Labor-Leisure Choice – Indifference Curves

Just like the

indifference
curves used to
derive consumer
demand.
Tradeoff is
between leisure
and all other
goods measured
in dollars (i.e.
income).
Slope is
marginal rate of
substitution.
Graph by Harcourt, Inc.
 Different Preferences for Leisure
Since MRS =
MUL/MUY,
steeper curve
enjoys leisure
more and flatter
curve enjoys
leisure less.
So Person B
requires more
money to be
willing to give up
leisure than
Person A does.

Graph by Harcourt, Inc.

 Different Budget Constraints
Non-
labor-
market
income
results
in a
shift up
of the
budget
line.

Hours not spent at leisure can be spent in market work

earning money to buy other goods, so wages are
represented by slope – a higher wage is a steeper slope.
Graph by Harcourt, Inc.
 Optimal Number of Hours Worked

Individuals maximize utility subject to their budget

constraint, so optimal hours worked is total hours available
minus chosen hours of leisure.
Graph by Harcourt, Inc.
 A Pure Income Effect

An increase in income with no change in the wage (pure

income effect) shifts out the budget constraint and implies
demanding more normal goods, including leisure. Move
from X to Z and hours of work decline.
Graph by Harcourt, Inc.
 A Wage Increase (Substitution Effect Dominate)

A wage increase has both income (budget line moves out)

and substitution (budget line’s slope changes) effects.
Income effect -> work less (Z), Substitution effect -> work
more (X). Overall effect is move from V to X (sub > inc).
Graph by Harcourt, Inc.
 A Wage Increase (Income Effect Dominate)

A wage increase has both income (budget line moves out)

and substitution (budget line’s slope changes) effects.
Income effect -> work less (Z), Substitution effect -> work
more (X). Overall effect is move from V to X (inc > sub).
Graph by Harcourt, Inc.
 The Reservation Wage

At this wage, it is not worth giving up leisure. The slope of the

indifference curve at B is the reservation wage. Only participate in
the labor market when W > reservation wage.

Graph by Harcourt, Inc.

 The Participation Decision – Wage Change

When the wage increases beyond the reservation wage, begin

to participate in the labor market (move from B to X).
Graph by Harcourt, Inc.
 The Participation Decision – Income Change

As income rises, tangency is at a steeper and steeper sections

of the indifference curves, until the current wage is the
reservation wage and individual drops out of the labor market.
Graph by Harcourt, Inc.
 Policy Analysis – Welfare Program

$200 guarantee, reduced as earn income. Program has

both inc effect (budget out) -> work less (Z), and sub effect
(flatter budget) -> work less (X). Clear work disincentive
from this program.
Graph by Harcourt, Inc.
 Policy Analysis – Social Security

Change time frame to year. Can earn a small amount with no

loss of benefits, then are reduced as earn more until completely
phased out. Here pure income effect, but if worked more without
program, will also be substitution effect. Both imply work less.
Graph by Harcourt, Inc.
 Policy Analysis – Progressive Income Tax

Proportional tax is just a wage change, but progressive tax adds

curvature to the budget line. The more one works, the less of
each extra dollar earned one gets to spend. Income effect is to
work more (Z), but strong substitution effect to work less (X).
Graph by Harcourt, Inc.
 Fixed Hours of Work Available

Person A would like to work 50 hours, Person B would like

to work 30 hours. If only jobs with 40 hours are available
at this wage, both will be worse off – working more or less
than is optimal.
Graph by Harcourt, Inc.
 Fixed Costs of Working

Fixed time costs reduce the time
available for either work or leisure
so budget line moves in. Less
income, less leisure, likely also
less work (more commuting).
Graph by Harcourt, Inc.
Fixed monetary cost is pure
income effect, so budget
line moves in. Less income,
less leisure, more work.
Household Production

Graph copyright © 2003 by Pearson Education, Inc.

HH Opportunity Frontier & Individual Budgets
350

300

250
Market Goods

200

150

100

50

0
0 50 100 150 200 250 300 350
Household Goods

Household Wife Husband

The husband has a higher wage, so he works first to get market
goods and the wife is first to produce household goods. As a
household they can have more of everything.
Different HH Divisions of Labor
350

300
A

250
Market Goods

200
B

150

100
C

50

0
0 50 100 150 200 250 300 350
Household Goods

In A the husband specializes in the market sector and the wife

splits her time. In B the husband specializes in the market
sector and the wife specializes in the HH sector. In C the
husband splits his time and wife specializes in the HH sector