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3-3
Introduction
Static model of Chapter 2 is not a complete depiction of how we allocate our time We extend the basic model to consider: - The long run - Husband-wife joint-decisions to supply labor
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The Life Cycle Path of Wages and Hours for a Typical Worker
Wage Rate
Hours of work
50
Age
50
Age
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There should be a positive relationship between changes in hours or work and changes in the wage rate As a worker ages, increases in the wage rate should increase hours of work
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Hours of Work over the Life Cycle for Two Workers with Different Wage Paths
Wage Rate Hours of Work
Joe (if substitution effect dominates)
Joe Jack
Joe (if income effect dominates)
Jack
t*
Age
t*
Age
Joes wage exceeds Jacks at every age. Although both Joe and Jack work more hours when the wage is high, Joe works more hours than Jack only if the substitution effect dominates. If the income effect dominates, Joe works fewer hours than Jack.
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2,500 Male
1,000
500 15 25 35 Age 45 55 65
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Retirement
Lifetime incomes are higher the longer workers put off retirement If pension benefits are constant, wage increases have a substitution and income effect, so lifetime income will not be altered An increase in pension benefits reduces the price of retirement, increasing the demand for leisure, encouraging the worker to retire earlier
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V80
P U1 U0 V60
10
20 Retirement
Point E gives a workers leisureconsumption bundle if he retires at age 60. Point F gives the leisure-consumption bundle if the worker never retires. A utilitymaximizing worker chooses point P, and retires for 10 years.
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G R
U1 F P U0 E 5 10 20 Years of Retirement
An increase in the wage rotates the budget line around point E, and generates both income effects and substitution effects as the worker moves from point P to point R. The figure assumes that substitution effects dominate and the worker delays his retirement.
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U1 U0 F R
An increase in pension benefits rotates the budget line around point F. It too generates income and substitution effects, but both effects encourage the worker to retire earlier.
10
15
20 Years of Retirement
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R2 R3
Worker 3
Hours of Leisure
The Social Security earnings test (which taxes retirees when they earn more than $17,000 per year) generates the budget line HGFE. The repeal of the earnings test moves retirees to budget line HE. The first retiree (worker 1) would not change his hours of work; the second retiree would reduce his hours; and the third retiree might increase or decrease his hours, depending on whether substitution or income effects dominate.
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Household Production
Leisure includes many forms of nonmarket work, including work around the home Why do some household members specialize in the market sector and other members specialize in the household sector?
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Married Men
40.2
14.3
77.6
22.4
13.5
Unmarried Men
32.9
12
76.9
24.2
22
Married Women
16.7
34.9
78.7
22
15.7
Unmarried Women
22.2
23.5
79.4
23.8
19.1
Market Work
Household Work
Personal Care
Passive Leisure
Other
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200 150
100
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350 G
Jills
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(a)
(b)
( c)
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An increase in Jacks wage moves the household from point P to point P and Jack specializes in the labor market
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P U
P U
An increase in Jills marginal product in the household sector moves the household from point P to point P and Jill specializes in the household sector.
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Fertility
Malthus Theory of Fertility: as incomes rise, families want more children (focus on income effect) An increase in the price of a persons time will increase the opportunity cost of rearing children when this person exits the market sector
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I/pX
The households utility depends on the number of children and on the consumption of goods. A utility-maximizing household chooses point P and has three children.
Indifference Curve Number of Children
I/pN
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R R P U0 3 4 Number of Children 1 2 U1
P U1
Q
U0 D 3 Number of Children
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End of Chapter 3