Why labor demand elasticity is important?

Example 1
• What would happen to employment and wages when a minimum wage is introduced?

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Why labor demand elasticity is important?
Example 1
• What would
happen to
employment and
wages when a
minimum wage is
introduced?
• Graph from
Doucouliagos &
Stanley (2009)

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LABOR ECONOMICS
JAKUB GROSSMANN WEEK 3, FALL 2023

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Supply of labor
• Last week we discussed how the demand side of the labor market works
• Let us look at the supply of labor this week
• To derive labor supply we need to understand individuals’ decision to work

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Supply of labor
• Last week we discussed how the demand side of the labor market works
• Let us look at the supply of labor this week
• To derive labor supply we need to understand individuals’ decision to work
• Basic assumption: individuals maximize utility
• For simplicity we assume that individuals divide their time between work and leisure only.
• Individuals derive utility from leisure and consumption.
• To consume, individuals need to purchase goods.
• Individuals use income to purchase goods

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Supply of labor
• Last week we discussed how the demand side of the labor market works
• Let us look at the supply of labor this week
• To derive labor supply we need to understand individuals’ decision to work
• Basic assumption: individuals maximize utility
• For simplicity we assume that individuals divide their time between work and leisure only.
• Individuals derive utility from leisure and consumption.
• To consume, individuals need to purchase goods.
• Individuals use income to purchase goods
Income = earnings + unearned income

Wage*time worked

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Utility
Let us measure consumption in money
• How many dollars one uses to purchase consumption goods.
• For simplicity, assume individual uses all income for consumption.
Utility function is a mapping between a combination of factors that make people
happy and an abstract measure of “happiness”, which economists call utility.

𝑈(𝐶, 𝐿)

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 Utility
Utility function is a mapping between a combination of factors that make people
happy and an abstract measure of “happiness”, which economists call utility.

𝑈(𝐶, 𝐿)

How much utility one derives from a specific combination of consumption and leisure
depends on his/her preferences.
• Two individuals might derive different levels of utility from the same combinations of
consumption and leisure
• Two individuals might experience different increase in utility when having more time
for leisure and keeping consumption constant.

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 Indifference curves
Money
income
per day
Each point on an
indifference curve
represents a
combination of
consumption and
leisure that result is
the same level of
utility.

Hours of leisure per day

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Indifference curves
Characteristics of indifference curves:
• Any such curve that lies to the northeast (up and to the right) of another one
is preferred to any curve to the southwest because the northeastern curve
represents a higher level of utility.

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Indifference curves
Characteristics of indifference curves:
• Any such curve that lies to the northeast (up and to the right) of another one
is preferred to any curve to the southwest because the northeastern curve
represents a higher level of utility.
• Indifference curves do not intersect (individual level).

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Indifference curves
Characteristics of indifference curves:
• Any such curve that lies to the northeast (up and to the right) of another one
is preferred to any curve to the southwest because the northeastern curve
represents a higher level of utility.
• Indifference curves do not intersect (individual level).
• Indifference curves are negatively sloped.

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Indifference curves
Characteristics of indifference curves:
• Any such curve that lies to the northeast (up and to the right) of another one
is preferred to any curve to the southwest because the northeastern curve
represents a higher level of utility.
• Indifference curves do not intersect (individual level).
• Indifference curves are negatively sloped.
• Indifference curves are convex—steeper at the left than at the right.

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Indifference curves
Characteristics of indifference curves:
• Any such curve that lies to the northeast (up and to the right) of another one
is preferred to any curve to the southwest because the northeastern curve
represents a higher level of utility.
• Indifference curves do not intersect (individual level).
• Indifference curves are negatively sloped.
• Indifference curves are convex—steeper at the left than at the right.
• Different people have different sets of indifference curves.

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 Indifference curves
Money
income
per day Indifference curves are convex
• At few hours of leisure a
day one does not want to
give up much leisure for
income
• At many hours of leisure a
day one is willing to give up
much of leisure for income

Hours of leisure per day

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 Indifference curves
Money
income
per day • Person A values leisure
less, he/she is wiling to
give up much leisure to
reach higher income level
• Person B values leisure
more, he/she is wiling to
give up lust a little leisure
to reach higher income
level

Hours of leisure per day

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4 minutes summary
Grab your pen and pencil and write in your own words:
• What is utility (when do we use this concept, what units, how do we measure
it,…)
• What is indifference curve (why do we use this concept, what are the
characteristics of IC, what space we plot them, ….)
• Think about 1-3 difficult questions (to which you might not have a clear
answer) regarding the utility and indifference curves and write them down

! You will need this hand-written summary for the following activity – do not skip
this !

