Non-pecuniary Work Incentive and Labor Supply

Transcription

1 Non-peuniary Work Inentive and Labor Suppy Y. Hossein Farzin and Ken-Ihi Akao NOTA DI LAVORO FERUARY 2006 SIEV Sustainabiity Indiators and Environmenta Vauation Y. Hossein Farzin, Department of Agriutura and Resoure Eonomis, University of Caifornia Ken-Ihi Akao, Shoo of Soia Sienes, Waseda University This paper an be downoaded without harge at: The Fondazione Eni Enrio Mattei Note di Lavoro Series Index: Soia Siene Researh Network Eetroni Paper Coetion: The opinions expressed in this paper do not neessariy refet the position of Fondazione Eni Enrio Mattei Corso Magenta, 63, Miano (I), web site: e-mai:

2 Non-peuniary Work Inentive and Labor Suppy Summary Reognizing that peope vaue empoyment not ony to earn inome to satisfy their onsumption needs, but aso as a means to gain soio-psyhoogia (nonpeuniary) benefits, we show that one nonpeuniary work inentives are inorporated into standard abor suppy theory, (i) the wage rate under-estimates (over-estimates) the true vaue of nonwork/eisure time when work has nonpeuniary benefits (osts), (ii) nonpeuniary benefits an be a substitute for monetary wages as work inentives, (iii) at very ow wage rates, work an beome a net soure of utiity, and (iii) the shape of abor suppy urve differs from standard theory. We aso identify onditions under whih a greater nonpeuniary work inentive generates a arger individua abor suppy, and examine the effets of non-wage inome on abor suppy both for paid and vountary work. Keywords: Nonpeuniary inentives, Labor suppy, Non-wage inome, Vountary work JEL Cassifiation: D62, J22, I31 For hepfu omments and suggestions, we thank Caro eretta, Rihard Carson, Faraz Farzin, Jonathon Kapan, Stephan Kro, Chery Long, Phiip Martin, Siwa Masengi, and partiipants at the Annua Conferene of Pubi Eonomi Theory, Marseie, Frane, June 16-18, 2005, and at the seminars at Waseda University, University of Wyoming, and University of Caifornia at Davis. The usua aveat, however, appies. Address for orrespondene: Y. Hossein Farzin Department of Agriutura and Resoure Eonomis University of Caifornia Davis CA USA E-mai: farzin@prima.udavis.edu

3 1 Introdution If being empoyed is not ony a soure of earning inome to satisfy materiaisti needs, but aso the prinipa means of ommunity invovement, then empoyment an provide soio-psyhoogia (or nonpeuniary) benefits. However, the standard theory of individua abor suppy fouses on an individuaisti notion of work and abstrats from the nonpeuniary benefits. It onsiders work as a soure of disutiity, and any time off work (eisure) as a soure of utiity, assuming that utiity aways dereases with hours worked. 1 Standard abor-eisure hoie theory asks how an individua makes a tradeoff between onsumption (made possibe by work) and eisure (time not aoated to work), but ignores the soio-psyhoogia effets of empoyment. This shortoming of the standard theory, whih treats abor time merey as a means of earning inome, is uidy expressed by Krugman (1998, P.15): Eonomis textbooks may treat the exhange of abor for money as a transation muh ike the sae of a bushe of appes, but we a know that in human terms there is a huge differene. A merhant may se many things, but a worker usuay has ony one job, whih suppies not ony his iveihood but often muh of his sense of identity. An unsod ommodity is a nuisane, an unempoyed worker a tragedy. This raises a basi question: How is the individua abor suppy deision affeted by the nonpeuniary effets of work? In this paper, we go beyond the standard neoassia inome-eisure hoie, where the vaue of eisure is the ost of inome foregone, and foow soioogists and psyhoogists (see, for exampe, Jahoda (1981)(1982), Whean (1994) and Agerbo et a (1998)), who reognize that, in addition to being a soure of inome and materia satisfation, empoyment an provide non-materiaisti individua satisfations. y inorporating the positive nonpeuniary effets of empoyment on individua we-being, we extend the standard abor suppy mode and provide severa new insights. 2 1 See, for exampe, Deaton and Muebauer (1980, Ch. 4 and 11), Varian (1984, Ch. 6), and Kiingsworth (1986), for a standard treatment of abor suppy. 2 A notabe departure from the standard mode is eker s (1965) insightfu mode of hoie where an individua (or househod) ombines nonwork time with market goods to produe ommodities or 1

