How education impacts earnings and the decision to obtain education

AJ 499: O1 spring 2020
Writing assignment 3.
Chapter 12 can be very useful to complete this assignment.
Please submit to my email [email protected] on or before March
27th 2020.
Write a short paper (2-4 pages) about domestic violence and
how certain aspects of being in those situations can further
impact lives.
ECON 370 - Chapter 9 - Labour
Economics
Maggie Jones
Why do people obtain education?
I Our discussion of labour supply has focused on the quantity
aspect

I extensive margin: do individuals provide labour at all?
I intensive margin: how much labour to provide?
I So far we have ignored the quality dimension
I quality encompasses education, training, labour market
information, mobility, and health
I Two prevailing theories:
I Becker (1964): Human Capital Model
I investments are made in human resources to improve
productivity and hence earnings
I Spence (1974): Signalling Model
I education is used to signal or “sort” workers of di↵ ering
abilities
Human Capital Model
Human Capital Model
I Education enhances productivity
I Costs are incurred now because of the expectation of future
benefits

I costs:
I benefits:
Human Capital Model
I Decision rule: go to school if the benefits exceed the costs
I Model is a simplification in that it only considers:
I investment components (ignores consumption components)
I private components (ignores social components)
Return to Schooling
Return to Schooling
Age-Earnings Profile by Education
I Environment consists of 3 levels of schooling
I Each level of education is associated with an age-earnings
profile
I None = < High School =) enter workforce at age 16 and
earn Ynone
I HS = High School Degree =) enter workforce at age 18 and
earn Yhs

I PS = Post-Secondary Degree =) enter workforce at age 22
and earn Yps
I Assume Ynone,t < Yhs,t < Yps,t 8t
I Education is costly: tuition, books, opportunity costs
Age-Earnings Profile by Education
Assumptions
I No psychic utility/costs from education
I hours of work are fixed
I expected income is known for each level of education
I individuals can borrow or lend at rate r
Age-Earnings Profiles by Education
E
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s
Age

Signaling Model
Signaling Model
I Education does not increase productivity
I Workers are still rewarded for productivity, but their
productivity varies according to their underlying ability
I Employers do not know underlying ability, so must use
“signals” to infer productivity
I In this sense, imperfect information is embedded in the
signaling model
I Individuals know their productivity and employers wages and
choose education to maximize their utility

Economics
Maggie Jones
Compensating Wage Differentials
I Our discussion thus far has mostly assumed that workers are
homogenous
I One of the implications of this assumption is that wages will
be the same for these workers
I In reality the wages of di↵ erent members of the population
di↵ er substantially
I We’re going to shift focus to understand some of the ways in
which wage di↵ erentials can arise
Compensating Wage Differentials
I Workers may be equally productive but face di↵ erent working
environments for which they receive di↵ erent compensation
I Adam Smith outlined 5 principals that result in di↵ erential
compensation

I agreeableness or disagreeableness of employments themselves
I easiness and cheapness or di�culty and expense of learning
them
I constancy or inconstancy of employment in them
I small or great trust which must be reposed in those who
exercise them
I probability or improbability of success in them
The Firm
Single Firm’s Isoprofit Schedule
I We will begin by focussing on wage di↵ erentials that arise
due
to compensation for risk of injury or illness
I Trace out firm’s isoprofit schedule to obtain all the
combinations of wages and “safety” (or any job attribute) that
generate a given level of profits
I Both wages and providing a safe work environment are costly
and must be traded-o↵ accordingly
I firm can provide more safety and maintain the same level of
profits if it can reduce wages
I Firm exhibits a diminishing marginal rate of transformation
between wages and safety

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safety
Different Firms with Different
Safety Technologies
I Higher isoprofit schedules correspond to lower profits
I The shape of the isoprofit schedule is determined by the
underlying safety technology
I di↵ erent firms can have di↵ erent abilities to provide safety at
a given cost
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safety
Safety Technologies
I The outer limits of the two isoprofit schedules are known as

the market envelope curve
I They display the maximum compensating wages that will be
o↵ ered in the market for various levels of safety
I Note that in a competitive equilibrium, firms earn 0 profits so
that I1 = I2 = 0
The Worker
Single Individual’s Preferences
I Define an individual’s preferences over wages and safety
I These preferences can be represented by an indi↵ erence curve
I ICs exhibit a diminishing marginal rate of of substitution
between wages and safety
I When safety is “scarce” the individual will give up a large
amount of wages for an incremental change in safety
I When safety is “plentiful” the individual is less inclined to
give
up wages
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safety

Differences in Risk Preferences
I Individuals may di↵ er across their “riskiness”
I e.g., risky individual does not need to be paid a much higher
wage to accept a lower level of safety
I less risky individual needs to be paid a higher wage in order to
accept a lower level of safety
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safety
Equilibrium with Single Firm, Single
Individual
Individual

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safety
Equilibrium with Many Firms and
Individuals
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safety
Equilibrium with Many Firms and
Individuals
I Risk averse individuals sort themselves into safer
firms/industries/occupations
I Risky individuals sort into less safe
firms/industries/occupations that pay high wages
I Set of tangencies between isoprofit and indi↵ erence schedules
outline the wage-safety locus
I slope of the wage-safety locus gives the change in the wage
premium that the market yields for di↵ erences in the risk of

the job
I given that compensating wages are required for reductions in
safety, the only restriction on the slope of the wage-safety
locus is that it is negative
Effects of Safety Regulations
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safety
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safety
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safety
Single Firm’s Isoprofit Schedule
I Referring to the previous graph, we see that the firm’s
isoprofit schedules exhibit a diminishing marginal rate of
transformation
I At s = 0 the firm provides no safety. It can therefore increase
safety relatively cheaply.
I Once safety increases substantially, it becomes more costly for
the firm to provide increased levels of safety
Safety Technologies
I Firm 1: safety is costly to implement (e.g. dangerous
industries like mining or logging)
I Firm 2: safety is cheap to implement (e.g. o�ce job)
I Outer edge of isoprofit schedules represents the market
envelope curve (a.k.a. the employer’s o↵ er curve)

