Taste for Leisure and Market Goods

Leisure (L)

Market Goods (Y)HEAVEN

U0

U1

U2

Budget Constraint for Leisure and Market Goods

Leisure (L)

Market Goods (Y)Y = W(T – FT – L)+ YN

W = 5 = real wage

T=24

FT=10

YN =0

Y = 5H

14

Hours of work (H)014

0

70

feasible

infeasible

Slope = -W = -5

Budget Constraint for Leisure and Market Goods

Leisure (L)

Market Goods (Y)

Y = W(T – FT – L) + YN

Wage rises to $6

Y = 6H

14

Hours of work (H)014

0

70

Slope = -W = -5

Slope = -W = -6, so

price of leisure increases

Income increase

Budget Constraint for Leisure and Market Goods

Leisure (L)

Market Goods (Y)

Y = W(T – FT – L) + YN

Nonlabor income rises to

YN = 20

Y = 5H + 20

14

Hours of work (H)014

0

70

Slope = -W = -5

90

Income increase

Taste for Leisure and Market Goods

Leisure (L)

Market Goods (Y)HEAVEN

U0

U1

U2

A

B

C

W = (MUL / MUY)

Taste for Leisure and Market Goods

Leisure (L)

Market Goods (Y)

U0

U1

U2

A

B

C

W = (MUL / MUY)

W > (MUL / MUY)

W < (MUL / MUY)

Taste for Leisure and Market Goods

Leisure (L)

Market Goods (Y)

UB

UA

Who has the stronger taste for Leisure?

Y0

Y1

LB LAL0

Taste for Leisure and Market Goods

Leisure (L)

Market Goods (Y)

UB

UA

A

B

Flatter indifference curve means Goods lover

Steeper indifference curve means Leisure lover

YA

YB

LA LB

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 goodstoward leisure (away from hours of work)

Substitution effecttoward goodsaway from leisure (toward hours of work)

Totaltoward goodsleisure demand (labor supply) ambiguous

Response to a wage increaseIncome effect

toward goods

toward leisure (away from hours of work)

Substitution effecttoward goods

away from leisure (toward hours of work)

Totaltoward 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 increaseIncome effect

toward goods

toward leisure (away from hours of work)

Substitution effecttoward goods

away from leisure (toward hours of work)

Totaltoward 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 FemaleIncome 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 FemaleIncome 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?

Marital Status Male Female

Single (never married) 70.2 65.9

Married (spouse present) 77.1 60.5

Divorced 73.5 71.5

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

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 2009to 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 income2000 $10,080 2001 $10,680 2002 $11,280 2003 $11,520 2004 $11,640 2005 $12,000 2006 $12,480

1990

2000

2025

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

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

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

ExampleWage = $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 Participation2003 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