Labor Supply

Income Effect of a Wage Increase

A higher wage raises a worker's income, increasing the demand for all normal goods, including leisure, so the quantity of labor supplied to market work decreases. (Or, individuals can stay on the same indifference curve while working less)

Suppose the government were to subsidize the wages of all women in the population by paying their employers 50 cents for every hour they worked. What would be the effect on the wage rate women received? What would be the effect on the net wage employers paid? (The net wage would be the wage women received less 50 cents.)

As long as the labor supply is responsive to wages, labor demand would increase. This would mean the effect on the wage rate would be positive (due to the subsidy) but only so much as the supply of labor does not increase. The wage rate would be somewhere in between. This would lower the new wage because more women would join the labor force, rising wages by less than 50c and letting the employer keep the rest.

Evaluate the following quote: "Higher take-home wages for any group should increase the number of hours worked for group." True or False?

False. The income effect will cause some workers to choose to work less, maximizing their utility with more leisure time. People want well-balanced baskets

What is a labor supply curve?

How a worker's desire to work (or supply labor) relates to his wages

How do you determine where an individual will move on the graph when when the income and substitution effects are working in opposite directions?

It depends on the exact preferences of the individual. If not given, it is indeterminate.

The city of Rochester, New York, was declared a "foreign trade zone" by the U.S. Department of Commerce. A foreign trade zone is designated as "international ground," and companies in that zone are exempt from paying customs duties on component parts they import to manufacture their products. Analyze the effects of this foreign trade zone designation on the demand for labor in the Rochester area.

Scale + Substitution effects More manufacturing in Rochester could be expected to increase demand for labor. However, the exceptions from duties on component parts might lead firms to sub out domestic for foreign labor for manufacturing component parts.

Do stars earn more than nonstars? How are the wages of each group determined?

Stars earn more than nonstars because wages are set by W' or the wages of the employees alternative offer. Since teams are competing, this wage can rise up to the MRP of the player. For non-stars, MRP is less significant so wages are set mostly by W' or the amount needed to pay so they don't switch to a non-football job.

Suppose a decrease in non-wage income and an increase in wages. The original budget constraint and new budget constrain intersect at point A. Where are the income and substitution effects working in opposite directions, and where are they working in the same direction?

The income and sub effects are working in opposite directions left of A, and in the same direction right of A.

The marginal revenue product of labor in the local saw mill is MRPL = 20 - .5L, where L = the number of workers. If the wage of saw mill workers is $10 per hour, then how many workers will the mill hire?

The mill will hire workers until MRPL = W. 10 = 20 - .5L L = 20 workers.

What's the effect of reducing the Marginal Tax Rate? (1986 Tax Reform) Given that Tax Revenue remains constant?

The wage-rate is essentially increased: as individuals are taxed less per dollar earned. However, if Tax Revenues remain constant we can assume that individuals are choosing to work more given the increased wage rate, showing a pure substitution effect.

Suppose a decrease in non-wage income and an increase in wages. The original budget constraint and new budget constrain intersect at point A. What is the change in work incentives for those left of A?

Those left of A have mixed incentives. They want to work more because the price of leisure is now more expensive, however they also can now work less while maintaining a position on the same or higher indifference curve, thus reducing their incentive to work. Which incentive is stronger is indeterminate as it depends on individuals' preferences.

Suppose a decrease in non-wage income and an increase in wages. The original budget constraint and new budget constrain intersect at point A. What is the change in work incentives for those right of A?

Those right of A have a strengthening of incentives to work. Remaining on the same indifference curve (substitution effect), an individual would choose the work more due to the higher wage. Given that an individual might now choose to move left onto a higher indifference curve, we can say that both the income and substitution effects are moving in the same direction: making this strengthening of incentive clear-cut.

Evaluate the following quote: "Higher take-home wages for any group should increase the labor force participation rate for that group." True or False?

True. Key word: Participation. Not be that everybody will increase their hours, but if you are deciding whether or weather not to enter the labor market, the income effect is NULL, it's simply about the substitution effect of whether the wage is high enough to induce you to give up an hour of leisure.

What leads to a backwards bending labor supply curve?

When an individual will work MORE up until a certain wage, and then after that point, work LESS

What leads to a negatively sloped labor supply curve?

When the income effect dominates: labor supply will decrease with the wage rate.

What leads to a positively sloped labor supply curve?

When the substitution effect dominates: labor supply will increase with the wage rate.

What does it mean to "analyze work incentives"?

Will people work more or less? Income vs. substitution effect.

substitution effect of a wage increase

a higher wage encourages more work because leisure now has a higher opportunity cost