Individual
I In the previous graph we assume perfect competition
I Firm will operate on IP schedule such that profits are equal to
0 given the safety technology that the firm faces
I Consumer will try to reach maximum utility (indi↵ erence
curve) given that the firm is restricted to making 0 profits
Equilibrium with Many Firms, Many
Individuals
I We imagine 3 firms:
I A - least safe (costly to increase safety)
I B - middle ground
I C - most safe (cheap to increase safety)
I And 3 workers:
I i - riskiest (don’t have to pay much higher wages to accept
less
safety)
I ii - middle ground
I iii - risk averse (have to compensate them a lot for them to be
willing to accept lower safety)
I Equilibrium: risky workers will sort into less safe firms and
receive higher wages and risk averse workers will sort into
more safe firms and accept lower wages

I The previous graph represents a situation where safety
regulations don’t improve the well-being of the individual
I We assume the firm operates in perfect competition and let sR
represent the minimum level of safety mandated by the
government
I The previous graph represents a situation where utility doesn’t
decline in response to an increase in safety
I We assume the firm is not operating in perfect competition, so
that profits are greater than 0
I If the firm makes profits, then to pay for an increase in safety,
the firm can dip in to profits
I This is likely unrealistic in reality
Economics
Maggie Jones

Wages and Employment in a Single
Labour Market
I Chapter 7 puts the supply and demand of labour together to
examine equilibrium wages and employment
I We will start by assuming output markets and labour markets
are perfectly competitive
I Workers sell labour on an individual basis
I We begin with the single firm’s decision problem, then move
to
the market–e.g. “occupation”, “industry”, “region”, etc.–the
level of aggregation that determines wages
I We then examine the implication of relaxing the perfect
competition assumption
The Competitive Firm’s Interaction
with the Market
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Employment
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Employment
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Employment
The Competitive Firm’s Interaction
with the Market
I One problem with the previous analysis is that it assumes that
the firm can actually get all the labour it needs at a given wage
I In the short run this may not always be the case (although in
the long run it is more realistic)
I E.g. the firm may have to raise wages in the short run to
attract workers
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Employment
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Employment
Implications of Competitive Markets
I Wages are equalized across homogeneous workers and
homogeneous firms
I No involuntary unemployment
I No queues to work
In reality, we may have imperfect competition, imperfect
information, risk and uncertainty, or a long-run relationship
between firms and workers
Imperfect Competition in the
Product Market
Imperfect Competition in the Product

Market
I If the industry is competitive in the product market, then the
industry demand for labour is obtained by aggregating all
labour demand curves
I If the firm is a monopolist in the product market, then their
labour demand curve IS the industry labour demand curve
I Under perfect competition, the firm sets MPN ⇥ P = w⇤,
where w⇤ is determined in the market (assumes MR = P)
I The monopolist sets MPN ⇥ MR = w⇤
I as monopolist expands output, MPN AND MR decline
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Market
I Note that there is no reason that the monopolist should a↵ ect
the market wage
I As long as there is a large number of other firms (possibly in
other industries) drawing from the labour market, the

monopolist will not a↵ ect wages
I Thus, the monopolist will continue to act as a wage-taker, as
was the case under competitive markets
Market
I However, it doesn’t always appear to be the case that
monopolists act as wage-takers
I monopolists may earn profits and workers may be part of a
union that collectively bargain for profits to be split among
employees
I monopolists may be larger firms where monitoring is costly,
and thus a “premium” is paid to workers to prevent shirking
Imperfect Competition in the
Labour Market
Imperfect Competition in the Labour
Market
I It may be the case that the firm is the only firm purchasing
labour in a given market

I In this case, the firm has market power in the labour market,
in a similar way that we think about market power in a
product market
I Monopsonists can be either perfectly discriminating or
non-discriminating
I perfectly discriminating = everyone paid reservation wage
I non-discriminating = if you increase the wage to attract more
workers, you have to increase the wage of existing workers, too
Market
I Both types of monopsony result in an upward sloping labour
supply schedule
I Perfectly discriminating:
I Average cost and marginal cost curves flatter
I Non-discriminating:
I Average cost and marginal cost curves steeper
Example: Discriminating vs
Non-Discriminating
N w TCd TCnd ACd ACnd MCd MCnd
1 5

2 10
3 15
4 20
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Market
I Firm will max profits by hiring labour until MC = MRPN
I discriminating monopsonist: wage determined by intersection
of MC and MRPN
I non-discriminating monopsonist: wage determined by point on
AC curve that corresponds to N associated with intersection
of MC and MRPN
I di↵ erence between MRPN and w has been called measure of
monopolistic exploitation

Working with Supply and Demand
I We can use our tools of labour supply and demand is to
“simulate” the e↵ ects of a policy change on equilibrium
employment and wages
I This requires a functional form for labour supply and demand
I NS = f(W ; X)
I ND = g(W ; X)
I W, NS, ND are endogenous variables (meaning they are
determined by the system)
I Z, X are exogenous variables (meaning they are determined
outside the system)
I Solving the system requires a market clearing condition,
NS = ND, from which we can derive w⇤ and N⇤

Economics
Maggie Jones
Demand for Labour in Competitive
Labour Markets
Labour Markets
I The principles that determine the demand for any factor of
production can be applied to study the demand for labour
I We consider the short run as a period of time during which
one or more factors of production cannot be varied
I The long run is then the period during which the firm can
adjust all of its inputs
Labour Markets
I The demand for labour refers to the firm’s decision of how
much labour to employ at each wage
I This decision will depend on the firm’s:

