECW2121ECG9170

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ECW2121/ECG9170 Labour Economics
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Labour Economics
Topic 3 (Two weeks) Labour supply, labour demand
and market equilibrium
Topic 9 Wage relativities and the personal
distribution of income
Topic 2 The supply of labour
Topic 1 An overview of the study of labour
markets
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Aims
The supply of labour

• To have understanding of the following
• the factors which determine the total labour
  supply to the economy
• the participation rate and the determinants of
  its size and
• hours of work and how individuals make choices
  as to the number of hours of labour they wish to
  supply.

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The supply of labour
Population growth
Participation rate
Average hours of work
Hours of work Theoretical aspects
The work-leisure choice
An alternative approach
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Reading

• Textbooks
• Norris, Ch. 2.
• Hamermesh and Rees, Chs. 1, 2.
• King, Ch. 3
• McConnell and Brue, Chs. 2, 3.
• Other
• Carter, R. and Maddock, R., Working Hours in
  Australia, in Blandy and Covick (eds.),
  pp.222-245.

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The supply of labour
Population growth

• Changes in the rate of population growth have a
  long term effect on the size of the labour force
  and therefore the total quantity of labour
  available.

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Components of population growth
The supply of labour
Population growth

• Natural growth
• cultural, religious differences
• economic development
• health care
• Migration
• inter-national economic disparities
• national policies
• Regional disparities

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Factors of population growth
The supply of labour
Population growth

• T. Malthus
• improvements in living standards would lead to
  rapid increase in population, which would plunge
  society back into poverty and starvation

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Factors of population growth
The supply of labour
Population growth

• Natural growth - a function of economic
  development
• long term evidence
• Can be studied based on comparison of
  contemporary societies at different levels of
  development

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The supply of labour
Participation rate
Refers to the number of persons in the labour
force not just the number of persons employed.
If an unemployed person actively seeking work
obtains employment there is no change in the
participation rate. Unemployment can increase
even if there is no reduction in employment, if
additional people seek work, that is if the
participation rate rises. Changes in the
participation rate may be as important a factor
in determining the unemployment rate as changes
in the number of jobs available.
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Factors affecting participation rate
The supply of labour
Participation rate

• The age distribution of the population
• Social conventions, (the school leaving age and
  the attitude towards married women holding paid
  employment)
• The structure of employment
• a rapid growth in part-time jobs and a relative
  decline in full-time employment
• the availability of part-time jobs is likely to
  attract new entrants to the labour market, thus
  changing the participation rate.

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Factors affecting participation rate
The supply of labour
Participation rate

• Wages and Taxes
• Higher wages may encourage married women and
  persons of school leaving age into the workforce
• May discourage early retirement
• May mean that it is unnecessary for both partners
  to work
• Alternatively a higher (net) wage means the cost
  of not working is greater. This may encourage
  some people to give up not working and join the
  labour force.
• Thus there is a positive relationship between
  participation and the substitution effect of a
  wage change.
• Change in tax margins may affect decisions on
  working hours/overtime.
• The reservation wage.
• The idea is that there exists a minimum wage
  level which will induce a person to enter the
  labour market.
• The net effect of a wage change on participation
  depends on which of these two effects is the
  greater.

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Factors affecting participation rate
The supply of labour
Participation rate

• The additional worker/discouraged worker
  hypothesis - factors affecting PR in different
  directions
• If unemployment is high it is suggested that
  additional persons will be encouraged to enter
  the workforce (if the usual breadwinner is
  unemployed other members of the household will
  enter the workforce and seek jobs)
• Alternatively, in times of high unemployment some
  persons, unable to find a job, become discouraged
  and abandon job search
• Cultural differences.
• Different attitudes at women in labour force

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The supply of labour
Average hours of work

• Labour supply is measured in number of hours of
  work supplied. Based on
• hours worked per period
• total number of persons in the workforce
• The long term trend to reduced working hours

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The supply of labour
Average hours of work

• Hours worked are a function, in part, of the
  level of wages
• This involves looking at the choice workers make
  between income (i.e. goods and services) and
  leisure.
• Leisure has a cost - the income lost by not
  working.

