Question

1. Is it important to assume that leisure is a normal good? Why or why not?
   

Answer 1

Answer :

Leisure: any time spent not working for compensation.

Consumers derive utility from two goods: consumption and leisure. Both are normal goods. Consumers are limited by a budget constraint. Most economists assume that unpaid time (or "leisure") is a normal good and so people want more of it as their incomes (or wealth) rise. Since a rising wage rate raises incomes, all else constant, the attraction of unpaid time rises, eventually neutralising the substitution effect and causing the backward bend. If leisure is a normal good, the demand for it increases as income increases this increase in income tends to make workers supply less labour so they can "spend" the higher income on leisure (the "income effect"). Individual labor supply curves can be aggregated to derive the total labour supply of an economy.

The Supply of Labor :

The demand for labor is one determinant of the equilibrium wage and equilibrium quantity of labor in a perfectly competitive market. The supply of labor, of course, is the other.

Economists think of the supply of labor as a problem in which individuals weigh the opportunity cost of various activities that can fill an available amount of time and choose how to allocate it. Everyone has 24 hours in a day. There are lots of uses to which we can put our time: we can raise children, work, sleep, play, or participate in volunteer efforts. To simplify our analysis, let us assume that there are two ways in which an individual can spend his or her time: in work or in leisure. Leisure is a type of consumption good; individuals gain utility directly from it. Work provides income that, in turn, can be used to purchase goods and services that generate utility.

The more work a person does, the greater his or her income, but the smaller the amount of leisure time available. An individual who chooses more leisure time will earn less income than would otherwise be possible. There is thus a tradeoff between leisure and the income that can be earned from work. We can think of the supply of labor as the flip side of the demand for leisure. The more leisure people demand, the less labor they supply.

Two aspects of the demand for leisure play a key role in understanding the supply of labor. First, leisure is a normal good. All other things unchanged, an increase in income will increase the demand for leisure. Second, the opportunity cost or “price” of leisure is the wage an individual can earn. A worker who can earn $10 per hour gives up $10 in income by consuming an extra hour of leisure. The $10 wage is thus the price of an hour of leisure. A worker who can earn $20 an hour faces a higher price of leisure.

Income and Substitution Effects :

Suppose wages rise. The higher wage increases the price of leisure. We saw in the module on consumer choice that consumers substitute more of other goods for a good whose price has risen. The substitution effect of a higher wage causes the consumer to substitute labor for leisure. To put it another way, the higher wage induces the individual to supply a greater quantity of labor.

We can see the logic of this substitution effect in terms of the marginal decision rule. Suppose an individual is considering a choice between extra leisure and the additional income from more work. Let MULe denote the marginal utility of an extra hour of leisure. What is the price of an extra hour of leisure? It is the wage W that the individual forgoes by not working for an hour. The extra utility of $1 worth of leisure is thus given by MULe/W.

Suppose, for example, that the marginal utility of an extra hour of leisure is 20 and the wage is $10 per hour. Then MULe/W equals 20/10, or 2. That means that the individual gains 2 units of utility by spending an additional $1 worth of time on leisure. For a person facing a wage of $10 per hour, $1 worth of leisure would be the equivalent of 6 minutes of leisure time.

Let MUY be the marginal utility of an additional $1 of income (Y is the abbreviation economists generally assign to income). The price of $1 of income is just $1, so the price of income PY is always $1. Utility is maximized by allocating time between work and leisure so that:

MU_Y/P_Y>MU_Le​/​W​​​​​

Now suppose the wage rises from W to W’. That reduces the marginal utility of $1 worth of leisure, MULe/W, so that the extra utility of earning $1 will now be greater than the extra utility of $1 worth of leisure:

MU_Y/P_Y>MU_Le​/​W'​​

Faced with the inequality above, an individual will give up some leisure time and spend more time working. As the individual does so, however, the marginal utility of the remaining leisure time rises and the marginal utility of the income earned will fall. The individual will continue to make the substitution until the two sides of the equation are again equal. For a worker, the substitution effect of a wage increase always reduces the amount of leisure time consumed and increases the amount of time spent working. A higher wage thus produces a positive substitution effect on labor supply.

But the higher wage also has an income effect. An increased wage means a higher income, and since leisure is a normal good, the quantity of leisure demanded will go up. And that means a reduction in the quantity of labor supplied.

For labor supply problems, then, the substitution effect is always positive; a higher wage induces a greater quantity of labor supplied. But the income effect is always negative; a higher wage implies a higher income, and a higher income implies a greater demand for leisure, and more leisure means a lower quantity of labor supplied. With the substitution and income effects working in opposite directions, it is not clear whether a wage increase will increase or decrease the quantity of labor supplied—or leave it unchanged.

1. A higher wage increases the opportunity cost or price of leisure and increases worker incomes. The effects of these two changes pull the quantity of labor supplied in opposite directions.
2. A wage increase raises the quantity of labor supplied through the substitution effect, but it reduces the quantity supplied through the income effect. Thus an individual’s supply curve of labor may be positively or negatively sloped, or have sections that are positively sloped, sections that are negatively sloped, and vertical sections. While some exceptions have been found, the labor supply curves for specific labor markets are generally upward sloping.
3. The supply curve for labor will shift as a result of a change in worker preferences, a change in nonlabor income, a change in the prices of related goods and services, a change in population, or a change in expectations.
4. In addition to the effects on labor supply of the variables just cited, other factors that can change the supply of labor in particular markets are changes in wages in related markets or changes in entry requirements.