I objectives: to maximize profits
I constraints: demand in product markets, supply conditions in
factor markets, production function
I in the short run, this includes having at least one factor of
production whose quantities are fixed
I Our goal will be to derive the theoretical relationship between
labour demand and the market wage, holding all else constant
Demand for Labour and Market Types
I The amount of labour demanded will depend on the structure
of the product and labour markets
I Product markets (firms sell their output here):
I Perfect Competition*
I Monopolistic Competition
I Oligopoly
I Monopoly
I Labour markets (firms purchase one of their inputs here):
I Perfect Competition*
I Monopsonistic Competition
I Oligopsony
I Monopsony
Perfect Competition in Product and
Labour Markets
I Product markets:

I large number of sellers
I sellers produce a homogeneous product
I sellers and buyers have perfect information
I no barriers to entry
I Labour markets:
I large number of workers
I workers are homogeneous
I workers and employers have perfect information
I no barriers to entry
I Implication is both a horizontal demand in the product market
as well as a horizontal supply in labour market
Demand for Labour in the
Short-Run
Demand for Labour in the Short-Run
I We will consider a firm that produces output Q using inputs of
capital K and labour N
I The firm turns capital and labour into a product according to
the production function:
Q = F(K, N) (1)
I In the short run, capital is fixed at K0 (i.e. it can be treated
like a constant)
I Then the production is just a function of N
I firms can either adjust N by changing the number of people

employed or by changing the number of hours it requires
Demand for Labour in the Short-Run
I Demand in the short-run is derived from examining short-run
output and employment decisions
I Two decision rules follow from profit maximization
I firm will operate if it can cover variable costs (fixed costs
treated as sunk costs)
I if the firm operates, it should produce quantity Q⇤ that sets
marginal revenue (MR) equal to marginal costs (MC)
I If the firm is a price taker, the marginal revenue of another
unit sold is the prevailing market price (MR = P)
I Under perfect competition, the firm cannot influence the
market wage, and so the marginal cost of an additional unit of
labour as input is the prevailing wage (MC = W)
Marginal and Average Product of
Labour
Marginal and Average Product of
Labour vs Employment
Q

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ity
Employment
Marginal Revenue Product and
Average Revenue Product
I Firms only care about quantity because it relates to revenue
I Marginal Revenue Product of Labour: additional
revenue due to additional worker
I Average Revenue Product of Labour: average revenue
per worker
MRPN and ARPN vs. Employment
$
Employment
Deriving Labour Demand
I Two key points arise from firms profit maximizing under
perfect competition
I Operate if total revenue exceed total variable costs
I If producing, produce quantity at which marginal revenue =

marginal cost
MRPN = MCN
Deriving Labour Demand
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Demand for Labour in the Long-Run
Demand for Labour in the Long-Run
I In the long-run, firms can vary all their inputs
I both K and N now choice variables
I Decisions are examined in two stages

I minimum-cost of K and N to produce any output
I given cost minimization, choose profit-maximizing level of
output Q
I Starting point
I isoquants: combinations of capital and labour required for a
given output
I iso-cost curve: combinations of capital and labour the firm
can purchase given their market price for a given expenditure
level
Isoquants
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Labour
Isoquants
I As with utility functions, isoquants exhibit diminishing
marginal rates of technical substitution
I as one input becomes scarce it’s harder to substitute away
from it

I Di↵ erent technologies may have di↵ erent substitutability
across inputs
I 1 broom per employee cleaning sidewalks - adding 10 brooms
without any additional workers doesn’t increase output
I self-checkout machines are highly substitutable for cashiers
Isocost Lines
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Labour
Isocost Lines
I The profit maximizing firm will choose the cheapest level of
K
and N that yields the output Q0
I i.e., choose the combination of K and N on isoquant Q0 that
lies on the isocost line closest to the origin
Cost Minimization
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Labour
Cost Minimization
I Tangency point between isoquant and isocost lines yields the
point at which the marginal rate of technical substitution is
equal to the market rate of substitution:
I In the short run, the marginal product of labour is equal to
the wage
I In the long run, the relative marginal product of labour is
equal to the relative wage
Deriving Labour Demand in the
Long-Run
I Labour demand tells us how firms change the amount of
labour they employ in response to changes in the wage
I Deriving labour demand simply amounts to varying the wage
in our isoquant-isocost framework
Labour Demand in the Long-Run
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Labour
Labour Demand in the Long-Run
I Implication is that in the long-run, demand for labour is
downward sloping
I As wages increase, demand for labour falls, output declines
I Why does the firm decide to lower output?
Profit Maximizing Output Levels
Pr
ic
e
Output
Pr
ic
e
Output
Costs, Capital, and the Wage Rate

I Total costs may increase or decrease as wages increase
I lower quantity produced decreases total costs
I higher wage increases total costs
I Capital may also increase or decrease as wages increase
I Labour will always decrease
I Costs and capital depend on:
I substitution e↵ ect: how much of the cheaper input does the
firm substitute for labour
I scale e↵ ect: how much does the firm reduce quantity
produced in response to cost increase
Substitution and Scale Effects
I Substitution e↵ ect:
I capital becomes cheaper (relative to labour)
I firm substitutes away from labour and towards capital
I N falls, K increases, C increases
I Scale e↵ ect:
I firm reduces scale of operation
I K falls, N falls, C falls
Scale and Substitution Effects
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Labour
Short vs. Long-Run Demand for
Labour
Short vs. Long-Run Demand for
Labour
I Short-run
I capital is fixed
I =) no substitution between capital and labour
I =) no substitution e↵ ect
I Long-run
I firm can choose both inputs
I substitution and scale e↵ ects work to reduce labour demand
(in event of wage increase)
I Together, this means an increase in the wage will lead to a
larger e↵ ect on labour demand in the long-run compared to
the short-run
Elasticity of Labour Demand
Elasticity of Labour Demand

