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Indifference curve analysis:

• budget line and "full income"
• income effect
• substitution effect
• Slutsky equation
• corner solution and the "reservation wage"

Distinguish between different types of labor supply:

• Marshallian labor supply
• Hicksian labor supply
• intertemporal wage changes
• labor supply to specific industries

Empirical evidence:

• Over the long term, real wages have risen, but hours worked and labor participation have fallen for men, while hours and participation have risen for women. One justification is that women used to work shorter (or even no) hours. Thus the strength of the income effect is smaller for women than for men.
• Recent studies found that the decline in labor participation of older men is mainly concentrated among those with low market wages, so the decline in labor participation reflects the substitution effect as well.
• Cross section studies of male labor supply often find that the income effect dominates the substitution effect. The elasticity is about -0.1 to -0.2.
• For women, the real wage rate is found to have a strong positive effect on labor force participation.
• Economists typically assume that leisure is a normal good, but hard evidence for this is not so easy to come by. For one thing, non-labor income is not well measured in survey data. For another, non-labor income in one period may be the result of labor income in previous periods. So in a life-cycle setting, non-labor income is really endogenous, which makes estimating the income effect tricky. Hotz-Eakin, Joulifaian, and Rosen (1993) did a study that makes use of data on inherited wealth. They found that labor force participation among people who received larger amounts of inheritance (average US$346,200) fell from 70% to 65%, while labor participation among people who received small amounts of inheritance rose from 76% to 81% in the same period. Even among the labor force participants, people who received larger amounts of inheritance a more likely to experience a fall in earnings than are people who received less inheritance (perhaps because they work fewer hours or take a more desirable job at lower wages once thay received the inheritance).
• Gerald Oettinger (1999) studied labor supply of food vendors at a baseball stadium. These vendors are hired on a daily basis and they are free to choose whether to work at any given game. Earnings from sales fluctuate by the game, but these fluctuations are to some extent predictable. These fluctuations tend to cancel out so the income effect is probably not very strong (more precisely, one may think of the labor supply response as a response to intertemporal wage changes). Oettinger found that a US$10 rise in daily earnings (the average was about $43) lured an extra 6 vendors (the average number was about 45) to the stadium.

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Lecture Notes