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Chapter 2

Chapter 2

Course Code
Erik Gunderson

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Analyzing labour force participation behaviour
Reservation wage wage rage at which an individual would be indifferent between
participating and not participating in the labour force; the lowest wage required to prevent
the worker from withdrawing from the labour force; the wage threshold that suffices to
induce a nonparticipating worker to join the labour force; slope of the individuals
indifference curve at zero hours of work (WR)
If the market wage is less than the reservation wage individual will not participate in
labour force
If the market wage exceeds the reservation wage individual will participate in labour
force (since the return from engaging in labour market activity exceeds that individuals
valuation of time n nonlabour market activities)
Normal good: a good whose quantity demanded increases with the level of income (leisure
in the context of labour supply model)
Inferior good: a good whose quantity demanded decreases with the level of income
Income effect: the portion of the change in quantity demanded resulting from a price change
that is attributed to the change in income, holding relative prices constant (in the case of a
wage increase it leads to reduced work, assuming that leisure is a normal good)
Substitution effect: the change in quantity demanded of labour that results from a change
in the wage rate; holding the level of output fixed; the proportion of the change attributable
solely to the change in the relative factor prices (in the case of a wage increase, it leads to
increased work because the opportunity cost of leisure or the income forgone by not working
Is higher and hence the person may substitute away from leisure)
Increase in wage rate - As a wage increase may lead to a reduction in hours worked, it will
never induce a participant to stop working (the wage rate is still higher than the
reservation wage)but a nonparticipant may be induced to work if the wage arises above
the reservation wage.
Increase in reservation wage - An increase in nonlabour income will never cause a
nonparticipant to enter the labour force and may cause some participants to withdraw
from the labour force (pure income effect)
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