I Demand for labour is a negative function of the wage rate
I implication: factors that increase the wage will reduce demand
for labour
I e.g., union wage demand, wage parity scheme, minimum wage,
equal pay, fair-wage legislation, extension legislation
I In reality, the magnitude of the firm’s response to a wage
change depends on its elasticity of demand for labour
I Elasticity of demand is a↵ ected by the availability of
substitute inputs, the elasticity of supply of substitute inputs,
the elasticity of demand for output, and the ratio of labour
cost to total cost
Inelastic vs. Elastic Demand for
Labour
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Employment
Availability of Substitute Inputs

I Labour demand will be inelastic when (e.g.) capital is not
easily substituted for labour
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Employment
I More substitutable inputs mean there is a large substitution
e↵ ect and a larger change in labour demand
Availability of Substitute Inputs
A↵ ected by:
I Underlying technology: can only use labour for a given
process
I Institutions: union does not allow for non-union workers,
di�culty borrowing from lending institution, etc.
I Time: in the long-run substitutes are more likely to become
available
Elasticity of Supply of Inputs
I Alternative inputs also a↵ ected by changes in the price of
input
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Employment
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I If wage ", firm will substitute towards capital, demand for
capital shifts out
I More inelastic supply of substitutes =) more inelastic
demand for labour
Elasticity of Supply of Inputs
A↵ ected by:
I Availability of resources - if resources of alternate input are
plentiful, they will more easily adjust
I Technological innovation - as innovations occur, technology
underlying production may change and a↵ ect elasticity
I Number of producers
Elasticity of Demand for Output
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Employment
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Employment
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Employment
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Employment
I The size of the scale e↵ ect is determined by the elasticity of
demand for the product
I An inelastic demand for output leads to an inelastic demand
for labour
I Wage increase is e↵ ectively passed on to consumers in the
form
of higher prices

I The size of the scale e↵ ect is determined by the elasticity of
demand for the product
I An inelastic demand for output leads to an inelastic demand
for labour
I Wage increase is e↵ ectively passed on to consumers in the
form
of higher prices
A↵ ected by:
I Nature of the commodity - some commodities more or less
necessary (e.g. think of gasoline compared to something like a
fan)
I Availability of substitutes in output market (e.g. a firm
producing coca-cola may face an elastic demand for coca-cola
if, in response to a price change, individuals can substitute
towards pepsi)
I Income of consumers in the product market (high income
earners are generally less sensitive to price changes)
Share of Labour Costs in Total Costs
I Share of labour costs measures the extent to which labour is
an important component of total cost

I Demand for labour will be inelastic if labour is a small portion
of total cost
I firm won’t have to cut output by as much because the cost
from the wage increase will be small
I E.g., construction craftworkers, airline pilots, employed
professionals
Changing Demand Conditions,
Globalization, and Offshoring
Changing Demand Conditions,
Globalization, and Offshoring
I We can use our insights from labour demand theory to think
about how Canadian firms make employment decisions in an
increasingly globalized world
I outsourcing: delegation of specific elements of internal
production to external entity (e.g., a professor asking a
research assistant to do data entry)
I o↵ shoring: delegation of specific elements of internal
production to external foreign entity (e.g., a professor (or
lazy/clever domestic research assistant) sending data entry
work to a foreign country)

The Impact of Trade on a Single
Labour Market: Short-Run
I Scenario: Canadian firms compete with foreign firms for the
same product
I Product market conditions will a↵ ect output at Canadian
firms, which in turn a↵ ects labour demand
I In the short run, increased competition lowers the price of
goods =) MRPn #
I If the Canadian wage remains constant, then employment will
fall
Labour Market: Short-Run
Pr
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Output
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Offsetting Factors: Short Run
I Wage could decrease
I Marginal productivity could increase
Labour Market: Long-Run
I Scenario: Canadian firms compete with foreign firms for the
same product
I Product market conditions will a↵ ect output at Canadian
firms, which in turn a↵ ects labour demand
I However, in the long-run, we can think of Canadian labour as
being one labour input into a production technology that
draws on labour from other countries
I Just as firms can substitute capital for labour in the long-run,
they can also substitute foreign labour for domestic labour

Fo
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L
ab
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Domestic_Labour
I Implications are that Canadian firms will substitute towards
cheaper foreign labour
I Not always the case:
I foreign labour has to be a substitute for domestic labour
I if foreign and domestic labour are close substitutes then the
substitution e↵ ect (# domestic labour) may o↵ set the scale
e↵ ect (" domestic labour)
I relative productivity of domestic versus foreign labour matters
I focusing on labour costs alone is unwise as no firm would hire
purely foreign workers if the productivity of foreign workers is
too low

Compensation Costs (% of Canada)
Compensation Costs (% of Canada)
� Productivity, Hourly Compensation,
Unit Labour Costs in Manufacturing
Trends in Labour Costs and
Productivity
Canada relative to USA (base year (1989)
ECON 370 - Minimum Wages and
Employment
Maggie Jones
Minimum Wages Across Canada
$13.85
$13.00
$13.46

$12.71
$15.00
$12.50
$11.65
$14.00
$11.32
$11.50
$11.40
$11.55
$12.25
YUKON
NUNAVUT
NORTHWEST
TERRITORIES
NEWFOUNDLAND AND LABRADOR
PRINCE EDWARD ISLAND
NOVA SCOTIA
NEW
BRUNSWICK
QUEBEC

