2. Introduction
• In reality the basic model of a trad-off
between consumption and leisure neglets
various factors that affect labour supply
Household production
Life cycle
• (intertemporal labour supply)
3. Household production
• Leisure includes many forms of non-market work,
including work around the home
• Why do some household members specialize in
the market sector and other members specialize
in the household sector?
– Comparative advantage/return to skills
• Consider a two-person household: Jack and Jill, a
married couple
– Their household opportunity set is greater than when
they were not married: each specialize in the sector
where they are relatively more productive
5. Budget Lines and Opportunity Frontier of a
Married Couple
At point E, Jack and Jill allocate all
350 G
their time to the household sector.
If they wish to buy market goods,
Jack gets a job because he is
relatively more productive in the
F labor market, generating segment
200
FE of the opportunity frontier.
Jack’s After he uses up all his time in the
150
labor market, Jill can then enter
Jill’s
the labor force, generating
segment GF of the frontier.
E
100 250 350 Household
Goods ($)
6. Who Works Where?
Market Market Market
Goods ($) Goods ($) Goods ($)
P
U P
U
P
U
Household Household Household
Goods ($) Goods ($) Goods ($)
7. Division of Labor in the Household
• (a) Jill specializes in the household sector and
Jack divides his time between the labor
market and the household.
• (b) Jack specializes in the labor market and Jill
divides her time between the labor market
and the household.
• (c) Jack specializes in the labor market and Jill
specializes in the household sector.
8. An Increase in the Wage Rate or Household
Productivity Leads to Specialization
Market
Goods ($)
An increase in Jack’s wage
moves the household from
point P to point P, and
P
Jack now completely
specializes in the labor
U
market.
P U
Household
Goods ($)
9. An Increase in the Wage Rate or Household
Productivity Leads to Specialization
Market
Goods ($)
An increase in Jill’s marginal
product in the household
sector moves the household
from point P to point P, and
Jill now completely
P
specializes in the household
P
U U
sector.
Household
Goods ($)
10. Labor Supply over the Life Cycle
• Wage rates change over the worker’s life
(over the life cycle).
– Wages are low when young.
– Wages rise with time and peak around age 50.
– Wages decline or remain stable after age 50.
• The changes in wages over the life cycle are
“evolutionary” wage changes that alter the
price of leisure.
11. Theoretical Issues of
Evolutionary Wages
• A person will work more hours when wages are
higher .
• The profile of hours of work over the life cycle will
have the same shape as the age-earnings profile.
• Intertemporal substitution hypothesis: people
substitute their time over the life cycle to take
advantages of changes in the price of leisure.
• In a similar way we can describe a link between
wages and labour force participation rates.
12. The Life Cycle Path of Wages and Hours for
a Typical Worker
Only substitution effect
Wage Hours of
Rate work
50 Age 50 Age
13. Hours of Work over the Life Cycle for Two
Workers with Different Wage Paths
Hours of Substitution and
Wage Rate Work
income effect
Joe (if substitution effect
dominates)
Joe
Jack Jack
Joe (if income effect
dominates)
t* Age t* Age
Joe’s wage exceeds Jack’s at every age. Although both Joe and Jack work more
hours when the wage is high, Joe works more hours than Jack if the substitution
effect dominates. If the income effect dominates, Joe works fewer hours than Jack.
14. Labor Force Participation Rates over the
Life Cycle in 2005
100
90
Labor force participation rate
Male
80
70
Female
60
50
40
30
15 25 35 45 55 65
Age
15. Hours of Work over the
Life Cycle in 2005
2,500
Male
Annual hours of work
2,000
Female
1,500
1,000
500
15 25 35 45 55 65
Age
16. Labor Supply Over the Business Cycle
Cyclic changes in participation rates
• Added-worker effect.
– So-called “secondary” workers currently out of the
labor market are affected by a recession because
the main breadwinner becomes unemployed or
faces a wage cut.
– A secondary worker may choose to enter the labor
force during these bad times
– The labor force participation rate of secondary
workers (i.e., the added worker effect) is counter-
cyclical.
17. Labor Supply Over the Business Cycle
Cyclic changes in participation rates
• Discouraged worker effect.
– Unemployed workers find it very difficult to find jobs
during a recession, so they give up searching.
– Discouraged workers exit the labor force during bad
times.
– The labor force participation rate of discouraged
workers is pro-cyclical.
• What actually happens to participation rates over the
business cycle? The discouraged worker effect dominates
the added-worker effect, especially during recessions.
18. Conclusion
• Household production allocation
• Static and dynamic labour supply
• Labour supply and the business cycle
• Other factors affecting labour supply
– Demographic factors (fertility rate)
– Labour mobility and migration policies (to be
covered later).
