Income and Substitution Effects in Labor Economics
Labor Economics
Labour economics seeks to understand the functioning of the market for labour. Labour markets function through the interaction of workers and employers. Labour economics looks at the suppliers of labour services (workers), the demanders of labour services (employers), and attempts to understand the resulting pattern of wages, employment, and income.
It is an important subject because unemployment is a problem that affects the public most directly and severely. Full employment (or reduced unemployment) is a goal of many modern governments.
Real Wage
The real wage describes the quantity of goods that the worker gets for a number of hours of labor. the real wage is the nominal wage adjusted to the level of inflation. It determines how much labor workers will want to supply in the economy.
Factors that Influence Real Wage
Income Effect
When wages increase, the income effect states that a worker feels wealthier and that he needs to work less to have the same income. The effect will result in the laborer placing a greater demand on goods, services, and non-market activities so that he/she will cut down on supply of labor.
Substitution Effect
The substitution effect is simply when the laborer feels that because the wage has increased the worker realizes that by involving himself in non-market activities he is missing the opportunity to increase savings. Therefore, the result will be an increase in the supply of labor. For temporary wage increases the substitution effect dominates.
Gender Differences
Men and women are observed to react in a different way to changes in wages. For men, the substitution effect dominates, while for women, the income effect outweighs the substitution effect. In general though, we assume that substitution effect dominates the economic behavior of people. In this project, we are going to analyze the causes, effects and consequences of this generalization.
Sex based Wage Inequality
We consider wage inequality as one of the biggest problems in labor economics. This is why we decided to focus our attention on the wage differential, i.e. why women receive less money for the same quantity and quality of labor. The gap between men and women's payment tends to decrease worldwide, especially in the US, but we fell that this trend deserves serious consideration and analysis. For our analysis of the issue, we are using the work of Francine Blau, **** -the book about feminist economics, and the research of Mark Rosenzweig.
Opportunity Cost of Leisure Time
One of the main factors that plays a role when anylizing the income and substitution effects is the opportunity cost of leisure time. The importance that a laborer places on leisure time when compared with the want to increase one's income will play the role in determining, which effect will dominate. If there is greater importance on leisure time, than increased income, the income effect will dominate. If their is greater importance on income than leisure time, substitution effect will dominate. Generally men are more willing to sacrafice leisure time to increase their income, as opposed to females.
