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Chapter 2

EC306 Chapter Notes - Chapter 2: Opportunity Cost, Inferior Good, Statics

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Jason Dean

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EC306 Economics of Wages and Employment
Chapter 2: Labor Supply: Individual Attachment to the Labor Market
Labor Force Participation decision: a decision to participate in paid labor market activities as
opposed to other activities such as unpaid work in the home, volunteer work, education, or
Labor force(LF): consists of those persons in the eligible population who participate in labor
market activities, as either employed or unemployed.
- Employed (E), if they did any work at all in the survey period. Also considered as
employed if they are normally employed but happen not to be at work at the time of
the survey.
- Unemployed (U), with the latter being not employed but seeking work.
- Work- work for pay
Eligible population: portion of the population that is surveyed as potential labor force
- Persons from that potential population of labor force participants (POP) are categorized
as either in the labor force or no in the labor force (NLF).
Labor force participation rate (LFPR): the fraction of the eligible population that participates in
the labor force (LFPR = LF/POP)
Unemployment rate (UR): the proportion of the labor force that is unemployed (UR = U/LF)
Population Labor force Employed/ unemployed
Non labor force
Most of the variation in overall participation is due to differences in the participation
rate of women
Participation rate for women seem to be positively related to the level of economic
development, with the richer countries having higher female participation rates, or at
least smaller gaps between men and women.
- As outies get ihe ad as oe’s eduatio ad lao aket oppotuities
improve, a convergence occurs in the economic roles of men and women, at least as far
as their participation rate is concerned.
Hour-of-work aspect of labor supply: has variety dimensions including hours per day, days per
week, and weeks per year.
Change in hours of work can affect quantity and quality of our overall labor supply.
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EC306 Economics of Wages and Employment
Changes in hours of work, in turn, can be affected by changes in the age and sex structure of
the labor force, the prominence of two-earner families, government policies and laws, and the
wage rate.
Basic Income-Leisure Model
Labor supply model: to epeset a idiidual’s choice of hours worked given his or her
market opportunities and the value he places on their nonmarket time.
We wish to model this person as doing the best they can, subject to the constraints of the labor
market and the limited availability of time.
We diide the idiidual’s decision-making problem into two parts:
- What he would like to do (preferences)
- The choices available (constraints)
The assumption of rationality brings the two parts together, yielding a unique characterization
of a idiidual’s hoie as a futio of preferences and market constraints.
- consumption of goods and services
- Leisure
embodies all nonlabour market activities, including household work and education, pure
leisure activities.
We can graphically represent consumer preferences with indifference curves.
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EC306 Economics of Wages and Employment
- The individual is indifferent between various combinations of consumption and leisure
as given by the U0.
- The slope of the indifference curve exhibits a diminishing marginal rate of substitution
between consumption and leisure.
At point A, the individual has an abundant of consumption and hence is willing to
give up considerable consumption to obtain more leisure. Steeply sloped.
At point B, the individual has an abundance of leisure and hence is willing to give up
considerable leisure. relatively flat sloped.
At intermediate point C, consumption and leisure are more subsumable because the
individual is not saturated with either.
We cannot compare utility across individuals, but we can compare marginal rate of
substitution across consumers.
Consumer 1, bundle A lies on indifference curve U1, while for consumer 2 the same
bundle lies on indifference curve U2.
- Consumer 1 has a higher MRS at A than consumer 2. Consumer 1 places a higher
value on leisure (at A) than does consumer 2.
- To induce consumer 1 to give up leisure from l0 to l1 requires compensating him with an
increase in consumption from C0 to C1 to keep him equally happy, whereas it would
require an increase to only C2 to compensate consumer 2.
The value of consumption is PC.
We ignore saving so that we can set PC = income
This allows a simple transformation of our model from consumption-leisure to income-leisure.
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