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Breakout rooms - 6 minutes
1) You are divided into smaller groups; each of you should present what she/he
can remember about the utility and indifference curves
2) Bring up the difficult questions you could think of and ask specific person to
answer them.
• Introduce yourself
• One at time
• The idea is not to test you, you can help other colleagues to think about the
problem from different perspective
• You can learn from your colleagues, or you can clarify something for them: this
is useful!

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Income and wage constraints
• Individuals want to maximize utility, but in doing so are limited with time and
financial constraint
• Do you remember the term scarcity of resources?

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Income and wage constraints
• Individuals want to maximize utility, but in doing so are limited with time and
financial constraint
• Do you remember the term scarcity of resources?
• One day has only 24 hours!
• From now on, let us assume that one spends 8h sleeping, this gives 16h that can be devoted to
leisure and/or work.
• When an individual enjoys more leisure, he/she devotes less time to work and consequently earns
less money.

• This tradeoff and limitation can be visualized as a budget constraint.

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 Income and wage constraints
Money
income
per day
128
• Slope of the budget
curve corresponds to
the wage rate.

Hours of leisure per day

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 Income and wage constraints
Money
income
per day
128
• Let us include
indifference curves

Hours of leisure per day

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Labor supply
We can use the graphical representation of indifference curves and budget
constraint to derive individual’s labor supply.
1.Decision to work

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Labor supply
We can use the graphical representation of indifference curves and budget
constraint to derive individual’s labor supply.
2.Number of hours worked

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Labor supply
We can use the graphical representation of indifference curves and budget
constraint to derive individual’s labor supply.
2.Number of hours worked – individual labor supply curve

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Summary
What is the utility function?
What is the indifference curves?
Name the main characteristics of the indifference curves and explain what are
their implications.
What is the budget constraint, and what is the slope?
How can we derive the individual labor supply using the presented framework?

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Summary
What is the utility function?
• function that maps various factors that make people happy to "happiness" -
utility in economic terms
What is the indifference curves?
Name the main characteristics of the indifference curves and explain what are
their implications.
What is the budget constraint, and what is the slope?
How can we derive the individual labor supply using the presented framework?

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Summary
What is the utility function?
What is the indifference curves?
• The IC represents the same utility level derived from different combinations of
utility function inputs
Name the main characteristics of the indifference curves and explain what are
their implications.
What is the budget constraint, and what is the slope?
How can we derive the individual labor supply using the presented framework?

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 Summary
What is the utility function?
What is the indifference curves?
Name the main characteristics of the indifference curves and explain what are their implications.
• Any such curve that lies to the northeast (up and to the right) of another one is preferred to any
curve to the southwest because the northeastern curve represents a higher level of utility.
• Indifference curves do not intersect (individual level).
• Indifference curves are negatively sloped.
• Indifference curves are convex—steeper at the left than at the right.
• Different people have different sets of indifference curves.
What is the budget constraint, and what is the slope?
How can we derive the individual labor supply using the presented framework?

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Summary
What is the utility function?
What is the indifference curves?
Name the main characteristics of the indifference curves and explain what are
their implications.
What is the budget constraint, and what is the slope?
• We use it to formally introduce the tradeoff between leisure and income
• Wage rate
How can we derive the individual labor supply using the presented framework?

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Summary
What is the utility function?
What is the indifference curves?
Name the main characteristics of the indifference curves and explain what are
their implications.
What is the budget constraint, and what is the slope?
How can we derive the individual labor supply using the presented framework?
• by varying wage - budget constraint slope - we get tangent points of BC and
indifference curves (different levels) - by translating into W/L space we receive
the individual labor supply

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Thank you!
Next lecture on Wednesday September 27, 2023
• lecture will start with a quiz

• After a 45-min lecture,

• there will be a seminar session leaded by your Local Teacher

See you on Wednesday!!!

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