Real earnings have risen since 1940 and since the income effect dominates the substitution effect for older males, the participation rate has fallen.
Social Security and private pensions
Social Security benefits and coverage has increased over time.
This non-labor income has encouraged exit from the labor force.
Private pension coverage has expanded which is another source of non-labor income.
Pension rules have been changed to encourage early retirement.
The Social Security disability program has become more generous which encourages low wage workers to exit the labor force.
Earnings of workers past their mid 50’s tend to grow slowly or decline.
Their education and training become more obsolete as well as declines in physical and mental capabilities.
This lower wage growth encourages workers to substitute retirement for work.
Why LFP Rate of Older Males Declined
Female Participation Rates, by Age Most of the rise in participation rate is due to a rise in participation among married women . This is a surprising result since the rise in real wages of married men would have tended to decrease participation rates of married women
Rising real wage rates for women
The rise in real wages for women has both a Becker income and substitution effect.
Substitute towards goods in terms of both consumption and production of commodities.
Small income effect since its effect depends on the number of hours already working.
It is 0 if not currently working.
Changing preferences and attitudes
Career objectives of women have changed over time towards more market work.
Changed indifference curves to make them flatter.
Rising productivity in the household
Technology improvements have reduced the time necessary for household production and freed time for market work.
Microwaves, vacuum cleaners.
Why the Participation Rate of Females has Risen
Presence of pre-school is associated with lower participation rates and the one-half decline in the birth rate and has freed time for market work.
High wages tend to lower the birth rate since it raises the opportunity cost of children.
The impact of children on participation has declined over time.
Rising divorce rates
The rise in the divorce rate has increased the incentive for women to participate in order to protect themselves against the impact of a potential divorce.
Expanding job accessibility
There has been expansion in employment in jobs traditionally held by women.
The availability of part-time jobs has increased making it easier for women to work.
Why the Participation Rate of Females has Risen
Attempts to maintain living standards
In the last 20 years, the earnings of males has been stagnant and falling in some cases.
Married women may have increased their participation to maintain the family’s living standard.
Likely the most important explanations are the rise in the real wage rate and the expansion of “women’s jobs.”
The timing is off for the attitudes and anti-discrimination laws.
The technology innovations and lower birth rates may the result rather than the cause of the higher participation rates.
Why the Participation Rate of Females has Risen
Female Participation Rates, by Race
Male Participation Rates, by Race
African-American males face worse labor market conditions due to lower education, discrimination, and mismatch between location of jobs and residence.
Non-market income sources such as Social Security and public assistance are more appealing to African-American males since have lower wages.
Illegal activities may be also more attractive.
The health of older African-American males tends to be worse than for older white males.
High participation rate of African-American wives may lower the participation rate of African-American husbands.
Lower Participation Rate for African-American Males
The business cycle has two offsetting impacts on participation.
The added-worker effect occurs when the primary earner loses his or her job and other family members look for a job to offset the decline in family income.
This because the other family members suffer a decrease in their non-labor income.
The discouraged -worker effect occurs when a person stops looking for work because they become very pessimistic about finding a job.
Recessions lower wages and thus the “price” of leisure and so some workers substitute leisure for job search.
The discouraged worker effect outweighs the added worker effect and so the labor force shrinks in recessions.
The added worker effect applies only to families where the primary earner is unemployed, while the discouraged worker effect may impact all workers.
Some married women are only marginally attached to the labor force.
Cyclical Changes in Participation
Why Have Hours of Work Remained Stable since 1945
Rise in real wages since 1945 should have decreased weekly work hours due to the income effect.
A leading explanation is the rise in education levels has offset the impact the rise in real wages.
More education may reflect more job commitment
Educated worker have nicer working conditions and thus less desire to reduce hours.
Educated workers have more fixed costs per worker (e.g. training) and thus firms resist reductions in hours per week (costs per hour rise).
Other factors include higher tax rates, and overtime pay premiums
Americans face a “time squeeze” since total hours worked per person has risen.
Partly due to rise in share of prime-age workers who work more hours.
Much of the rise has been voluntary since highest paid jobs have had biggest rise.
Hours of leisure have risen not fallen.
Household production time has fallen.
Are Americans Overworked?
Household production and Technology
Technology made women more productive in HH,
but also makes long hours on household production unnecessary
first hours of H highly valued
additional hours much less valued
20 th century time savers:
shift some hours spent on housework to either
Households produce utility-yielding commodities with combinations of market goods and time.
Examples of commodities: meal, clean house, entertainment, quality of children
Three uses of time
Labor market time (generates income to buy market goods)
Household production time
Uses of time are competitive with each other
Work takes away time from household production and leisure
more hours worked, more $ to buy stuff
but less time for leisure and household production
Model of the allocation of time
Allocation of time
Should I work hours by 1 (and therefore leisure by 1)?
Answer: I will work by 1 hour as long as the market values my time more than I do.
Market time valuation : wage
Individual has no influence on market wage
Leisure time valuation : How I am willing to trade off work/leisure
Factors that affect decision
own preferences for work vs leisure, market wage, and nonlabor income.
