Taste for Leisure and Market Goods

Market Goods (Y)

HEAVEN

U2

U1

U0

Leisure (L)
 Budget Constraint for Leisure and Market Goods

Y = W(T – FT – L)+ YN
Market Goods (Y)
W = 5 = real wage
infeasible T=24

70 FT=10
YN =0
Y = 5H

Slope =
-W = -5
feasible

0 14 Leisure (L)

14 0 Hours of work (H)

 Budget Constraint for Leisure and Market Goods
Y = W(T – FT – L) + YN
Wage rises to $6
Market Goods (Y)

Y = 6H
Income
70 increase

Slope = -W = -6, so
price of leisure increases
Slope = -W = -5

0 14 Leisure (L)

14 0 Hours of work (H)

 Budget Constraint for Leisure and Market Goods
Y = W(T – FT – L) + YN
Nonlabor income rises to
Market Goods (Y)
YN = 20
90

Income
70 increase Y = 5H + 20

Slope = -W = -5

0 14 Leisure (L)

14 0 Hours of work (H)

Taste for Leisure and Market Goods
Market Goods (Y)
HEAVEN

W = (MUL / MUY)
B

U2
U1
C U0

Leisure (L)
 Taste for Leisure and Market Goods
Market Goods (Y)

A
W < (MUL / MUY)
W = (MUL / MUY)
B

U2
U1
C U0

W > (MUL / MUY) Leisure (L)

Taste for Leisure and Market Goods
Market Goods (Y)
Who has the stronger taste
for Leisure?

Y0
Y1 UA

UB

L0 LB LA
Leisure (L)
Taste for Leisure and Market Goods
Market Goods (Y)
Flatter indifference curve
means Goods lover

A
YA

UA Steeper indifference curve

YB B means Leisure lover

UB

LA LB
Leisure (L)
Work and Leisure: First-Year College Students

National Survey of Student Engagement, 2000 data

Two simultaneous effects of a wage
change
Income effect: Change in leisure demand caused
by a change in income, holding the wage rate
constant
If leisure is a normal good, an increase in income
increase leisure demand and lowers labor
supply.

Substitution effect: Change in leisure demand

caused by change in wage rate, holding utility
constant.
An increase in wage lowers leisure demand
 Response to a wage increase
Income effect
toward goods
toward leisure (away from hours of work)

Substitution effect
toward goods
away from leisure (toward hours of work)

Total
toward goods
leisure demand (labor supply) ambiguous
 Response to a wage increase
Income effect
toward goods

toward leisure (away from hours of work)

Substitution effect
toward goods

away from leisure (toward hours of work)

Total
toward goods

toward leisure demand (away from labor supply)

Backward-bending labor supply:

If income effect dominates substitution effect, a wage increase lowers
labor supply
 Response to a wage increase
Income effect
toward goods

toward leisure (away from hours of work)

Substitution effect
toward goods

away from leisure (toward hours of work)

Total
toward goods

toward leisure demand (away from labor supply)

Upward-sloping labor supply:

If substitution effect dominates income effect, a wage increase raises
labor supply
Effect depends on what happens to
the budget constraint
Change in slope =>substitution effect
steeper=> wage increase
flatter => wage decrease

Change in height => income effect

higher => income increasing
lower => income falling
 Empirical estimates
Hours = a0 + a1*Wage + a2*Nonlabor Income +…

Income effect = a2;

Substitution effect derived from a1 and a2

Effect of 10% wage increase on labor supply

Male Female
Income effect -2% -1%
Substitution effect 2% 4%
Total effect -0% 3%
 Empirical estimates
Hours = a0 + a1*Wage + a2*Nonlabor Income +…

Income effect = a2;

Substitution effect derived from a1 and a2

Effect of 10% wage increase on labor supply

Male Female
Income effect -2% -1%
Substitution effect 2% 4%
Total effect -0% 3%
“Backward- Bending” Labor Supply “Upward Sloping” Labor Supply
Why Pay Overtime?
Why Make Health Insurance
contingent on Full-time?
Why would wage increases have an
particularly large effect on women?
 Why does divorce raise labor
supply for women ?
and lower labor supply for men?

Labor Force Participation Rates, by Gender, Marital Status, 2004

Marital Status Male Female

Single (never married) 70.2 65.9
Married (spouse present) 77.1 60.5
Divorced 73.5 71.5
Bureau of Labor Statistics: http://www.bls.gov/cps/wlf-table4-2005.pdf
 Social Security
Retirement Earnings Test
Applies to retirees between 62 and 65*

*Normal retirement age rising to 66 by 2009

to 67 by 2027

For workers below normal retirement age, get full

benefits if earnings below exempt amount
Benefits fall $0.50 for every $ earned beyond the
exempt amount until benefits go to zero
 Social Security
Annual Retirement Earnings Test Exempt Amounts, Ages
below Normal Retirement Age
----------------------------------------------------------------------
Year Exempt income
2000 $10,080
2001 $10,680
2002 $11,280
2003 $11,520
2004 $11,640
2005 $12,000
2006 $12,480
1990
2000
2025
 48% of retired persons have no pension
income except Social Security

GAO. 2000. Characteristics of Persons without Pension Coverage in the Labor Force
http://www.gao.gov/archive/2000/he00131.pdf
 2/3 of retired women have no pension
income except Social Security

GAO. 2000. Characteristics of Persons without Pension Coverage in the Labor Force
http://www.gao.gov/archive/2000/he00131.pdf
 Iowa Unemployment Insurance

Replacement rate: Percent of previous

earnings that are replaced by benefit
Typical is ~50%

Why is replacement rate < 100%?

Why is benefit conditional on being laid off

or quitting for cause?
 Iowa Unemployment Insurance

In 1984, Iowa’s UI program was $304 million

in the red.
Interest on debt $1 million per month

Proposal—continue to pay partial benefits

after UI recipient finds work
As of 2004, Iowa UI fund was $683 million surplus

2004 Status Report On The Unemployment Insurance Trust Fund

 Iowa Unemployment Insurance
Benefit tied to previous earnings (highest quarter of
previous four excluding the current and once lagged quarter)
Average weekly wage = $586

If 0 dependents, 53% of previous earnings up to $310/week

4+ dependents: 65% of previous earnings up to $381/week

You can earn up to 25% of weekly benefit in earnings and

still get full benefit. After that, earnings taxed at 100%
until benefit is exhausted

2004 Status Report On The Unemployment Insurance Trust Fund

 Iowa Unemployment Insurance

Example
Wage = $14.65/hour ($586 per week)

UI Benefit = 65% of previous earnings

= $380
25% of benefit = $95 = max allowable labor
earnings
Possible part-time job = $9.50/hour
2004 Status Report On The Unemployment Insurance Trust Fund
 Value of time and Labor Force Participation
2003 dollars

Children Service Price(1) Opportunity Cost(2)

Ages <6 $27,736 $24,632
Ages 6-14 $24,960 $21,259
None $20,133 $19,997

(1) Over estimate

(2) Under estimate