Labor Supply Theoretical considerations Increasing(or decreasing) taxes changes the after-tax wage rate. Changing the wage rate has two effects Substitution effect -leisure is relatively less costly after the efective wage is cut, so a person substitutes toward leisure and away from work (t leisure) Income effect - The person feels poorer after the effective wage cut, and if leisure is a normal good the person consumes less of it(l leisure)
11 Labor Supply: Theoretical Considerations • Increasing (or decreasing) taxes changes the after-tax wage rate. Changing the wage rate has two effects: – Substitution effect – leisure is relatively less costly after the effective wage is cut, so a person substitutes toward leisure and away from work (↑ leisure). – Income effect – The person feels poorer after the effective wage cut, and if leisure is a normal good, the person consumes less of it (↓ leisure)
Labor Supply Theoretical considerations Progressive taxes Consider three tax rates t, for income under L t2 for income between L and M t3 for income greater than M The effective wage rate(and the slope of the budget constraint) changes as hours of work Increases 12
12 Labor Supply: Theoretical Considerations • Progressive taxes – Consider three tax rates – t1 for income under L – t2 for income between L and M – t3 for income greater than M • The effective wage rate (and the slope of the budget constraint) changes as hours of work increases
Labor Supply Theoretical considerations Figure 16. 4 depicts this situation Budget constraint is now TLMN In this figure, person maximizes utility at E4 One common theoretical prediction that arises from kinked budget constraints is that many people should locate at the kink points 13
13 Labor Supply: Theoretical Considerations • Figure 16.4 depicts this situation • Budget constraint is now TLMN. • In this figure, person maximizes utility at E4 . • One common theoretical prediction that arises from kinked budget constraints is that many people should locate at the kink points
Figure 16.4 g D Slope f3)u M (1-1)$5000+(1-12)S5,000 E (1-1)S5000 Slope=(1-I2)n Hours of work Slope=(1-ti)n before tax P F Hours of work Hours of leisure per week after tax
Figure 16.4
Labor Supply Empirical Findings Theory suggest labor supply should depend on After -tax wage Preferences(factors like age, gender, marital status, and children Econometricians have estimated regression equations relating hours of work to these variables 15
15 Labor Supply: Empirical Findings • Theory suggest labor supply should depend on: – After-tax wage – Preferences (factors like age, gender, marital status, and children) • Econometricians have estimated regression equations relating hours of work to these variables