Labor Supply Prof. Kang-Shik Choi Yonsei University
It s true hard work never hurt anybody, but I figure, why take the chance? -Ronald Reagan 2
Introduction to Labor Supply Labor facts Men: labor force participation rates declined from 80% in 1900 to 72% in 2009. Women: labor force participation rates rose from 21% in 1900 to 59% in 2009. Hours worked fell from 40 to 34 per week during the same time period. 3
Measuring the Labor Force Current population survey (CPS) Labor Force = Employed + Unemployed LF = E + U Size of LF does not tell us about intensity of work. Labor Force Participation Rate LFPR = LF/P P = civilian adult population 16 years or older not in institutions. 4
Measuring the Labor Force Current population survey (CPS) Employment: Population Ratio (percent of population that is employed). EPR = E/P Unemployment Rate UR = U/LF 5
Measuring the Labor Force Labor force measurement relies on subjectivity and likely understates the effects of a recession. Hidden unemployed: persons who have given up in their search for work and have therefore left the labor force. The employment rate (E/P) can be a better measure of fluctuations in economic activity than the unemployment rate. 6
Labor Force Participation Facts Labor force participation (LFP) is greatest for all groups during the ages of 25 to 55. LFP increases with education. LFP has decreased for men over the age of 65 from 63% in 1900 to under 22% by 2010. 7
Labor Force Participation Facts More women than men work part-time. More men who are high school drop outs work than women who are high school drop outs. White men have higher participation rates and hours of work than black men. 9
Labor Force Participation Facts [Labor Force Participation Rates of Men in the US, 1900-2010] Year All Men Man aged 25-44 Man aged 25-64 Man aged over 64 1900 80.0 94.7 90.3 63.1 1920 78.2 95.6 90.7 55.6 1930 76.2 95.8 91.0 54.0 1940 79.0 94.9 88.7 41.8 1950 86.8 97.1 92.0 45.8 1960 84.0 97.7 92.0 33.1 1970 80.6 96.8 89.3 26.8 1980 77.4 93.0 80.8 19.0 1990 76.4 93.3 79.8 16.3 2000 74.7 93.1 78.3 17.5 2010 71.2 90.6 78.4 22.1 8
Labor Force Participation Facts [Labor Force Participation Rates of Men in Korea, 2000-2015] Year All Men Man aged 15-64 Man aged over 60 2000 74.4 77.1 49.7 2001 74.3 77.1 50.5 2002 75 77.9 51.7 2003 74.7 78 48.6 2004 75 78.3 49.7 2005 74.6 78.2 49.8 2006 74.1 77.8 50.7 2007 74 77.6 51.6 2008 73.5 77.3 50.6 2009 73.1 76.9 50.5 2010 73 77.1 50.3 2011 73.1 77.4 50.9 2012 73.3 77.6 51.4 2013 73.2 77.6 52.2 2014 74 78.6 52.9 2015 73.8 78.6 52.7 8
Labor Force Participation Facts [Labor Force Participation Rates of Women in the US, 1900-2010] Year All Women Single Women Married Women Widowed, Divorced,or Separated 1900 20.6 43.5 5.6 32.5 1920 25.4 51.1 10.7 34.1 1930 24.8 50.5 11.7 34.4 1940 25.8 45.5 15.6 30.2 1950 29.0 46.3 23.0 32.7 1960 34.5 42.9 31.7 36.1 1970 41.6 50.9 40.2 36.8 1980 51.5 64.4 49.9 43.6 1990 57.5 66.7 58.4 47.2 2000 60.2 69.0 61.3 49.4 2010 58.6 63.3 61.0 48.8 8
Labor Force Participation Facts [Labor Force Participation Rates of Women in Korea, 2000-2015] Year All Women Women aged 15-64 Women aged over 60 2000 48.8 52 30.2 2001 49.3 52.8 30 2002 49.8 53.5 30.1 2003 49 52.9 27.8 2004 49.9 54.1 28.3 2005 50.1 54.5 28.1 2006 50.3 54.8 28.3 2007 50.2 54.8 28.7 2008 50 54.7 27.9 2009 49.2 53.9 27.4 2010 49.4 54.5 26.9 2011 49.7 54.9 27.1 2012 49.9 55.2 28.4 2013 50.2 55.6 29 2014 51.3 57 29.8 2015 51.8 57.9 30 8
Labor Force Participation Facts [Labor Supply in the United States, 2010 (persons aged 25 64)] Labor Market Participation Rate Annual Hours of Work Percent of Workers in Part-Time Jobs Men Women Men Women Men Women All Persons 85.4 72.4 2031 1797 5.8 15.5 Education Attainment: Less than 12 years 74.0 48.2 1763 1617 9.4 18.5 12 years 83.1 68.2 1949 1755 5.8 15.8 13-15 years 85.6 75.0 2030 1771 6.2 16.3 16 years or more 91.6 80.4 2182 1878 4.6 14.1 Age: 25 34 89.9 74.5 1930 1749 7.0 14.4 35 44 91.6 76.1 2084 1798 4.3 15.8 45 54 86.9 76.5 2089 1853 4.6 14.2 55 64 70.5 60.8 2015 1777 8.0 18.6 8
