LongRunLaborSupply

Migration.
Endogenous population adjustment in closed economy
(Malthus, Becker, Willis).

ShortRunLaborSupply

Even if population is fixed in the short run, workers

still need to decide
(i) whether to participate in the labor market;
(ii) how many hours to supply.

Assumptions:

A worker maximizes own utility of the simple form

U = U(C,L)
where C = consumption, L = leisure.
- The worker is endowed with 1 unit of time per period.
- The worker earns a wage of w per unit time and faces a
price of p for the consumption good.
- There is an unearned income of V even if the worker
does not work.
-

TheModel
The maximizing problem for the worker:

Max U (C, L)
C,L

subject to

V + w(1 - L) = pC

Lagrangian for the constrained max problem:

= U(C,L) + (V + w(1 L) pC)

where 8 = Lagrange multiplier for the budget constraint.

InteriorSolution
Assuming 0 < L < 1, the FOCs for utility maximization:

C:

U C C, L p

L:

U L C, L w

8:

V w1 L pC

where
Y

Ui = U / i .

UL /UC = w/p

Holding utility constant

U
U
dC
dL0
dU(C,L) =
C
L

C
UL

MRS
LU
UC

where MRS = marginal rate of substitution.

Indifferent curves downward sloping if
(1) both C and L are goods;
(2) non-satiation.

U1

Direction of preference

U3
U2
U1

pC = w(1 L) + V
Y

V w w
C
L
p
p

V+w = full income

= value of endowment

w/p = opportunity cost of leisure

C
(w +V )/p

V/p

-w/p

C
(w +V )/p

C*

D
U(C*,L*)
-w/p

V/p

L*

H*=1-L*

C
(w +V )/p

B
V/p

U1
1

C
(w +V )/p

B
V/p

U2
U1
1

C
(w +V )/p

C*

D
U (C*,L*)
U1

V/p

L*

Tangency condition:
Slope of indifference curve = slope of budget line

UL w
MRS

UC
p
or

U L UC

w
p

Suppose, in absolute terms, slope of indifference curve <

absolute slope of budget line:

UL w

UC
p

U L UC

or
w
p

Y 8 spending on C by $1 and 9 spending on L by $1:

)U = - UL /w + UC /p > 0
Y Utility can be increased by 9L and 8C

Taking total derivatives of the FOCs:

U CC dC U CL dL pd dp
U LC dC U LL dL wd dw
pdC wdL Cdp 1 Ldw dV
where Uij = MUi /Mj .

Effect of a change in unearned income on leisure

(or labour supply):

L U CC w U LC p U LCU C U CCU L

where = (-UC2ULL + 2UCULULC - UL2 UCC)/2

> 0 by the SOC for maximization.

C
U

c1

C0 *
C1

F
D

V 1 /p
V 0 /p

L1L0* L1

U(C0*,L0*)

Effect of a change in wage on leisure (or labor supply):

L U CC w1 L p U CL 1 L p

U CLU C U CCU L 1 L U C2

L U C2
1 L

Slutsky Equation:
Total effect = income effect + substitution effect

-w1/p

C1
C0

-w0/p

F
D

U(C1,L1)
U(C0,L0)

V/p
L1L0

H0 =1-L0

-w1/p

-w1/p

C1
C
C0

-w0/p

F
D

U(C1,L1)
U(C0,L0)

V/p
L L1L0

C
Sub Effect: D 6 G
Income Effect: G 6 F
Total Effect: D 6 F

-w1/p

(Sub effect dominates)

-w1/p

C1
C
C0

-w0/p

F
D

U(C1,L1)
U(C0,L0)

V/p
L L1L0

C
-w2/p

w increases from w1to w2,

L increases from L1to L2

-w1/p

C2
C1
C0

-w0/p

Y Income effect dominates

U(C2,L2)

U(C1,L1)
U(C0,L0)

V/p
L1L0L2

C
-w2/p
-w1/p

C2
C1
C0

-w0/p

H Price expansion path/offer curve

U(C2,L2)

U(C1,L1)
U(C0,L0)

V/p
L1L0L2

w
w2
w1
w0

H2 H0H1

H = 1-L

w
w2
w1
w0

H2 H0H1

H = 1-L

U(V/p,1)

V/p

-w/p

E
1

U(V/p,1)

V/p

-w/p

E
1

wR = reservation wage
= p uL(V/p,1)/uC (V/p,1)
= p (MRS at E )
U(V/p,1)

V/p

-w/p

E
-wR /p

w
w2
w1
w0
wR
H2 H0H1

H = 1-L

f(wR)

Different people have different preferences and income

Y wR differs across workers.

wR

f(wR)

Different people have different preferences and income

Y wR differs across workers.

wR

f(wR)

Different people have different preferences and income

Y wR differs across workers.
In the
labor force

Out of the
labor force

wR

Assuming no interaction among labor supply of

different workers,
Market labor supply = horizontal sum of individual
workers labor supply

Workers LS

Market LS

n1> n0

w1

w0

wRi
H1i H0i

Hi

n0

n1

H H1i
i

i 1

i 1

3Hi

Assuming no interaction among labor supply of

different workers,
Market labor supply = horizontal sum of individual
workers labor supply
As w increases, 2 margins of adjustment:

Assuming no interaction among labor supply of

different workers,
Market labor supply = horizontal sum of individual
workers labor supply
As w increases, 2 margins of adjustment:
- intensive margin adjustment:
workers already in the market adjust working hours
(8 or 9)

w1
w0

wR
H0H1

H = 1-L

w1
w0

wR

wR
H1H0

H0H1

H = 1-L

Assuming no interaction among labor supply of

different workers,
Market labor supply = horizontal sum of individual
workers labor supply
As w increases, 2 margins of adjustment:
- intensive margin adjustment:
workers already in the market adjust working hours
(8 or 9)
- extensive margin adjustment:
number of workers increases.

f(wR)

New entrants

Out of the
labor force

In the
labor force

w0 w1

wR

Suppose V = 0, but the government guarantees G

C
H* = G/w

G/p

1-H*

Suppose V = 0, but the government guarantees G

C
H* = G/w

G/p

U1
-w/p

1-H* L0

U0

L1=1

Suppose V = 0, but the government guarantees G

C
H* = G/w

G/p

U0

U1

-w/p

L0 1-H*

L1=1

Suppose V = 0, but the government guarantees G and

tax earnings at rate t
C

H* = G/w
H** = G/w (1-t )
-w (1-t )/p

G/p

U0

U1

-w/p

1-H** L0 1-H*

L3

Time and purchased goods are inputs into the

production of household commodities
Utility is a function of quantities of these household
commodities
Suppose
- there are n household commodities (Z1 Zn)
- each commodity i is produced with purchased input
xi and time Ti according to production function:
Zi = f (xi,Ti)
- each worker is endowed with 1 unit of time and
unearned income V.

Workers maximization problem:

MaxU U Z1 ,... Z n
subject to
(1) Budget constraint:

Z1 ...Zn

px
i

V wTw

i 1

(2) Time constraint:

1 Tw

i 1

(3) Technology constraint: for i = 1,,m,

Zi f xi , Ti

Worker maximizes dynamic/lifecycle utility:

U Ct , Lt e t dt
T

or

t 1

U Ct , Lt

t 1

Subject to intertemporal or lifetime budget constraint

or

rt

pt Ct e dt

wt 1 Lt e rt dt V0

pt Ct T wt 1 Lt V

0
t 1
t 1
t 1
t 1 1 r
1 r
T

wt

Rt

wt

Rt

wt

Ht