LABOUR ECONOMICS

UNIT FOUR

LABOUR SUPPLY

• Labour may be defined as the application of human effort both mental and physical to the production process. There are 3 main dimensions of labour
• 1. Quantity of labour: This is concerned with the number of hours an individual is prepared to work if really the individual is going to work. 2. Quality of labour: This refers to the degree of skills applied to a job where skills may be acquired through education or on-the-job training.
• 3. Intensity of labour: This refers to the degree of effort that is applied to the job.

Classification of labour

• Labor can also be classified according to its location or skill characteristics.

• Locational characteristics relate to the industry or occupation within which the individual works or according to the region in which the job is found.

• In Ghana, industries can group labour into agricultural, construction and commercial workers.

• Regarding occupation, we can talk about engineers, accountants, and others.

• Regarding region, labour can be grouped into urban and rural labor.

Classification of labour

• With skills Classification labour is grouped into:
• Skilled labor refers to workers with specialized or formal training; typical examples of this group will be doctors and lawyers etc
• Unskilled labor refers to those with no formal training and here examples will be gardeners and house helps.
• Labour supply refers to the number of hours or days individuals in the labour force are prepared to put in at the prevailing wage rate.
• Labour force consists of persons who are willing to work and those who are working at the prevailing wage rate. The labour force excludes the following people: full-time students, retired personnel, housewives and discouraged workers.

Determinants of labour force

1. Rate of population growth – All things being equal, the higher the rate of population growth, the higher the labour force.

2 Regional and gender distribution of population – women generally have a lower rate of labour force participation. Where women dominate the population, the labour force will be low.

3 The Age Structure - The age structure determines the eligibility rate of the populace.

4. Other factors such as economic, religious and social also influence the taste of work.

Measurement of labour force

Theories of labour supply

• A theory of labour supply is concerned with the factors influencing two main decisions which constitute the decisions to work. These are;
• Participation decision which relates to the decision by the individual or household as to when to enter the labour force, whether to remain in it or interrupt it and when to re-enter or retire.

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• Hours decision also relate to the number of hours a week, or in a month that the individual or household would provide once the decision to participate has been made at the prevailing rate.
• Basically, there are two broad theoretical approaches used in analyzing the decision to supply labour:
• The Neo-classical theory of labour supply

• The Institutional approaches to labour supply

Labour-Leisure Choice Model (The Neo-classical Model)

• It is based on individual or household utility maximization subject to a budget constraint. The utility has as its main components income (consumption goods) and leisure.

Assumptions

1. Individuals derive utility from the consumption of goods and they work to purchase the commodities

2. Individuals are free to choose the number of hours they want to

work in a competitive market only constrained by time and the

prevailing market wage rate.

Assumptions

3. Work involves sacrificing time available for leisure. Therefore, the rational individual will work only when the wage rate is positive and the additional goods and services purchased through earned income yields positive utility.

4. The decisions of individuals are not affected by the behavior of other people, including their own family or household members. Thus, people work not by compulsion but by choice.

5. Work and leisure are the only possible uses of time, where leisure is broadly defined as any type of non-market work including studying or training.

The Indifference Curve

• Indifference Curves show all the possible combination of consumption goods and leisure which when consumed by the individual yields the same level of satisfaction and between which the individual is indifferent.
• Properties of Indifference Curves
• Higher indifference curve represent higher utility
• The indifference curves are assumed to satisfy the usual properties of smoothness, convexity and transitivity
• Indifference curves are convex to the origin.
• Indifference curves do not intersect.
• Indifference curves are downward sloping.

Indifference Curve

• The individual’s preference between consumption goods and leisure may be represented by the utility function:

• U = f (C, L)

• Uc > 0 and UL > 0. This means that the individual derives positive satisfaction from consuming goods and leisure.

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The Time-Budget Constraint

The Time-Budget Constraint

The Worker’s Time-Budget Constraints

Determining the Equilibrium Between Leisure and Hours of Works

Determining the Equilibrium Between Leisure and Hours of Works

Algebraic Analysis (the labour Supply function)

Algebraic Analysis (the labour Supply function)

Algebraic Analysis (the labour Supply function)

Example

Example Cont.

v. Compute the own wage elasticity of labour supply

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vi Examine what happens to number of hours supplied if a curfew imposed reduces T from 30 hours to 20 hours.

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Vii What is the effect of an increase in the wage rate from 6 cedis to 8 cedis on the number of hours supplied?

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Viii What happens to the number of hours supplied when non-labour income increases by 10%?

Solution

Soln. Cont.

Soln Cont.

• Substitute eqn (4) into (3)

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Soln Cont.

Soln Cont.

Soln Cont

• (f) Increase in wage rate from 6 cedis to 8cedis

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Soln Cont.

• (g) Increase in nonlabour income (V) by 10%

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Soln Cont

• The labour supply reduces from 7hours to 3hours with the imposition of a curfew from 30 to 20 hours.

Derivation of the Individual labour Supply Curve

• Initial equilibrium is attained at point A with a given wage rate w for which 14 hours are used for work by the individual. The remaining 10 hours of the total time of 24hours is used for leisure.
• Assuming there is an increase in the wage from w to w1 , the individual achieves a new level of equilibrium at a higher indifference curve thereby getting a higher level of satisfaction.
• At this new wage level, equilibrium is at point B where the individual reduces the amount of leisure enjoyed whilst increasing the number of hours worked from 14 to 18 hours. This generates the individual labour supply function.
• The labor supply function shows that there is a positive relationship between the number of hours worked and the wage rate. This is a truism since all of us will be willing to work for more hours when the wage rate is increased.

Substitution and Income Effects of Wages

• The movement from point A to B in diagram above is the total effect of the change (increase) in the wage rate from w to w1 . This total effect can be decomposed into two: substitution effect and income effect.

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• Geometrically, the income effect is identified by examining how much non-labor income must be given to the individual to move from indifference curve I to indifference curve II without any change in the wage rate.

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• This is done by drawing a line parallel to the initial budget line but tangent to the higher indifference curve. The parallel nature of the line shows that the slope of the budget line (which is the real wage) remains constant.

• The movement from point A to D represents the income effect. The income effect on leisure as a result of a wage increase is always positive but negative on the hours of work. This is because as people make more money in the labor market, they will need more time off the labor market to enjoy their returns from work.
• Thus

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Backward Bending Labour Supply Curve

• Theoretically, a backward bending labor supply curve can exist for an individual.
• The individual enters the labor market once the market wage exceeds the reservation wage meaning hours of work are positive for wage levels above the reservation wage.

• At this lower level of wage, the individual tends to see leisure as very expensive and shuns leisure when the wage increases. Thus, the substitution effect outweighs the income effect leading to a negative total effect on leisure but positive on hours worked.

• As the wage increases and the individual moves into the higher income bracket, leisure becomes less expensive and more affordable. In this case, the negative substitution effect is less than the positive income effect of a wage increase. The total effect is positive on leisure but negative on the hours worked. Hence more leisure will be demanded.