ONTARIO
MANITOBA
SASKATCHEWAN
ALBERTA
BRITISH
COLUMBIA
MINIMUM HOURLY WAGE RATES AS OF OCTOBER 1ST,
2019
RETAIL COUNCIL OF CANADA
RetailCouncil.org
Minimum Wages and Employment
I In Canada:
I Set by provinces and territories
I Highest: Alberta $15.00/hr
I Lowest: Nova Scotia $11.55/hr
I Interprovincial/international industries are under federal
jurisdiction
I In the United States
I Set by local, state, and federal governments
I Employers generally have to pay the highest out of the three
minimum wages

Minimum Wages and Employment
I One of the largest debates in labour economics revolves
around
the employment e↵ ects of raising the minimum wage
I According to the theory of the firm, we expect wage increases
to be accompanied by a decline in employment
I Empirical evidence does not always suggest this is the case
Card and Krueger
I In April, 1992, New Jersey increased the minimum wage from
$4.25/hr to $5.05/hr
I Card and Krueger compare changes in employment in the fast
food industry in New Jersey to that in Pennsylvania over the
same time period
I No evidence of reduced employment
Economics

Maggie Jones
Labour Supply and Public Policy
Public Policy
I Canada’s provincial and federal governments implement a
number of social programs designed to alleviate poverty
I transfer programs
I unemployment insurance
I welfare programs
I child care subsidies
I About 10% of GDP is spent on income maintenance schemes
Income Maintenance Programs
Public Policy
I Objective of these programs is to alleviate poverty
I universal: e.g., transfer everyone a fixed income (most
expensive type of program)
I targeted: e.g., transfer enough to low-income individuals so
that they make at least as much as the poverty line

I In any income maintenance program we are concerned about
the disincentive e↵ ects on labour supply
Types of Income Maintenance
I Transitory income shocks: temporary decline in income
I e.g. being laid o↵
I unemployment insurance
I e.g. workplace injury
I worker’s compensation
I Permanent income shocks: long-term decline in income
I e.g. permanent injury or disability
I disability benefits
I e.g. discouraged worker
I welfare programs after unemployment insurance is exhausted
I Returning to work: individual’s who have been out of the
labour force but plan to return
I e.g. having children
I child care subsidies
Types of Income Maintenance
I It turns out there are a number of di↵ erent types of income
maintenance programs that may have di↵ ering e↵ ects on a

worker’s labour supply choice
I demogrants, welfare, negative income taxes, wage subsidies,
earned income tax credits, employment insurance, disability
payments, worker’s compensation, child care subsidies
I We will focus on static partial equilibrium e↵ ects
I we will ignore dynamic (over time) e↵ ects and general
equilibrium (over the economic system) e↵ ects
Demogrants
Demogrants
I Income grants tied to specific demographic characteristics
(e.g., age, gender, etc.)
I Example: Universal Child Care Benefit (before it became the
Canada Child Benefit) paid $160/month for each child under 6
and $60 per month for each child between 6 and 18
Demogrants
In
co
m
e
Leisure

Welfare
Welfare
I Sometimes called “social assistance” or “income assistance”
I Financed in part by the federal government but administered
by provinces
I Payments to non-participants of the labour force; amounts
typically based on needs of the family (e.g. family size, city,
etc)
Welfare
Welfare
In
co
m
e
Leisure
Welfare

I Potential solutions to disincentive e↵ ects:
I Decrease payment amounts
I Increase market wage
I Reduce implicit tax
I Alter preferences
Negative Income Tax
Negative Income Tax
I Guaranteed income plan plus an implicit tax rate applied to
labour market earnings
Y = G + (1 � t) ⇥ W
Negative Income Tax
In
co
m
e
Leisure

Wage Subsidies and Refundable Tax
Credits
Credits
I Alternative to taxing earnings, per-hour wage is supplemented
by government
I Essentially can be viewed as an increase in the wage rate,
which e↵ ectively induces an income and substitution e↵ ect.
Credits
In
co
m
e
Leisure
Credits
I Work incentives tend to be better under wage subsidy

compared to negative income tax because the income and
substitution e↵ ects work in opposite directions
I Disadvantage is that it is not helpful for people who
legitimately cannot work
I Often wage subsidies are targeted to low-income people
I In Canada we have a program called the Working Income
Tax Benefit
I received in the form of tax breaks after you fill out income tax
forms
Working Income Tax Benefit
I Implemented in three phases
I phase-in: wage subsidy proportional to earnings
I flat range: constant subsidy at max wage subsidy
I phase-out: negative income tax as earnings reach highest level
In
co
m
e

Leisure
Employment Insurance
I Changes budget constraint faced by individuals
I Incentive e↵ ects often di↵ er based on individual attachment
to
the labour market
I Assumption: if individuals want to increase (or decrease)
labour supply they can
I E.g. 60% of weekly pay for up to 20 weeks, requires a min. of
14 weeks
0
10
0
20
0
30
0

40
0
50
0
In
co
m
e
0 10 20 30 40 50
Weeks Leisure
0
10
0
20
0
30
0
40
0
50
0
In

co
m
e
0 10 20 30 40 50
Weeks Leisure
Labour Income Benefits
Total Income
Disability Benefits and Worker’s
Compensation
Compensation
I Social assistance programs designed to compensate individuals
who legitimately cannot work
I Work incentives are less of a concern when designing
disability
benefit and worker’s compensation programs
I There are still instances when we might be concerned about
disincentive e↵ ects
I The type of program implemented will depend on the nature
of the disability or injury

