Sample mini-project Labor supply
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Sample mini-project: Labor supply
Suppose that you run a consulting firm. You currently have three clients with the following situation related to labor supply: Due to the tight labor market, I am having a hard time keeping all of my workers. Since there is substantial value to my company having low workforce turnover, I am considering increasing my wages by 10%. Since my employees can choose the number of hours they work, I am concerned that if I increase my employees’ wages, they will all want to work more hours.
Here are some current characteristics about the three clients:
- This firm only employs individuals earning 15% over the federal minimum wage.
- This firm employs individuals with college degrees, earning approximately average incomes.
- This firm employs movie stars currently earning thousands of dollars per hour.
Address the concerns of potential increases in employees’ hours worked from a 10% hourly employee wage increase for each of the firms described above. Make sure to include relevant course material to support your answer. Your answer can be the same for each firm, or answers can vary.
Please give a concise 200- to 250-word answer using material covered in the labor supply material from Econ 10A.
Note: Assume that hourly wage rates do not vary from number of weekly hours worked. This means that workers do not get extra pay for overtime work, and that all workers in the firms described above get paid a constant hourly wage.
Answer that addresses the problem well:
From the economic theory of labor supply, increasing the hourly wage increases the slope of the potential income constraint, but keeps non-labor income constant. In this context, there are two economic issues to address. The first is what most people assume when hourly wage rates rise, with hours worked increasing. This is from the substitution effect in a labor supply context. The second effect that many people do not think about is from assuming that recreation (or leisure) is a normal good, and the increase in income increases the demand for recreation. This is the income effect. Empirically, the substitution effect dominates for low-wage workers and the income effect dominates for high-wage workers. Since the substitution and income effects are probably heterogeneous among workers, each person may have a different wage that maximizes the number of hours worked. To address the problem to the three firms, it is very likely that the first firm’s increase in wages will positively affect hours worked for most or all of the workers, due to the low wage rate being offered. For the second firm, it is plausible some workers will work less due to having the income effect dominate the substitution effect. Most workers will still likely work a greater number of hours. For the third firm, the increased wages may result in fewer hours worked overall unless more employees are hired, due to the likely dominance of the income effect on more of the workers.
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