Labour Economics

Stephen W. Smith

• Publisher: Routledge
• Year: 2003
• ISBN:
  9781134511242
• Edition: 2
• Topic: Business
• Subtopic: Business General
• Index: Business

In the six years since the appearance of the first edition of Stephen Smith's book, labour economics has become a more firmly entrenched subject on the curriculum. Previously regarded as a subsection within industrial economics, there are now very few universities that do not devote a course to it in its own right. The focus of topics covered withi

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Labour supply

INTRODUCTION

Currently labour supply is one of the most active research areas in labour economics. According to Blundell and MaCurdy (1999) ‘research on labour supply during the past decade has been at the forefront of developments in empirical microeconomics’ (p. 1560). The surveys by Killingsworth (1983), Pencavel (1986) and Heckman (1993) bear witness to this activity at both the theoretical and empirical levels. It is not our intention either to replicate or to replace such near-exhaustive treatments. Instead this chapter will outline the dominant neoclassical theory of labour supply before extending the analysis to examine the effects of varying wage rates, incorporate income taxation, and introduce non-work welfare benefits. We shall distinguish between male and female labour supply both in theory and empirically. The more dynamic lifecycle modelling of labour supply will also be considered. There are important topical policy aspects of labour supply that need to be addressed, ranging across: concern over demographic changes; discussion about the role of women in the paid labour market; and consideration of the impacts of the tax and welfare benefit regimes. Our analysis of labour supply will touch upon all of these policy issues. It will also lay the foundation for the subsequent treatment of the other areas of labour economics, in particular, job search (Chapter 9), education, training and employee signalling (Chapter 5) and the supply-side view of unemployment (Chapter 10). An understanding of labour supply will also enter into an assessment of movements in labour productivity through an examination of labour supply responses to varying wage rates, a link that will be made explicit in Chapter 3.

INDIVIDUAL LABOUR SUPPLY

The supply of labour can be analysed at two levels: the microeconomic level, concerned with individual and household labour supply, and the macroeconomic or aggregate economy level. The following account of the economic analysis of labour supply begins with a microeconomic theory based upon the neoclassical solution to the consumers’ allocation problem.

The analysis constructs a simple model of an individual’s labour supply decision. Basically it involves a choice between work and leisure, subject to a budget or income constraint. We are not concerned with any particular individual, instead we are dealing with an ‘idealised’ microeconomic individual who seeks rationally to maximise his/her utility.

Utility is the benefit or satisfaction an individual presumably derives from the activity of consuming goods/services. Work is assumed to confer a certain amount of disutility. Wages help to offset that negative aspect and enable the individual to generate income, which can be used to consume goods and services in future time periods. Without resorting to excessive detail, the main results of the microeconomic analysis of labour supply can be simply reproduced. On the basis of the simplifying assumption that individuals are free to determine the hours they wish to work, Figure 1.1 shows the relationship between work and pay. Obviously in choosing how much labour to supply (hours worked, H), the individual is simultaneously determining leisure time (L). Hence labour supply and the demand for leisure are being decided jointly, with the opportunity cost of leisure being the wage earnings forgone by not working. Leisure is assumed to be a normal good, which features in the rational individual’s utility function. H_m is an imposed maximum duration of the working day.¹ Wages bring utility through the consumption of goods, services and leisure. Work brings disutility.²

Figure 1.1

Figure 1.2

The curves I₁, I₂ and I₃ form part of the individual’s indifference mapping. Each indifference curve joins together combinations of income and hours of work, which yield the same level of utility to the individual. The higher the indifference curve, the greater the level of utility.

The rays emanating from the origin O, R₁, R₂ and R₃ have slopes which represent different wage rates (OR₁ wage rate = £OA/OH₁ per hour). The parallels between this analysis and the microeconomic indifference analysis of consumption are obvious.

According to Pencavel (1986), ‘the neoclassical theory of labour supply is a straightforward extension of the consumers’ allocation problem’ (p. 6). We are in the familiar territory of constrained maximisation. If we plot the individual labour supply curve passing through the points of tangency A, B and C, we derive the labour supply function illustrated in Figure 1.2.

The individual labour supply curve (S) is backward bending, a feature which leaves open the question about whether greater remuneration results in increased work effort. As the wage rate rises from R₁ to R₂, the i...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright Page
• Table of Contents
• Tables
• Acknowledgements
• Introduction
• 1 Labour supply
• 2 Labour demand and productivity
• 3 Wage determination and inequality
• 4 Personnel economics
• 5 Human capital
• 6 Labour market discrimination
• 7 Trade unions and labour markets
• 8 Labour market flexibility
• 9 Job search and vacancy analysis
• 10 Unemployment
• 11 Trade, globalisation and labour markets
• Notes
• Bibliography
• Index