Labour Supply

Macroeconomics I

ECON222

Fall 2017

Macroeconomics I (ECON222) Production & Employment Fall 2017 1 / 10

Questions

How does the supply of labour respond to wages?

Over the last century average hours worked has generally fallen as real
wages have risen
,! during business cycles real wages and hours worked move together
,! how can we explain these conicting observations?

What is the classical labour market equilibrium?

Macroeconomics I (ECON222) Production & Employment Fall 2017 2 / 10

 Global trends in actual working hours 25
is a consistent and homogenous decline in annual working hours throughout
the twentieth century.
A more realistic estimate of annual working hours is provided by
Huberman (2002), who takes into account differences in weekly working
hours, paid leave and public holidays. As Figure 3.1 shows, working hours in
industrialized countries were reduced dramatically in the last century. In the
Netherlands, for example, workers worked 3,285 hours per year in 1870 but
only 1,347 hours in 2000. Interestingly, this reduction of working hours coin-
cided with economic progress: the period of severe economic turbulence
between 1929 and 1950 was accompanied by fluctuations in working hours,
sometimes involving an upward trend. Other periods such as post-World
War I and post-World War II are largely characterized by progressive reduc-
tions in working hours.
However, this overall historical development masks variations across
countries in terms of the speed or intensity of working-hour reductions. In
1870, the Netherlands, Germany and France had very long working hours
which exceeded 3,000 hours per year, while the United States, the United
Kingdom and Australia were enjoying much shorter hours (less than 3,000
hours per year). As Figure 3.1 demonstrates, a catching-up process began in
the early 1900s, and there was a strong sign of convergence in the 1920s when
annual working hours were dispersed in a narrow range between 2,213 (the
United Kingdom) and 2,371 (the Netherlands). Even after fluctuations
during World War II, working hours showed a small difference among these

3300 NET

GER

3100 FR

2900 US

UK
2700
Annual hours

2500 AUS

2300

2100

1900 US

A US

1700 UK

GER
FR
1500
NET

1300
1870 1900 1913 1929 1938 1950 1960 1973 1980 1990 2000
Year
France Germany Netherlands UK Australia US

Figure 3.1 Historical trend in annual working hours in selected countries

(18702000)
Source: Huberman 2002.
Economic theory of Labour Supply

People allocate time between work and leisure

The benet of one more hour of work is compared to the cost of one
less hour of leisure

Utility is maximized when these values are the same.

Macroeconomics I (ECON222) Production & Employment Fall 2017 4 / 10

Real wages and labour supply

Two eects working in opposite directions as wage increases

,! substitution eect ) increase in labour supplied
,! income eect ) decrease in labour supplied

The longer an increase in the real wage is expected to last, the larger
is the income eect
,! for temporary wage changes, the substitution eect dominates
,! for permanent wage changes, the income eect dominates

Macroeconomics I (ECON222) Production & Employment Fall 2017 5 / 10

The labour supply curve

Relates the amount of labour supplied to the current real wage

,! holding other factors constant, including expected future wage

Other than the current real wage, any factor which changes labour
supplied will shift the curve.

Macroeconomics I (ECON222) Production & Employment Fall 2017 6 / 10

Aggregate Labour supply

The total labour supplied in the economy

An increase in current real wages induces higher aggregate labour

supply for two reasons:
,! people already working supply more hours
,! some people are induced to join the labour force.

Macroeconomics I (ECON222) Production & Employment Fall 2017 7 / 10

Classical labour market equilibrium

Classical model ) real wage adjusts quickly to equate labour supply

and demand

Equilibrium level of employment after the complete adjustment is the

full-employment level (N)
,! corresponding real wage is the market clearing wage (w )

Aggregate labour demand or supply curve shifters aect

,! the equilibrium real wage
,! the full-employment level of employment.

Macroeconomics I (ECON222) Production & Employment Fall 2017 8 / 10

Unemployment

The drawback of the classical model is that it implies zero

unemployment

Possible explanations of unemployment

,! real wage could be slow to adjust
,! matching people to jobs is time-consuming

Macroeconomics I (ECON222) Production & Employment Fall 2017 9 / 10

Full employment output

Full-employment (potential) output (Y )

,! level of output supplied when wages and prices are fully adjusted

Eects of an adverse supply shock

,! output is reduced directly by a reduction in productivity
,! the MPN falls, employment falls, full employment output falls.

Macroeconomics I (ECON222) Production & Employment Fall 2017 10 / 10