ECON 381 LABOUR ECONOMICS. Dr. Jane Friesen

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1 ECON 381 LABOUR ECONOMICS Dr. Jane Friesen

2 Work disincentive effects ofa welfare program Y W 1 T Y 1 Y min U 1 U 2 L 1 L min T L

3 Welfare Reform Basic welfare programs create big disincentives to work This has prompted governments to explore welfare reform: changes that reduce the disincentives to work

4 The Self-Sufficiency Project Created a list of long-term (at least 1 year) single parent welfare recipients, randomly selected half for a work subsidy program, that provided a temporary, generous earnings supplement To be eligible for supplement, participants had to begin working full time (30+ hours/week) within a year of the offer Eligibility lasted for up to three years after finding full time work Supplement =(37000-earnings)/2

5 Supplement value Example: Single parent with 2 children in Vancouver received $17111 annually in welfare in If they obtained a job working 35 hours at $7 an hour and worked 52 weeks, they earned $12,740. The work subsidy is $12,130, giving them total earnings of $24,870. In general, most participants faced incomes $3- $7,000 higher with the subsidy, compared to welfare.

6 The self-sufficiency project Y U R -w -w/ T-30 T L

7 How did the program affect labour supply? Only 30% of those treated switch to working full time, compared to 15% of the control group during the first year of the study. Why do you think so many in the treatment group did not take up the program? By the time the subsidy was removed, the treatment group had no different employment rates than the control group. It seems that the overall effect of the program was to increase the speed at which welfare parents took up FT employment.

8 Should this program be adopted? Compare costs and benefits Total cost of subsidy was less than welfare would have been. But, the program also subsidizes individuals who would have started FT work anyway (windfall recipients). The 5 year per program group member cost was $40k for the treatment group and $37k for the control group (not including admin costs). Might be able to justify the program Could lower costs if did a better job targeting those who would have stayed on welfare otherwise.

9 Daycare costs (fixed) We can model daycare costs as a fixed cost or a variable cost. Y M 0 Here we have modeled it as a fixed cost. -w rd Fixed daycare costs increase the reservation wage makes it less likely that an individual will participate in the market. -w r Unearned income Daycare costs Daycare subsidy reduces daycare costs makes it more likely individual will participate. T Hours spent in home production (P)

10 Daycare subsidies (fixed cost) In this example, the individual choose to work offered wage is greater than reservation wage. What is the effect of a daycare subsidy? Pure income effect: work less. Y M 0 -w rd What happens to consumption of goods? Daycare costs T Hours spent in home production (P)

11 Daycare costs (variable) Here we have modeled daycare costs as variable - $d per hour. Variable daycare costs do not affect the reservation wage. They do affect the (after daycare costs) offered wage. Y -w -(w-d) Will have income and substitution effects. Effect on labour supply is ambiguous. Daycare subside will reduce d ; effect on labour supply is ambiguous. Unearned income T Hours spent in home production (P)

12 Quebec s $5/day child care program Subsidized care introduced in September, Phased in over period No income test; universal program. Increased labour force participation of women in two-person families with children aged 0-4 by 7.7 percentage points Also find that children are worse off in a variety of behavioral and health dimensions, ranging from aggression to motor-social skills to illness.

13 Introduction to Labour Demand

14 Labour demand The demand for labour is a derived demand. Firms demand labour in order to use it as an input into the production of a good or service for sale in the market.

15 Assumptions - technology Firms produce output q using capital k and labour l according to the production function Where: q = f (k,l)!f /!l > 0;!f /!k > 0! 2 f /!l 2 < 0;! 2 f /!k 2 < 0 Define the short-run as the period of time over which at least one input is fixed. We will treat k as fixed in the short-run. Is this a sensible assumption?

16 Assumptions market structure We will start by considering perfectly competitive firms Competitive firms that are price takers in all markets. What does that mean? Call the price of labour w, the rental price of capital r, and the price of output p.

