CHAPTER 3 | Productivity, Output, and Employment 111

Beyond any psychological satisfaction gained from having a job, the principal
benefit of working is the income earned, which can be used to buy necessities and
luxuries. The principal cost of working is that it involves time and effort that are
no longer available for other activities. Economists use the term leisure12 for all
off-the-job activities, including eating, sleeping, working around the house, spend-
ing time with family and friends, and so on. To make themselves as well off as
possible, individuals should choose to supply labor up to the point at which the
income obtained from working an extra hour just makes up for the extra hour of
leisure they have to forgo.

The Income–Leisure Trade-Off

To illustrate how the trade-off between income and leisure affects the labor supply
decision, let’s look at an example. Consider a tennis instructor named Ace who
offers tennis lessons. After paying taxes and job-related expenses, Ace can earn
$60 per hour, which we will call his (after-tax) nominal wage rate. Ace enjoys a
reputation as an outstanding tennis instructor and could work as many hours per
year as he chooses. He is reluctant to work too much, however, because every day
he spends teaching tennis means one less day available to devote to his real pas-
sion, skydiving. The decision Ace faces is how many hours to work this year—or,
in other words, how much labor to supply.
Ace approaches this question by asking himself: Economically speaking, what
really makes me happy? After a little reflection, Ace concludes that his level of
happiness, or utility, depends on the amount of goods and services he consumes
and on the amount of leisure time he has available to jump out of airplanes. His
question can therefore be recast as follows: How much should I work this year so
as to obtain the highest possible level of utility?
To find the level of labor supply that maximizes his utility, Ace must compare
the costs and benefits of working an extra hour. The cost of an extra hour of work
is the loss of an hour of leisure; this cost can be measured as the loss in utility that
Ace experiences when he must work for an hour instead of skydive. The benefit of
working an extra hour is an increase of $60 in income, which allows Ace to enjoy
more consumption.
If the benefit of working an extra hour (the utility gained from extra income)
exceeds the cost (the utility lost by reducing leisure), Ace should work the extra
hour. In fact, he should continue to increase his time at work until the utility he
receives from the additional income of $60 just equals the loss of utility associated
with missing an hour of leisure. Ace’s labor supply at that point is the one that
maximizes his utility.13 Using the idea that the labor supply decision results from
a trade-off of leisure against income, we can discuss factors that influence the
amount of labor supplied by Ace.

12The term leisure does not imply that all off-the-job activities (housework or schoolwork, for exam-

ple) are “leisurely”!

13Not everyone can choose their labor supply as flexibly as Ace; for example, some jobs are avail-
able for 40 hours a week or not at all. Nevertheless, by choosing to work overtime, part-time, or at
a second job or by varying the number of family members who are working, households do have a
significant amount of latitude over how much labor to supply.

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