Labor Force Participation Facts [Labor Supply in Korea, 2010 (persons aged 20-)] Labor Market Participation Rate Annual Hours of Work Men Women Men Women All Persons 73.0 49.4 2287 2174 Education Attainment: Less than 12 years 48.2 35.8 1816 12 years 74.8 52.6 1962 13-15 years 91.9 64.9 2080 16 years or more 87.9 62.2 2072 Age: 20-29 64.0 62.4 1,975 30-39 93.1 55.3 2,161 40-49 93.5 65.8 2,117 50-59 87.5 57.9 2,078 60-50.3 26.9 1,967 8
Average weekly hours of work of production workers, 1900-2013 10
Utility Function Neo-Classical Model of Labor-Leisure Choice Measure of satisfaction individuals receive from consumption (C) of goods and leisure (L). U = f(c, L) U is an index. The higher is U, the happier is the person. 11
Indifference Curves Downward sloping, indicating the tradeoff between consumption and leisure. Higher curves = higher utility. Do not intersect. Convex to the origin, indicating that opportunity costs increase. 12
Indifference Curves Consumption ($) 500 450 400 40,000 Utils 25,000 Utils 100 125 150 Hours of Leisure 13
Differences in Preferences Consumption ($) Consumption ($) U 1 U 1 U U 0 0 Hours of Leisure Hours of Leisure Workers with steeper indifference curves value their leisure relatively more than workers with shallower indifference curves. 14
The Budget Constraint The budget constraint defines the worker s opportunity set, indicating all of the consumption leisure combinations the worker can afford. C = wh + V Consumption equals labor earning (wages hours of work) plus nonlabor income (V). As h = T L, can rewrite C = w(t L) + V. 15
Graphing the Budget Constraint Consumption ($) wt+v Budget Line V E 0 T Hours of Leisure 16
The Hours of Work Decision Individuals choose consumption and leisure to maximize utility. Optimal consumption is given by the point where the budget line is tangent to the indifference curve. At this point the marginal rate of substitution (MRS) between consumption and leisure equals the wage. Any other consumption leisure bundle on the budget constraint would give the individual less utility. 17
Optimal Consumption and Leisure $1,200 $1,100 A Y $500 P U 1 U* $100 0 110 70 40 110 0 E U 0 Hours of Leisure Hours of Work 18
The Effect of a Change in Nonlabor Income on Hours of Work Consumption ($) F 1 F 0 P 1 U 1 $200 P 0 U 0 E 1 $100 E 0 70 80 110 Hours of Leisure An increase in nonlabor income leads to a parallel, upward shift in the budget line, moving the worker from point P 0 to point P 1. If leisure is a normal good, hours of work fall. 19
The Effect of a Change in Nonlabor Income on Hours of Work Consumption ($) F 1 F 0 P 1 U 1 $200 P 0 U 0 E 1 $100 E 0 60 70 110 An increase in nonlabor income leads to a parallel, upward shift in the budget line, moving the worker from point P 0 to point P 1. If leisure is inferior, hours of work increase. 20
More Leisure at a Higher Wage When the income effect dominates the substitution effect, the worker increases hours of leisure in response to an increase in the wage. Consumption ($) G U 1 D R Q F U 0 P D V E 0 70 75 85 110 Hours of Leisure 21
More Work at a Higher Wage When the substitution effect dominates the income effect, the worker decreases hours of leisure in response to an increase in the wage. Consumption ($) G U 1 D U 0 R Q D F P V E 0 65 70 80 110 Hours of Leisure 22
To Work or Not to Work? Are the terms of trade sufficiently attractive to bribe a worker to enter the labor market? Reservation wage: the lowest wage rate that would make the person indifferent between working and not working. Rule 1: if the market wage is less than the reservation wage, then the person will not work. Rule 2: the reservation wage increases as nonlabor income increases 28
The Reservation Wage Consumption ($) H Has Slope -w high Y G X E U H U 0 0 T Has Slope -w Hours of Leisure 24
Labor Supply Curve Relationship between hours worked and the wage rate. At wages slightly above the reservation wage, the labor supply curve is positively sloped (the substitution effect dominates the income effect). If the income effect begins to dominate the substitution, hours of work decline as the wage rate increases (a negatively sloped labor supply curve). 30
The Backward Bending Labor Supply Curve Wage Rate ($) 25 20 10 0 20 30 40 Hours of Work 26
