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3.3Labour Supply 3.3.1Assumptions of the Model 3.3.2Deriving the Budget Constraint 3.3.3Labour Supply Decision 3.3.4Summary.

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Presentation on theme: "3.3Labour Supply 3.3.1Assumptions of the Model 3.3.2Deriving the Budget Constraint 3.3.3Labour Supply Decision 3.3.4Summary."— Presentation transcript:

1 3.3Labour Supply 3.3.1Assumptions of the Model 3.3.2Deriving the Budget Constraint 3.3.3Labour Supply Decision 3.3.4Summary

2 3.3.1 Assumptions of the Model People have a choice: to work or not to work If not working, they will remain at home or engage in leisure Supply labour if Price (wage) > reservation wage Reservation wage is the minimum wage needed to attract a person away from leisure and into work Represents the opportunity cost of labour

3 Simplify the analysis to a choice between work and leisure Assume seven days of 24 hours available Can analyse using indifference curve analysis Assume labour is homogeneous and waged Can we model this decision making? Assume the wage rate is

4 Leisure Hours Income 168 If no work undertaken then 168 hours of leisure taken and income is zero (a) If worker then decides to work one hour then leisure decline and income rises to a b w One more hour gives income of 2 c 2w Work Hours Deriving the Budget Constraint

5 Leisure Hours Income 168 w Slope = - 1 Maximum income is 168

6 Indifference curve for income-leisure trade off Leisure Hours Income U2 U3 U1 Work Hours

7 3.3.3Labour Supply Decision Once someone is working how do they respond to a change in the wage rate? Two key elements: Substitution effect – as wages rise, person works more and substitutes work for leisure as the opportunity cost of leisure rises Income effect – as wages rise, person works less as his/her income has risen thus allowing him/her to spend more time in leisure activities

8 Leisure Hours Income 168 Y1 a b c U2 U1 Y2 Substitution: a to c (wage up, work up) Income: c to b (income up, work down)

9 For most workers, SUBSTITUTION > INCOME effects but…... Y1 Y2 Y3 Y4 Y5 (no I curves shown) Price consumption curve

10 Hours worked Wage W1 H1 BACKWARD BENDING SUPPLY CURVE FOR LABOUR

11 3.3.4Summary Reservation wages determine the point of entry into the labour market Need to trade-off between leisure and income Can analyse using indifference curve approach Income effects can outweigh substitution effects to give a backward bending supply curve Implications for tax/benefit policy


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