Topic 2.2c - Labour Force Participation. Professor H.J. Schuetze Economics 370

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1 opic 2.2c - abour Force Participation Professor H.J. Schuetze Economics 370 abour Force Participation abour force participation involves the decision to engage in labour market activities rather than leisure. abour force participation affects unemployment rates the composition of the labour force the size of the labour force It is, therefore, very important to understand what things influence decisions about whether or not to participate in the labour force. Professor Schuetze - Econ

2 abour Force Participation We will examine what determines labour force participation using the income-leisure choice model that we just developed. First, however, lets examine what it means to be in the labour force. et s start by defining the eligible population or the potential labour force participants (POP) he POP includes: civilians non-institutionalized those 15 years of age or older In Canada in the year 2015 (August) the eligible population totalled 29.3 million Professor Schuetze - Econ abour Force Participation hose from the potential labour force are then categorized as either in the labour force or not in the labour force. hose who are not in the labour force include: students retired persons discouraged workers (not looking for work) household workers 10 million (2015) Professor Schuetze - Econ

3 abour Force Participation hose who are in the labour force are of two types 19.3 Million i. Working => Employed ii. ooking for Work => Unemployed 18.0 Million 1.3 Million Professor Schuetze - Econ abour Force Participation ou can see then that the unemployment rate which equals # unemployed # in the labour force is not a clear measure. For instance in the news they often say that a decline in the unemployment rate is good news while an increase is bad news. However, if the unemployment rate falls it could be the result of more potential labour force participants becoming discouraged. abour Force Participation ate = #F #POP Professor Schuetze - Econ

4 abour Force Participation ypically, data on the rate of unemployment and the labour force participation rate are taken from a monthly survey conducted by Statistics Canada called the abour Force Survey. In this survey people are asked about their labour market activities in the week prior to the survey date. If they were not working they are asked whether or not they looked for work and are classified according to their responses. Professor Schuetze - Econ heory We now turn to our model to see what might influence labour force participation. 1 Non-Participant: corner solution 0 2 Participant: interior solution N N 0 Here are two possible solutions to the utility maximization problem for a given wage Professor Schuetze - Econ

5 heory Figure 1: he individual maximizes utility at (i.e at the maximum amount of leisure available) here is no tangency between the indifference curve and the budget constraint he individuals indifference curve at the optimum is steeper than the budget constraint. Figure 2: ooks more like the examples we have looked at so far. he individual here will participate in the labour market Here, the individual has a positive number of hours worked and maximizes utility between the two extreme points here is a tangency point between the indifference curve and the income constraint. Professor Schuetze - Econ heory hinking about the participation decision in terms of the graphics: he critical point in determining participation in the graphs is the maximum leisure point () he slope of the indifference curve at measures the individuals willingness to exchange leisure for income he budget constraint measures the value the market puts on leisure relative to market work If, as in 1, the slope of the indifference curve is steeper than the budget constraint then we say that the individual values leisure more than the market values leisure. For example: Not many of us would be willing to give up a couple of hours in front of the V to work at a factory job that pays $1.00 an hour. Professor Schuetze - Econ

6 heory In figure 2, we can draw in an additional indifference curve from the family of indifference curves that crosses through the point at which leisure is maximized: 0 N 2 Notice that the slope of the indifference curve at this point is flatter than the budget constraint. i.e., the individual values leisure less than the market. 0 his individual will participate in the labour market. Professor Schuetze - Econ eservation Wage he wage at which the individual values leisure time exactly as much as the market values leisure he individual is just indifferent between working and not working or participating and not participating Put another way, the reservation wage is equal to the slope of the individuals indifference curve at zero hours of work. 1 Professor Schuetze - Econ

7 eservation Wage N 0 If the reservation wage is above the market wage (as in figure 1) the individual won t work If the reservation wage is below market wage (figure 2) the individual will work. So the reservation wage is another way to measure the individuals valuation of leisure (taken from the point of view of the critical point ) Professor Schuetze - Econ Effect of Changes in the Wage (A) Participant W 0 N E As before, an increase in the wage can have either a positive or negative effect on hours worked because of income and subs effects. However, increases in the wage can never force an individual out of the labour market. he individual can always achieve higher levels of utility by participating than by not participating eservation wage is always lower than the going wage. Professor Schuetze - Econ

8 Effect of Changes in the Wage (B) Non-Participant E 1 1 W For a non-participant, a wage change can either: eave labour force participation unchanged, or Coax the individual into the labour market. 1 * Notice that for the non-participant there can be no income effect he individual cannot choose any more leisure! here is only a substitution effect (i.e., increase in the hours worked = decrease in leisure). Professor Schuetze - Econ Effect of a Change in Non-abour Income 0 N (A) Participant E 1 U he individual is better off at U 1 than U 0. his is an example of a pure income effect. he price has not changed (W) only income has risen. he amount of leisure can only rise or the hours worked can only fall, if leisure is a normal good. 1 U1 Professor Schuetze - Econ N he effect of an increase in non-labour income on a participant is that it can: Cause the individual to exit the labour market or o choose fewer hours. 8

9 Effect of a Change in Non-abour Income Given that an increase in N is an income effect we know that an increase in N can never cause a nonparticipant to enter the labour market N (B) Non-Participant N 2 N he individual is better off with the increase in nonlabour income (as we would expect) but still chooses full leisure (). U 1 U 0 Professor Schuetze - Econ o Summarize An increase in the wage can never influence a participant to leave the labour force but can induce non-participants to enter the labour force (pure substitution effect). An increase in non-labour income has the opposite effect. An increase in non-labour income can induce a participant to leave the labour force but can t induce a non-participant to enter the labour force (pure income effect for both). Professor Schuetze - Econ

10 Determinants of Participation eservation Wage (non-labour income) Children present Importance of hh work (e.g., farm) hese reservation wage and participation Market wage Unions Wage Education Both Age Higher market wage Higher reservation wage (harder to work) Professor Schuetze - Econ Empirical Evidence Again, many have tested using married women. ypically find participation rates higher for More highly educated ( opportunity cost of leisure) ounger women ower family incomes ( N ) Women with fewer children (value leisure highly with more children) Professor Schuetze - Econ

11 ong-un rends heory can explain long-run trends also. Older males (55+) leaving the labour force % % % could be wealth effect, can buy more of everything including leisure. could be increase in private pensions. Increased female labour force participation % among prime aged women % compared to 94%-91% for men most dramatic in post war period and more dramatic for married women. Increase in two earning families is large. Professor Schuetze - Econ ong-un rends Why? Most males are in the labour force for a long time and have large number of hours already. Over this period real wages were rising, mostly an income effect for males. Females have lower hours and mostly a substitution effect for them. Income effect is small. herefore, find increase in female participation. Other theories: Increased education of females (leisure is costly). Women having fewer children (value leisure less). Social acceptance Increase in white collar jobs Professor Schuetze - Econ