Topic 1 Lecture 9

1
Topic 1 Lecture 9
Applications of Consumer Choice Theory 1. Labour
Supply The Income-Leisure Trade-off
Income
IC
Leisure
2
Topic 1 Lecture 9
Labour Supply The Income-Leisure Trade-off
Tmax
Income
Time Constraint Tmax
IC
Tmax
0
Leisure
Labour Supply
0
3
Topic 1 Lecture 9
Labour Supply The Income-Leisure Trade-off
Tmax
Income
Wage Constraint w (wage per hour)
w
Tmax
0
Leisure
Labour Supply
0
4
Topic 1 Lecture 9
Labour Supply The Income-Leisure Trade-off
Tmax
Income
Wage Constraint w (wage per hour) And Non-labour
income, N.
w
N
Tmax
0
Leisure
Labour Supply
0
5
Topic 1 Lecture 9
Labour Supply The Income-Leisure Trade-off
Tmax
Optimisation, given w, N and Tastes. Total
Income Labour Income Non-Labour
Income Total Income Y N
Income
Y
IC
w
N
N
Tmax
0
L
Leisure
Labour Supply
0
6
Topic 1 Lecture 9
Labour Supply The Income-Leisure Trade-off
Tmax
Optimisation, given w, N and Tastes. What
happens to optimal Labour Supply if N rises (why
might it?)?
Income
Y
IC
w
N
N
Tmax
0
L
Leisure
Labour Supply
0
7
Topic 1 Lecture 9
Labour Supply The Income-Leisure Trade-off
Tmax
What happens to optimal Labour Supply if N rises
Income
IC
N
Tmax
0
Leisure
8
Topic 1 Lecture 9
Labour Supply The Income-Leisure
Trade-off
Tmax
What happens to optimal Labour Supply if N
rises? Under what assumption? Why?
Income
b
IC
a
IC
N
Tmax
0
Leisure
9
Topic 1 Lecture 9
Labour Supply The Income-Leisure Trade-off
Tmax
Income
w
a
a
w
Y
IC
w
N
N
L, Labour Supply
L
Tmax
0
L
Leisure
Labour Supply
0
What happens to optimal Labour Supply if w rises?
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Topic 1 Lecture 9
Tmax
Income
w
a
a
IC
w
N
L, Labour Supply
L
Tmax
0
L
Leisure
Labour Supply
0
What happens to optimal Labour Supply if w rises?
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Topic 1 Lecture 9
Tmax
Income
w
a
a
a
IC
w
L, Labour Supply
L
Tmax
0
L
Leisure
Labour Supply
0
What happens to optimal Labour Supply if w rises?
12
Topic 1 Lecture 9
Tmax
Income
w
a
a
a
a
IC
L, Labour Supply
L
Tmax
0
L
Leisure
Labour Supply
0
What is the implied shape of the Labour Supply
curve in this case?
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Topic 1 Lecture 9
Tmax
Income
w
a
Ls
a
IC
L, Labour Supply
L
Tmax
0
L
Leisure
Labour Supply
What is the implied shape of the Labour Supply
curve in this case? And the elasticity of Labour
Supply?
0
14
Topic 1 Lecture 9
To understand how labour supply responds to a
change in the wage rate, it is useful to exploit
the distinction between Income and Substitution
Effects. To do this, we need to shift back the
new Budget Line until it is just a tangent to the
original Indifference Curve . . .
Tmax
Income
a
a
IC
Tmax
0
L
Leisure
Labour Supply
0
15
Topic 1 Lecture 9
To understand how labour supply responds to a
change in the wage rate, it is useful to exploit
the distinction between Income and Substitution
Effects. To do this, we need to shift back the
new Budget Line until it is just a tangent to the
original Indifference Curve . . .
Tmax
Income
a
a
Tmax
0
L
Leisure
Labour Supply
0
16
Topic 1 Lecture 9
To understand how labour supply responds to a
change in the wage rate, it is useful to exploit
the distinction between Income and Substitution
Effects. To do this, we need to shift back the
new Budget Line until it is just a tangent to the
original Indifference Curve . . . with the move
from a to a split into a gt b
Substitution Effect, b gt a Income
Effect.
Tmax
Income
a
b
a
I
S
Tmax
0
L
Leisure
Labour Supply
0
17
Topic 1 Lecture 9
Tmax
Income
a gt b Substitution Effect, b gt
a Income Effect. When the Substitution and
Income Effects just cancel each other out, the
rise in the wage rate has no net effect on Labour
Supply and the derived Labour Supply curve is
vertical, as we have seen.
a
b
a
I
S
Tmax
0
L
Leisure
Labour Supply
0
18
Topic 1 Lecture 9
a gt b Substitution Effect, b gt
a Income Effect. How would you interpret
the Income Effect in words? And the Substitution
Effect (Hint exploit the concept of the
Opportunity Cost)
Tmax
Income
a
b
a
I
S
Tmax
0
L
Leisure
Labour Supply
0
19
Topic 1 Lecture 9
a gt b Substitution Effect, b gt
a Income Effect. When the Substitution and
Income Effects just cancel each other out, the
rise in the wage rate has no net effect on Labour
Supply and the derived Labour Supply curve is
vertical, as we have seen. What about if the
Substitution Effect dominates? What is the shape
of the Labour Supply curve in this case?
Tmax
Income
a
b
a
I
S
Tmax
0
L
Leisure
Labour Supply
0
20
Topic 1 Lecture 9
When the S-effect dominates the I-effect
Tmax
Income
w
a
a
Ls
a
a
I
S
L, Labour Supply
L
Tmax
0
L
Leisure
Labour Supply
What is the implied shape of the Labour Supply
curve in this case? And the elasticity of Labour
Supply?
0
21
Topic 1 Lecture 9
When the S-effect dominates the I-effect
Tmax
Income
w
Ls
a
a
a
a
I
S
L, Labour Supply
L
Tmax
0
L
Leisure
Labour Supply
What is the implied shape of the Labour Supply
curve in this case? And the elasticity of Labour
Supply?
0
22
Topic 1 Lecture 9
When the I-effect dominates the S-effect
Tmax
Income
w
Ls
a
a
a
a
I
S
L, Labour Supply
L
Tmax
0
L
Leisure
Labour Supply
What is the implied shape of the Labour Supply
curve in this case? And the elasticity of Labour
Supply?
0
23
Topic 1 Lecture 9
Labour Supply the evidence . .
. And for most people? And the
implication for income tax cuts?
Ls
w
L
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Topic 1 Lecture 9
Now read BB 4th Ed., pp. 187-191 (but dont
worry about issues (especially the mathematical
material) which go beyond what you have seen in
lecture notes or seminar exercise sheets)