Labor Supply Elasticity The labor supply elasticity (σ) measures responsiveness in hours worked to changes in the wage rate. σ = Percent change in hours worked divided by the percent change in wage rate. Labor supply elasticity less than 1 is inelastic as hours of work respond proportionally less than the change in wages. Labor supply elasticity greater than 1 is elastic as hours of work respond proportionally more than the change in wages. 32
Labor Supply of Women Substantial cross-country differences in women s labor force participation rates. Over time, women s participation rates have increased. In most studies on female labor supply, the substitution effect dominates the income effect for women, implying an upward sloped labor supply curve. 33
Growth in Female Labor Force Participation Rates and the Wage Cross Countries, 1960-1980 Source: Jacob Mincer, Intercountry Comparisons of Labor Force Trends and of Related Developments: An Overview, Journal of Labor Economics 3 (January 1985, Part 2): S2, S6. 34
Policy Application: Welfare Programs and Work Incentives Cash grants reduce wage incentives. Welfare programs create work disincentives. Welfare reduces supply of labor by increasing nonlabor income, which raises the reservation wage. 35
Effect of a Cash Grant on Work Incentives A take-it-or-leave-it cash grant of $500 per week moves the worker from point P to point G, and encourages the worker to leave the labor force. Consumption ($) F 500 P G U 1 U 0 0 70 110 Hours of Leisure 31
Effect of a Welfare Program on Hours of Work Consumption ($) U 0 U 1 F slope = -$10 H D slope = -$5 Q P R $500 D G 0 70 100 110 E Hours of Work 32
Labor Supply over the Life Cycle Wage rates change over the worker s life (over the life cycle). Wages are low when young. Wages rise with time and peak around age 50. Wages decline or remain stable after age 50. The changes in wages over the life cycle are evolutionary wage changes that alter the price of leisure. 38
Theoretical Issues of Evolutionary Wages A person will work more hours when wages are higher (i.e., the substitution effect tends to dominate the income effect). The profile of hours of work over the life cycle will have the same shape as the ageearnings profile. Intertemporal substitution hypothesis: people substitute their time over the life cycle to take advantages of changes in the price of leisure. 39
The Life Cycle Path of Wages and Hours for a Typical Worker Wage Rate Hours of work 50 Age 50 Age 37
Hours of Work over the Life Cycle for Two Workers with Different Wage Paths Wage Rate Hours of Work Joe Joe (if substitution effect dominates) Jack Jack t * Age t * Joe (if income effect dominates) Joe s wage exceeds Jack s at every age. Although both Joe and Jack work more hours when the wage is high, Joe works more hours than Jack if the substitution effect dominates. If the income effect dominates, Joe works fewer hours than Jack. Age 38
Labor force participation rate Labor Force Participation Rates over the Life Cycle in 2013 100 90 80 Male 70 60 Female 50 40 30 15 25 35 45 55 65 Age 39
Annual hours of work Hours of Work over the Life Cycle in 2013 2.500 Male 2.000 Female 1.500 1.000 500 15 25 35 45 55 65 Age 40
Labor Supply Over the Added-worker effect. Business Cycle So-called secondary workers currently out of the labor market are affected by a recession because the main breadwinner becomes unemployed or faces a wage cut. A secondary worker may choose to enter the labor force during these bad times The labor force participation rate of secondary workers (i.e., the added worker effect) is countercyclical. 44
Labor Supply Over the Business Cycle Discouraged worker effect. Unemployed workers find it very difficult to find jobs during a recession, so they give up searching. Discouraged workers exit the labor force during bad times. The labor force participation rate of discouraged workers is pro-cyclical. 45
Labor Supply Over the Business Cycle The discouraged worker effect dominates the added-worker effect, especially during recessions. The Labor Force Participation Rate is procyclical 46
Retirement Lifetime income is higher the longer a worker puts off retirement. If pension benefits are constant, wage increases have a substitution and income effect, so lifetime income might not be altered. An increase in pension benefits reduces the price of retirement, increasing the demand for leisure and encouraging the worker to retire earlier. 47