Supply of LaborSupply of Labor

How do We Spend our Time?How do We Spend our Time?

• Working, playing, sleeping, eating, travelling, working out

• Simplify: work and leisure

• Time spent working is time not spent in leisure, and vice versa

• How do we determine how much of our time to allocate to work and leisure?

• Marginal decision rule: Do whichever activity has the higher marginal benefit, until they equal.

Marginal UtilityMarginal Utility• MUy= Marginal utility of 1$ of

income• Py= Price of 1$ of income

(=1$)• MULE= Marginal utility of 1

extra hour of leisure• W = Wage (that is given up

to have that one hour of leisure)

• So, you choose to spend an hour sleeping in rather than going to work, because the marginal utility of that hour of leisure was worth more to you than the marginal utility of working an hour. (1 hour sleep > 1 hour’s wages)

W

MU

P

MULE

y

y

And if your wages rise?And if your wages rise?• Assume that you balanced

amount of work and leisure such that at the margin the fractions now balance. Then wage rises.

• What happens to your marginal decision rule?

• Marginal utility of income becomes greater, so you choose to work more and have less leisure

• This is the substitution effect. You substitute work for leisure because of the greater payoff.

W

MU

P

MULE

y

y

W

MU

P

MULE

y

y

But the Income effect…But the Income effect…

• But leisure is a “normal” good, which means you consume more of it when your income rises.

• So, as income rises, you want more leisure, not less.

• This conflicts with the substitution effect.

• For some people, their supply of labor curve could bend backwards

Shifts in Labor Supply CurveShifts in Labor Supply Curve

• Change in preferences.– In the 1970s, women entered the

workforce instead of raising children– People now are working later in life

• Changes in income– (Not increase in wage, but income

from a source other than work)– Person could inherit wealth, and be

less likely to work• Changes in prices of related goods

– If child care prices rise, women may work less

• Changes in expectations– If worker’s child is about to enter

college, worker may work longer hours

– If workers near retirement age and have ample savings, may work less

– If stock market crashes, workers may have less savings, so work more

• Change in population

Practice IdeasPractice Ideas

• What is the effect on wages of an increase in labor demand?

• Increase in labor supply?

Minimum WageMinimum Wage

• Draw a labor market at equilibrium.• Explain the results on wages and

employment if the government imposed a minimum wage above the market equilibrium wage