17 Assumptions behaviour Firms maximize profit = total revenue total cost The expression for the firm s profit in the short-run is! = pq! wl! r k _ What are the firm s choice variables in the short run?

18 Short-run profit maximization _ max! = pq! wl! r k l = pf (l, k _ )! wl! r k _ FOC : p!f /!l " w = 0 p!f /!l = w p* mpl = w

19 The firm s short run labour demand MPL, Real Wage (W/p) Nominal Wage (W) W 3 /p W 3 W 2 /p W 1 /p W 2 W 1 mpl p*mpl l 3 l 2 l 1 l l 3 l 2 l 1 l

20 The short-run labour demand curve of a competitive firm How do we know the competitive firm s short-run labour demand curve slopes downward? What causes a movement along the short-run labour demand curve? What causes a shift in the short-run labour demand curve?

21 A change in the product price Nominal Wage (W) What would cause a change in the product price? An increase in the price causes the demand curve to shift upwards (to the right) W p 1 *mpl p 0 *mpl l 0 l 1 l

22 The competitive firm s labour demand curve in the long-run Now both capital and labour are variable. The firm has two decisions: how much output to produce and what combination of k and l to use to produce that output. Note that in the short-run, these were not different decisions. Again, we assume the firm maximizes profit. If the firm is maximizing profit, it must be producing its output at the lowest possible cost. We can break the problem into two pieces: (1) Choose k and l to minimize the cost of producing any level of output (2) Choose the level of output that maximizes profit

23 Isoquants We represent all the combinations of k and l that can be used to produce a given level of output with an isoquant Isoquants slope downwards in k, l space. Why? What do we call the slope of an isoquant? What assumption do we make such that isoquants are convex?

24 Properties of Isoquants Negative slope Convex Mixtures of l,k are more productive than extremes Diminishing marginal rate of technical substitution Don t cross The bundles (l 1,k 3 ), (l 2,k 2 ), and (l 3,k 1 ) all produce the same level of output Q=100. If we fix capital at k 3, changing the quantity of labour changes output: (l 1,k 3 ) = 100 f(l 2,k 3 ) = 150 f(l 3,k 3 ) = 200 k k 3 k 2 k 1 l 1 l 2 l 3 q=200 q=150 q=100 l

25 Costs Need to introduce the analog to the budget line: called an isocost line The isocost line represents combinations of l,k that cost the same amount just like a budget line, except the firm can choose their level of expenditure, i.e., which isocost line they are on

26 The isocost line Suppose W = $10 r = $20 Here are three isocost lines. They give combinations of l,k that cost $1000, $1500, and $2000 respectively In each case, Slope = W / r = - 1 / 2 k Cost=$1000 Cost=$1500 Cost=$ l

27 The cost minimization problem cost-minimizing condition: ð W / r = MRTS The cost-minimizing way to produce output level q* is (l*,k*), which costs C* Is this profit maximizing? k k* Cost = C* q=q* l* l

28 Choosing output to maximize profit Profit maximizing condition: P P=MC q P* q* q

29 Scale and Substitution Effects How do firms respond to changes in input prices? Suppose W increases Because labour is now more expensive relative to capital, and because labour and capital are substitutes in production, firms will change their input mix to use less labour and more capital to produce any level of output This is a substitution effect Because it is now more expensive to produce any level of output, the firm will reduce output (and hence reduce use of labour (and probably capital too) This is a scale effect (like an income effect in the leisure consumption choice model)

30 Scale and Substitution Effects Graphically 1. Wage is W 0, and firm chooses (l 0,l 0 ) to produce Q 0 units at cost C 0 k Cost = C 0, slope = -r/w 0 2. Wage increases to W 1 Substitution effect: (l 0,k 0 ) to (l s,k s ) [change in input mix due to higher wage, holding output constant] k s k 1 k 0 Cost > C 0, slope = -r/w 1 Scale effect: (l s,k s ) to (l 1,k 1 ) [change in inputs due to reduced output q 1, because production is more expensive] Note: we don t know q 1 l 1 l s l 0 q=q 1 q=q 0 l