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Application 1: Labor supply

L9. Application 1: Labor supply. Review. Model of choice We know preferences and we find The two differences – net demands Buying, selling?. Geometry. x 2. w 2. w 1. x 1. Three Applications. 1. Labor Supply (Labor-Leisure Choice) 2. Intertemporal Choice

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Application 1: Labor supply

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  1. L9 Application 1: Labor supply

  2. Review • Model of choice • We know preferences and we find • The two differences – net demands • Buying, selling?

  3. Geometry x2 w2 w1 x1

  4. Three Applications 1. Labor Supply (Labor-Leisure Choice) 2. Intertemporal Choice (Consumption-Savings Choice) 3. Uncertainty (Insurance) (Consumption across states of the world)

  5. Labor Supply Model (One day) • Two “goods”: leisure time, R, and consumption, C • A worker is endowed with time 24h • Consumption good’s price is pc. • w is the wage rate in $ • New: Labor supply

  6. Translation:

  7. Budget set • The worker’s budget constraint iswhere C, R denote gross demands for the consumption good and for leisure. • This can be rewritten as

  8. Budget set C 24 R

  9. Budget set C 24 R

  10. Quiz: Real Price • Budget set depends on wage and price only through ratio • Ratio is called a real wage rate Q: Real wage rate is a “price” of • time in terms of $ • time in terms of commodity • commodity in terms of $ • commodity in terms of time

  11. Preferences C 24 R

  12. Labor supply Curve: Definition C R 24

  13. Cobb Douglass: Optimal Choice

  14. Cobb Douglass: Labor Supply C R 24

  15. Cobb Douglass: Labor supply L

  16. Empirical Evidence: Inelastic Backward-Bending Labor supply

  17. Solution: overtime wage First 8 hours of work: w The following hours: w’>w w’ is an overtime wage rate

  18. Overtime wage rate: Budget set

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