I Depending on the type of disability/injury, the individual’s
budget constraint and preferences will be a↵ ected di↵ erently
Compensation
I Ways in which individual labour supply may be a↵ ected by
disabilities and injuries:
I partially disabling injury could a↵ ect time allocated to the
labour force, but may not a↵ ect performance
I other disabilities may a↵ ect productivity (wages) but not time
devoted to the labour force
I some disabilities may require expensive medical expenditures
I it is also possible for a disability to a↵ ect an individual’s
preferences over their labour-leisure allocations
Time Constraints
In
co
m
e
Leisure
Productivity

In
co
m
e
Leisure
Medical Expenses
In
co
m
e
Leisure
Preferences
In
co
m
e
Leisure
Compensation
I As we saw previously, di↵ erent policies will have di↵ erent
e↵ ects on labour supply

I Worker’s compensation*
I Disability pension entitlements
I Long-term disability insurance
I Court awards
Worker’s Compensation
I Designed to soften the negative e↵ ects of a temporary
disability/injury on wages
I Consider the case where an individual is compensated up to
two thirds of the loss of income
I Idea is that as the individual is forced to reduce their labour
supply, the negative impact on wages is not as severe
In
co
m
e
Leisure
Child Care Subsidy

Child Care Subsidy
I We often think of child care as a fixed cost incurred by the
household
I Several types of child care subsidies available (e.g. from
in-class discussion readings)
I Imagine a program designed to subsidize child care for those
who are employed
I cost incurred only if individual works
Child Care Subsidy
In
co
m
e
Leisure
Child Care Subsidy
In
co
m
e
Leisure

Child Care Subsidy
In
co
m
e
Leisure
Economics
Maggie Jones
Labour Supply: Individual
Attachment to the Labour Market
Labour Supply
I Is supply upward sloping?
I Intuitively it makes sense that higher wages generate an
“incentive” e↵ ect, wherein people are incentivized to work
more when the wage increases
I This may not always be the case (we will see why/where)
I Concept that people will work more when wages are higher is

still at the heart of the study of labour supply
I We will study how this a↵ ects the decision to work (extensive
margin) and how much to work (intensive margin)
Extensive Margin: To Participate or
Not
Labour Force Participation
I labour force participation decision: to participate in paid
labour market activities or not
I as opposed to: unpaid work in the home, volunteer work,
education, retirement
I has implications for the size and composition of the labour
force
I a↵ ects unemployment, economic growth, occupation and
gender composition
I these, in turn, a↵ ect relative wages, unionization, daycare,
equal pay, etc.
The Labour Force
I potential labour force: everyone who is eligible who
participates in labour market activities

I eligible: civilian non-institutional population, �15 years old,
excluding the territories and Indian reserves
I labour force: those in the “potential labour force” who are
in the labour force
I employed: those in the labour force who did any work during
the survey period, or those in the labour force who were ill or
on strike, but otherwise would have been working, during the
survey period
I unemployed: those in the labour force who are not
employed, but are seeking work
Participation vs. Unemployment
I labour force participation rate: fraction of eligible
population who is in the labour force
I unemployment rate: fraction of those in the labour force
that are unemployed
How does the LFP change?
Labour Force Participation Rate Over
Time

Labour Force Participation Rate
Across Countries
Labour Force Participation Rate
Across Countries
LFPR vs.Per Capita Log GNI
Intensive Margin: How Much to
Participate
Hours Worked
I The “hours worked” decision encompasses more than just how
many hours to work
I hours per day, days per week, weeks per year
I In the short-run, hours of work are relatively fixed
I Occupation choice, flexible working hours, additional part-
time
jobs, allow hours worked to be more variable than we may
assume

Distribution of Hours Worked
Basic Income-Leisure Model
Labour Supply Model
I We want to represent an individual’s choice of hours worked,
given their market opportunities and the value they place on
non-market activities
I We will assume that individuals do the best they can
(optimize) with the time they have (constraints) given their
individual preferences
I Our model is grounded in the canonical consumer theory
model
Preferences
I Starting point is to provide a framework for modelling
individual preferences
I We will assume there are two goods
I Consumption goods: things you can buy in the market
I Leisure: time spent doing all non-labour market activities

(household work, education, etc.)
I Preferences can be graphically represented by indi↵ erence
curves which depict all the potential combinations of
consumption and leisure that yield the same utility
C
on
su
m
pt
io
n
Leisure
C
on
su
m
pt
io
n
Leisure
C
on
su
m

pt
io
n
Leisure
Constraints
I We assume individuals want to reach the highest indi↵ erence
curve subject to the constraints they face
I Money
I Time (which e↵ ectively equals money in this framework)
I Let price of consumption good be P so that the value of
consumption is P ⇥ C
I Ignore savings =) income equals the value of consumption
I Allows us to transfer our consumption-leisure framework to an
income-leisure framework
I Understanding the constraints agents face helps us to
determine the set of feasible income-leisure combinations from
which the consumer can choose
In
co
m
e

Leisure
In
co
m
e
Leisure
In
co
m
e
Leisure
Consumer’s Optimum
I Putting together the individual’s budget constraint and
preferences (i.e. indi↵ erence curves) yields the consumer’s
optimal allocation of labour/income-leisure
I in other words, the individual’s labour supply
In
co
m

e
Leisure
In
co
m
e
Leisure
I Let’s consider the individual’s decision to work when faced
with specific wage rates
I When MRS > wage the individual will not work
I When MRS < wage the individual will increase hours until
MRS = wage
I E.g. Suppose you value one hour of leisure at $10. Someone
o↵ er’s you $8 to complete a task that requires an hour of your
time. Would you complete this task?
In
co
m
e
Leisure