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The supply of labour
Average hours of work

• The effects of an increase in wages on average
  hours of work
• The cost of leisure has risen therefore workers
  will substitute work for leisure, i.e. the
  substitution effect is positive.
• The higher wage means real income has increased.
  
• Therefore workers can consume more goods, one of
  which may be leisure.
• Therefore the income effect of higher wages is
  negative.
• Whether or not an increase in wages leads to an
  increase or a decrease in the amount of labour
  supplied depends on the relative sizes of the
  substitution and income effect.

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A microeconomic approach
The supply of labour
Hours of work Theoretical aspects
The work-leisure choice

• AB is the budget constraint.
• OB is the total possible leisure hours (168 per
  week).
• OA is maximum possible income
• Utility is maximised with OD hours leisure and
  income OC. DB therefore represents hours of work
  per week.
• The model can be used to examine the impact of a
  number of factors on the work leisure choice.

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The supply of labour
Hours of work Theoretical aspects
The work-leisure choice
The effect of a change in the wage rate.

• An increase in the wage rate raises the maximum
  possible income from OA to OE.
• The budget constraint is now EB.
• Utility has increased to U3
• Income has increased to OG and
• Leisurer has reduced to OF.
• Increase in hours worked from DB to FB.

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The supply of labour
Hours of work Theoretical aspects
The work-leisure choice
The components of change.

• Substitution Effect decrease in leisure (MD)
• Income effect Increase in leisure (MF)
• Total effect - FD

N
M
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The supply of labour
Hours of work Theoretical aspects
The work-leisure choice
The effect of a change in the wage rate.

• The effect of a change in the wage rate on the
  quantity of labour supplied is ambiguous.
• A change in the wage rate will have both an
  income effect and a substitution effect, which
  tend to operate in opposite directions.
• The net result depends on the relative sizes of
  these effects.
• Where the income effect outweighs the
  substitution effect the labour supply curve will
  be negatively sloped, i.e. a rise in the wage
  rate will lower the labour supply, and vice versa.

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The supply of labour
Hours of work Theoretical aspects
The work-leisure choice
Effect of Taxation

• A proportional tax is imposed on income above OE
• Maximum potential income is now OG
• The budget constraint is now GFB.
• The new equilibrium is
• income OJ,
• leisure OH and
• a lower level of utility U3.
• Taxation has acted as a disincentive to work
  effort - working hours are reduced from DB to HB.

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The supply of labour
Hours of work Theoretical aspects
The work-leisure choice
Effect of Taxation

• The effect of taxation on work effort is unclear.
  
• Taxation reduces a workers disposable wage income
  
• However, the effect of a lower wage may be either
  an increase in the hours of work offered, or a
  decrease.
• The claim that higher taxes reduce work effort is
  only true if the substitution effect outweighs
  the income effect.
• It is not inconceivable that higher taxation
  could increase the supply of labour.

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The supply of labour
Hours of work Theoretical aspects
An alternative approach

• A sharp distinction between income (goods) and
  leisure is unrealistic.
• Playing golf requires leisure time but also
  income (to purchase clubs, balls, membership of a
  golf club etc).
• The true cost of any commodity is the direct
  price of the product plus the opportunity cost of
  the time required to enjoy it. Thus a consumer
  could calculate the full cost of all commodities
  (including leisure) as
• Full price Cost of time Cost of goods
• element element
• In this case an indifference analysis would
  compare the consumption of goods intensive
  commodities with time intensive commodities.

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Reading for Lecture 3

• Textbooks
• Norris, Ch. 3.
• Hamermesh and Rees, Chs. 4, 5.
• King, pp.11-23.
• McConnell and Brue, Ch. 5, pp.155-170, Chs. 13,
  17.