Question

Graphically show and explain how reservation wage related to the decision to work? Use your understanding of reservation wage to explain how it relates to labor force participation for women.

Answer 1

In the graph we see two individuals, one with a non labor income and one with no non labor income. The individual with no non labor income has both intercepts of work-leisure line touching the axes. This implies that when there is no work, there is no income and all time is spent in enjoying leisure. This person has a wage rate that is higher relatively and so he is more likely to participate in labor market. He has a utility function of U2 and a total maximum income W2. The slope of the work-leisure line is higher showing a higher opportunity cost of work and a lower opportunity cost of leisure.

In contrast, the individual with a non-labor income has a lower wage because he is already enjoying complete leisure while still having money to finance his spending. This implies that he is less encouraged to participate and work. This is perhaps because his wage rate is lower and even if he works for all the time, the overall income is lower. His indifference curve is steeper and MRS is high relatively. This person therefore develops a reservation wage below which he will not participate and work

This is the reason for lower women participation because they were earning at a lower wage rate and have a higher opportunity cost of leisure (non-working time perhaps because they had to raise children and look after the home which reduced their leisure activities and reduced opportunity cost of work). This implies that they are less encouraged to participate and work.