Reservation Wage
I This analysis illustrates the idea at the core of the
reservation wage
I The wage rate at which the individual is indi↵ erent between
working and not working (labour and leisure)
I It equals the slope of the individual’s indi↵ erence curve at 0
hours worked (T)
Comparative Statics
Comparative Statics
I We are now equipped with the basic framework required to
analyze how individual’s will respond to changes in the
underlying economic environment
I changing non-labour income
I changing the wage rate
I First we need to consider how the purchase of leisure will be
a↵ ected by changes in income if leisure is a:
I normal good: " income ! " demand for leisure
I inferior good: " income ! # demand for leisure

I Whether leisure is normal or inferior depends entirely on
preferences (most empirical evidence points to leisure being
normal)
Changing Non-Labour Income
In
co
m
e
Leisure
In
co
m
e
Leisure
Changing Wages
Increasing the wage rate has two opposing e↵ ects:
I income e↵ ect: for each hour of work the individual can buy
more goods including leisure. If leisure is a normal good this
means the “purchase” of more leisure and a decline in the
number of hours worked.
I substitution e↵ ect: return to work is greater so the

individual may choose to work more in response to a wage
hike. The opportunity cost of leisure has increased, i.e. we
have a shift in the relative price of leisure (it is more
expensive). The individual will increase the number of hours
worked.
The overall e↵ ect depends on whether the income or
substitution
e↵ ect dominates.
In
co
m
e
Leisure
Changing Wages
Note that increasing the wage can never cause people to not
participate in the labour force. That is, LFP will not decrease
because of increases in the wage rate. Individuals can always
reach
higher indi↵ erence curves, and will not choose the lower IC

that
will lead to no participation.
Increasing the wage could result in labour force participation
among people who otherwise would not participate.
In this sense, increases in the wage rate cannot decrease LFP,
but
could potentially increase it.
Wage Elasticities of Supply
I uncompensated elasticity:
%�hours
%�wage
I compensated elasticity:
%�hours attributed to substitution e↵ ect
%�wage
The Individual Labour Supply Curve
Individual Labour Supply

I Using our leisure-income model, we can examine how varying
the wage rate will a↵ ect individual’s optimal labour-leisure
choice in order to map out their labour supply.
I i.e., how much labour would the individual supply at each
value of the wage?
I 0 hours until the wage = reservation wage
I substitution e↵ ect dominates at low initial levels of the wage
I income e↵ ect dominates as individual becomes wealthier
I At low wages the individual has an abundance of needs that
higher wages can help address. As wages rise and these needs
are met, the individual does not need as much extra money
and can begin to reduce labour supply.
Individual Labour Supply Curve
In
co
m
e
Leisure
In
co
m
e
Leisure

Barriers in the Labour Market
I Assumption underlying our model is that individuals can
choose any labour-leisure combination given their budget
constraint and preferences.
I In practice this may not be realistic.
I e.g. suppose you wish to work 35 hours per week, but your
employer requires 40
I e.g. suppose you wish to work 12 hours per day, but your
store is only open for 8
I It turns out that we can incorporate these barriers into our
basic income-leisure model.
Moonlighting & Underemployment
In
co
m
e
Leisure
Overemployment
In
co

m
e
Leisure
Economics
Maggie Jones
Labour Supply Over the Life Cycle
Labour Supply Over the Life Cycle
I So far we have assumed that individuals do not consider the
future when they are making current labour supply decisions
I can be an unrealistic way to think about decision making
I This chapter considers labour supply schedules when
individuals consider their entire life
I Are labour supply schedules of men and women the same over
time?
I What do we have to change in our labour supply framework
when considering the life cycle?

I How have labour-saving technologies affected the evolution of
female labour supply?
Male Labour Force Participation
Female Labour Force Participation
Labour Force Participation Over the
Life Cycle
I We will focus on understanding whether the observed labour
force patterns over the life cycle can be explained by changes
in the economic environment in a way predicted by theory
I We will consider three additional life cycle phenomena that
warrant individual attention
I women’s fertility decisions
I the decision to retire
I the school-work decision
A Dynamic Model of Labour Supply
A Dynamic Model of Labour Supply

I Individuals plan out their lifetime labour supply, given their
expected lifetime economic environment
I Starting point:
I individuals live and potentially work for N periods
I no uncertainty regarding future economic variables
I prefs are defined over consumption and leisure in every period
u = U(C1, C2, . . . , CN, l1, l2, . . . , lN )
I budget constraints defined over all periods
C1 + C2 + · · · + CN = W1 ×H1 + W2 ×H2 + · · · + WN ×HN
Income and Substitution in the
Dynamic Framework
I Income and substitution effects are more complicated in the
dynamic framework
I We will consider three types of changes in a simplified
framework:
I permanent unanticipated wage increase (A-B)
I evolutionary anticipated wage increase (B-C)
I transitory unanticipated wage increase (C-D)
Dynamics of Life Cycle Wage Changes
*Note: each wage change is supposed to represent the same
magnitude

Income and Substitution in the
Dynamic Framework
I permanent unanticipated wage increase (A-B): this type of
wage change leads to standard income and substitution effects.
I evolutionary anticipated wage increase (B-C): the anticipated
wage change is factored into the individual’s decision making
at the beginning of period 1. This means there will be no
immediate income effect, rather the income effect is spread
over the life cycle. The individual will still see a substitution
effect as their wage increases.
I transitory unanticipated wage increase (C-D): this will yield a
substitution effect at time t and a small income effect spread
over the life cycle.
Fertility and Childbearing
I Clearly, from our previous diagram, fertility is an important
determinant of female labour supply
I But the arrival of children is not a random occurrence
I Many individuals make their decision of when to have children
based on economic considerations and do so in a forward
looking manner

