Managerial Economics

Topic 1
Individual Choices and Decisions

Individual’s choice between leisure and work

- Determination of labor supply

Sumit Sarkar, XLRI Jamshedpur

HRM - Term I – 2021
Session 8
 Individual’s choice between work and leisure

C
wT+V

E U3
C*

U1 U2
V

L* T L

h*
Sumit Sarkar, XLRI
The Individual’s Equilibrium is at E.
L* is the equilibrium leisure choice
Choice of work: T – L*= h*
Income earned: C* = wh* + V

Sumit Sarkar, XLRI

 Changes in wage rate and effect on wage-
time constraint
C

w3T+V
As w increases, slope w2T+V
of the wage-time
constraint increases. w1T+V

w0T+V
V

T L

Sumit Sarkar, XLRI

Changes in wage and supply of labor by the individual
C Case 1: w ↑ (Leisure dearer)
w3T+V
→ Leisure L↓
→ hours of labor supply h = (T – L) ↑
w2T+V
w
Individual labor
w1T+V
supply curve

w0T+V

L3 L2 L1 L0 T L h
Sumit Sarkar, XLRI
Changes in wage and supply of labor by the individual
C Case 2: w ↑ (Leisure dearer)
w3T+V
→ Leisure L↑
→ hours of labor supply h = (T - L) ↓
w2T+V
w

w1T+V Individual labor

supply curve

w0T+V

L0 L 1 L2 L3 T L h
Sumit Sarkar, XLRI
 Individual labor supply curve
How does the individual
labor supply curve look
like?
Upward rising or w
downward falling?
Commonly, the individual
labor supply curve is
backward bending.
That is, upward rising for
w*
wages below a certain level
(w* say) and downward
falling for wages higher
than w*.

h
Sumit Sarkar, XLRI
 Why is the individual labor supply curve backward bending?

 When w < w* wage is too low. As w rises, the worker would

like to work more hours. At such low wage, MU of
consumption is more than MU of leisure.
 Increased wage induces larger labor supply as long as w < w*.
 When w > w* wage is high. As w rises, the worker likes to
reduce her working hrs. At such high wages, MU of
consumption is low. The worker values leisure more than
income. She would not mind taking time off for leisure.
 Increased wage reduces labor supply for w > w*.
 For each individual w* is different.

Sumit Sarkar, XLRI

 Problem 9 – Set 1

An employer offers the wage rate of Rs. 200 per hour to her
employees. However, if an employee works for more than 8
hours, s/he is given the overtime rate that is Rs. 300 per hour.
 Draw an employee’s wage-time constraint in the leisure-

consumption plane. Measure consumption in terms of its

monetary value.
 Suppose the employer decides to withdraw the overtime

scheme because of recession. Show that some of the

employees who used to work overtime may choose to work
for less than 8 hours when the overtime scheme is withdrawn.
Assume that the employee’s utility increases at a decreasing
rate in both leisure and consumption.

Sumit Sarkar, XLRI

 Problem 9 – Set 1

Consumption The slope of the

wage-time
6400
constraint is
more negative
for over-time.
The IC touches
the constraint at
1600 + 300y
two points
1600
200(8 – x)

Leisure
16 - y 16 16 + x 24

Sumit Sarkar, XLRI

Reading
• Besanko & Braeutigam. Ch. 5 (Section 5.5)
• Problems 5.28-5.30.

Sumit Sarkar, XLRI