Model assumes individual will maximize utility subject to budget constraints (limits on time, money to spend, etc.).
Time-intensive commodities use a large amount of time and a small amount of goods.
Watching the sunset.
Goods-intensive commodities use a small amount of time and a large amount of goods.
Meal at fast-food restaurant.
As labor-market time becomes more valuable—substitute time-intensive commodities for goods-intensive ones.
Indifference Curve Leisure Hr Income/day 24 0 Indifference curve shows work and leisure combinations that yield the same amount of total utility. 24 0 Work Hr U
To keep the level of utility the same, some of income must be given up if one wants more leisure
Convex to origin
With low hours of leisure, individuals are willing to give up large amount of income to get 1 more leisure hour.
With high hours of leisure, individuals are willing to give up small amount of income to get 1 more leisure hour.
Budget Constraint Leisure Income/day 24 0 Budget constraint shows the combinations of income and leisure that a worker could get given a wage rate $120 At a wage rate of $5, a worker could get a maximum income of $120 per day ($5/hour * 24 ) At a wage rate of $10, a worker could get a maximum income of $240 per day. At a wage rate of $15, worker could get a maximum income of $360 per day. $240 $360 Slope of budget constraint (rise/run) = wage rate
Utility Maximization Leisure Income/day 24 0 The optimal or utility maximizing point is where the budget constraint is tangent to the highest attainable indifference curve $240 U 1 U 2 U 3 16 $80 A At a wage rate of $10/hour, the optimal hours of leisure is 16 (8 hours of work) at point A $360
Utility Maximization Leisure Income/day 24 0 The optimal or utility maximizing point is where the budget constraint is tangent to the highest attainable indifference curve $240 U 2 U 3 16 $80 A If the wage rate rises to $15/hour, the optimal hours of leisure is 15 at point B B At a wage rate of $10/hour, the optimal hours of leisure is 16 (8 hours of work) at point A 15 $360
Utility Maximization Leisure Income/day 24 0 $240 U 2 U 3 15 16 17 $80 A Income effect is measured through a parallel shift of the old budget constraint, from A to C (from 16 to 17 hours of leisure). Substitution effect is measured by movement along U 3 , from C to B (from 17 to 15 hours of leisure). Net effect is an increase of hours of work by 1 hour. B C Income and substitution effects
Assume Mark has maximized utility subject to his budget constraint so that he is working for pay 40 hours per week with wage = $10/hour.
What if wage increases to $15/hr ?
Income effect of higher wage
higher wage increases income (he is richer)
Demand for leisure increases, hours of work fall
Substitution effect of higher wage
higher wage increases opportunity cost of leisure
hours of work increase
Substitute goods for time in production of commodities
buy more restaurant meals and fewer home-cooked meals.
fly to vacation rather than drive.
Income and Substitution Effects
Effect of Change in Wage on Employment
Dominant substitution effect, at least at lower wages.
perhaps income effect has become more dominant in recent years.
If only working few hours per week:
wage could cause person to leave labor force.
If start out of LF and then wage increases:
Causes only substitution effect so will increase probability of working for pay.
Change in Nonlabor Income
Mark has maximized utility subject to his budget constraint so that he is working for pay 40 hours /week with wage = $10/hour.
Now there is an nonlabor income (he won a lottery):
demand for all normal goods including leisure
paid work hours.
probability of working for pay (because it means a higher market wage is required to induce Mark to work for pay).
Effect is opposite if nonlabor income falls.
Taxes and Labor Supply
Progressive tax system based on taxing families instead of individuals means that the earnings of a sequentially secondary earner are taxed at a higher marginal rate.
Higher marginal tax rate means that household production has lower opportunity cost.
Lower wage should mean less leisure, if leisure is a normal good.
Therefore, theoretically, the overall impact on labor supply is ambiguous.
Empirical research suggests that reductions in tax rates do increase both the hours worked and labor force participation
Income Tax and Individual Labor Supply Leisure Income/day 24 0
An income tax shifts the after- tax wage downward and may either raise or lower a person’s optimal number of hours of work.
$240 I 1 I 2 16 U 2
Prior to the income tax, the optimal hours of work is 9 (15 hours of leisure) at point U 1 .
15 U 1 $360
The optimal hours of work would increase if the income effect was larger than the substitution effect.
After the income tax, the optimal hours of work decreases to 8 (16 hours of leisure) at point U 2 . This implies the substitution effect caused by the tax is larger than the income effect.
Leisure Cost of Goods
Leisure cost of an $8 movie ticket: how many hours you have to work in order to pay for it
If wage=$6/hr, work 1 hr 20 min to pay for ticket
If wage=$16/hr, ticket costs 30 min of leisure
1908 Ford Model T cost 2 years of average wages.
1997 Taurus cost 8 months of wages
Gallon of gas in 1970: 6.6 min, in 1997 5.4 min
Half-gallon of milk in 1919: 39 min, in 2000: under 7 min
in 1900 a pair of Levis was 9 hours and 42 min,
2000: 3 hours and 24 min
In 1910 a 3-min coast-to-coast phone call: 90 hrs 40 min, today, many people treat such phone calls as free.