1. The Market System – Labour Supply Rational Worker’s ChoiceSource

2. Household Choice in Input Markets The Labour Supply Decision As in output markets, households face constrained choices in input markets. They must decide 1. Whether to work 2. How much to work 3. What kind of a job to work at In essence, household members must decide how much labour to supply. The choices they make are affected by 1. Availability of jobs 2. Market wage rates 3. Skills they possess

3. Household Choice in Input Markets The Trade-Off Facing Households The decision to enter the workforce involves a trade-off between wages (and the goods and services that wages will buy) on the one hand and leisure and the value of nonmarket production on the other hand.

4. Household Choice in Input Markets The Opportunity Cost The eternal truth of opportunity cost applies here as well. “Buying” more leisure means reallocating time between work and non-work activities. For each hour of leisure that I decide to consume, I give up one hour’s wages. Thus the wage rate is the price of leisure. Or, the opportunity cost of leisure is the work I forego (give up).

5. Household Choice in Input Markets Income and Substitution Effects of a Wage Change labour supply curve A curve that shows the quantity of labour supplied at different wage rates. Its shape depends on how households react to changes in the wage rate.

6. Household Choice in Input Markets Labour Labour Two Labour Supply Curves When the substitution effect outweighs the income effect, the labour supply curve slopes upward (a). When the income effect outweighs the substitution effect, the result is a “backwardbending” labour supply curve: The labour supply curve slopes downward (b).

7. Income and Substitution Effects Google: Is It Work or Is It Leisure? By providing many services at the workplace, Google has potentially affected the trade-off people make between work and leisure. In the end, without increasing wages, Google may have reduced the marginal utility of leisure and made people more willing to work longer hours.

8. Income and Substitution Effects Saving and Borrowing: Present versus Future Consumption Just as changes in wage rates affect household behaviour in the labour market, changes in interest rates affect household behaviour in capital markets. Most empirical evidence indicates that saving tends to increase as the interest rate rises. In other words, the substitution effect is larger than the income effect. financial capital market The complex set of institutions in which suppliers of capital (households that save) and those who demand capital (firms wanting to invest) interact.

9. Key terms • diamond/water paradox • financial capital market • homogeneous products • income effect of a price change • labour supply curve • substitution effect of a price (wage) change • opportunity cost of working