I Starting point is the Becker/Mincer model:
I applies the principles of consumer theory to the decision to
have children
I children are a “good” that are “consumed”
Several factors may affect a woman’s fertility decisions that we
can
consider in the context of our dynamic labour supply model
I Income
I Cost of children
I Price of related goods
I Tastes and preferences
I Technology
Income and Fertility
I Theoretically positive relationship between children and
income
I assumption: children are a normal good
I problem: income correlated with other things, like knowledge
of contraception, opportunity cost of having children
I often we see a negative relationship between income and
fertility
I Income effect: higher income =⇒ more children

I Substitution effect: higher income usually correlated with
higher wages =⇒ higher opportunity cost of having children
I Once potential earnings have been accounted for, empirical
evidence suggests that yes, children are like normal goods
Cost of Children
I Not surprisingly, if the price of having children increases, the
number of children should decrease
I Price includes many things:
I food, clothing, housework associated with raising a child
I forgone income
I As we saw previously, an increase in the potential earnings of
wives leads to both an income and substitution effect of having
children
Price of Related Goods
I Complementary goods: medical expenses, daycare, education,
etc.
I A rise in the price of any complementary good should decrease
the number of children
Tastes and Preferences

I Over time we have seen large changes in attitudes towards
women’s employment, religion, family planning, contraception,
etc.
I These can all be viewed as changing preferences for children -
in this case, they would lead to a reduction in family size
I Increased educational attainment may also change preferences
by changing the set of “alternative goods”, e.g. travel,
entertainment, etc.
Technology
I Decrease in family size: contraceptive devices, medical
advances (vasectomies, tubal ligation), reduction in infant
mortality
I Increase in family size: medical advances that decrease risks
of
pregnancy, processed food and diapers
The Decision to Retire
The Decision to Retire
I The decision (typically among older workers) not to
participate in the labour force
I can mean leaving the labour market, reducing hours worked,
moving to a less onerous job

I can be a gradual process or a discrete change in employment
I Micro level effects:
I financial status, psychological state
I Macro level effects:
I unemployment, labour force participation, private savings
Factors Affecting Decision to Retire
I Mandatory retirement age
I typically in North America, age 65; individuals are not
actually forced to leave the labour market
I variability across jobs, provinces, countries
I Wealth and earnings
I wealth: income effect
I earnings: income and substitution effect
I Health and the nature of work and the family:
I poor health can lead to early retirement
I shift from blue collar to white collar jobs may increase
lifetime
employment
I decline of extended family, rise in dual income families,
deinstitutionalization of health care
Social Support Programs

I In Canada there are 3 main types of pension programs:
I Universal Old Age Security
I Canada/Quebec Pension Plan (CPP/QPP)
I Employer sponsored occupational pension plans
I Individuals can also save on their own through RRSPs
Universal Old Age Security
I Financed by general tax revenue
I Demogrant paid to those 65+
I Max monthly benefit as of June 2016 for a single person:
$570.52
I benefits reduced for high earners (expected to save)
I May be supplemented by a Guaranteed Income Supplement
(up to $773.60)
Social Insurance Pension:
Canada/Quebec Pension Plan
I Financed by compulsory employer and employee contributions
through payroll tax
I Benefits related to contributions based on payroll tax applied
to past earnings, but funds come from payments from current
workforce
I Max monthly benefit in June 2016: $1093
I Virtually universal participation

Employer-Sponsored Occupational
Pension Plans
I Financed by employer, sometimes with employee contributions
I Benefits depend on type of plan
I Covered 32% of LF and 38% of paid workers in 2013
Labour Supply Over the Life CycleA Dynamic Model of Labour
SupplyFertility and ChildbearingThe Decision to Retire
Economics
Maggie Jones
The Canadian Labour Market
At home exercise:
1 Go to Stats Canada Census Profile, 2016:
https://www12.statcan.gc.ca/census-recensement/2016/
dp-pd/prof/details/page.cfm?Lang=E&Geo1=PR&Code1=01&
Geo2=&Code2=&SearchText=Canada&SearchType=Begins&
SearchPR=01&B1=All&TABID=1&type=0

2 Examine how these ratios look for median income in 2016
Variation in Earnings
I Variation in earnings is due to both wages and hours worked
I These are two of the fundamental outcomes studied by labour
economists
I Hours worked are typically modelled as a choice by
individuals
regarding their optimal labour supply
I Our discussion of wages will be grounded in the competitive
labour markets model
The Competitive Labour Market
The Supply and Demand Model:
Workhorse of Labour Economics
I Fundamental outcomes: employment and wages

I We can use tools from previous economics classes to study
quantity and prices in the labour market
I Quantity = employment (how much to work)
I Prices = wages (what is the price of work)
I This comes together in the neoclassical supply and
demand model
I assumptions about how buyers and sellers respond to prices
and other factors
I assumptions about how buyers and sellers interact, and how
the market determines levels and terms of exchange
Wages & Employment in a Competitive
Labour Market
I Labour supply curve depicts the amount of labour individuals
would like to sell at each wage rate (workers’ side)
I Labour demand curve depicts the amount of labour firms
would like to hire at each wage rate (firms’ side)
I Equilibrium given by intersection of supply of and demand for
labour and generates a wage and level of employment
I In a competitive labour market we assume workers and firms
take wages as given and then make decisions based on their
supply and demand functions

Wages & Employment in a Competitive
Labour Market
W
ag
es
Employment
Implication 1:
Wages will equalize in markets with homogeneous workers &
jobs
W
ag
es
Employment
W
ag
es
Employment
Implication 2:
I Absence of involuntary unemployment (i.e., you would like to
work but can’t find work at the going wage)

I In equilibrium, no workers who are currently unemployed
would WANT to work at the going rate
Implication 3:
I No queues or rationing (all jobs are equally satisfactory)
Do Implications Align With Reality?

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