4 The next setion briefy reviews some of the empiria studies indiating the presene of nonpeuniary benefits from work. In Setion 3.0 we extend the standard abor suppy mode, showing in Setion 3.1 that, when work invoves nonpeuniary benefits (osts), the standard theory s vauation of nonwork/eisure time at the wage rate resuts in an underestimation (over-estimation) of its true vaue, thus eading to an over-aoation (underaoation) of time to nonwork ativities. This simpe but quite striking resut has important impiations for orret ost-benefit assessment of nonwork ativities (suh as rereationa, transportation, househod and do-it-yoursef ativities) and unempoyment, retirement, and disabiity ompensation shemes. The extended mode shows expiity that nonpeuniary benefits and monetary wages are substitute inentives in empoyment and abor suppy deisions. As suh, it an hep to expain, among other things, why peope sometimes hoose ower-paying jobs and resist retirement despite finaniay attrative ompensation and benefits shemes, or even offer their abor vountariy. Setion 3.2 shows that in the presene of nonpeuniary work inentives, as the wage rate, and hene inome and onsumption, deines beow a ritia eve, the time not aoated to work (eisure) may ose its desirabiity to suh an extent that one hooses to work as muh as possibe. Indeed, it shows that at very ow wage rates, work an even beome a soure of utiity. As suh, our mode impies an individua abor suppy urve that differs markedy from that derived from the standard theory. Setion 4 extends the anaysis of Setion 3 by examining the effets of nonwage inome on abor suppy both when the individua earns wage inome and when she works vountariy. It shows that depending on the individua s preferenes and the share of non-wage inome in tota inome, an inrease in non-wage inome an enarge or shrink the range of wages at whih abor is suppied fuy and perfety ineastiay. It aso shows that servies whose onsumption yieds utiity. In that mode, eisure is not the same as nonwork time; it is a onsumption good or servie whose prodution is time intensive and its fu ost onsists of both the diret ost of market goods and the foregone earnings due to spending time to produe eisure ativities. eker examines the effets of hanges in the foregone inome on hours of work, produtivity measurement and eonomis of queues. As suh, eker s mode and the fous of anaysis differ from those of the present paper whih onentrates on the soio-psyhoogia (nonpeuniary) effet of work on utiity and hene abor suppy. In fat, in eker s mode the amount of time aoated to work.. woud be determined soey by the effet on inome and not by any effet on utiity (p.498), where inome denotes the money inome ahieved if a the time avaiabe were devoted to work (p.497). 2

5 beow a ritia inome eve vountary work wi be offered fuy, but for higher inomes, vountary work dereases with inome. Setion 5 presents onuding remarks. 2. Nonpeuniary Vaue of Empoyment Empoyment is a prinipa means for peope to onnet and beome invoved with ommuna ativities. In turn, whether through sef-assessment or assessment by others, ommunity invovement direty or indirety brings a sense of sef-esteem, sef-respet, beonging, identity, reognition, reputation, friendship, seurity, and status, a of whih are ingredients of one s quaity of ife and satisfation (Jahoda (1988)). 3 In fat, the phrase I am what I do is sometimes used to express the soio-psyhoogia importane of work. eing empoyed is an essentia determinant of happiness; the unempoyed have signifianty ower we-being sores in the soia psyhoogy and abor eonomis iterature (see, for exampe, Fryer and Payne (1986), Feather (1990) and Argye (2001)). Further, Luas, et a (2004), find strong statistia evidene that the adverse effet of unempoyment on individuas subjetive we-being persists even after they beome re-empoyed. More interestingy, empiria work in abor eonomis has estabished that unempoyment is strongy negativey orreated with individua we-being, even after ontroing for inome and other individua harateristis. In other words, the unempoyed are generay worse off than the empoyed, and by more than their ower inome woud predit (see, for exampe, Cark and Oswad (1994), Korpi (1997), Winkemann and Winkemann (1998), Di Tea, MaCuoh and Oswad (2001)(2003), and Cark (2003) and referenes ited therein). For exampe, Winkemann and Winkemann (1998) used pane data on ife satisfation from German-Soio-Eonomi Pane for , where the individua s subjetive we-being was measured on an ordina sae from 0 to 10. After ontroing for inome and various observed individua harateristis and speifi fixed effets, they found that (a) being unempoyed has a statistiay signifiant and substantia negative effet on satisfation, and (b) the peuniary osts of unempoyment, ourring direty through redued inome, are 3 For a genera treatment of the effets of identity on eonomi behavior and outomes, see Akerof (2000). See partiuary Akerof and Kranton (2003)(2005) for a nove and insightfu prinipa-agent mode anayzing the effets of workers identifiation with a firm, or with a job, or with a work group, on their inentives to exert effort, on wage rate variation, and on firms optima management strategies. For a survey of the soia psyhoogia onsequenes of unempoyment and impiations for behaviora maroeonomi mode and poiy see Darity and Godsmith (1996). 3

6 muh smaer than the nonpeuniary osts, ourring indirety through redued we-being. They estimated that inome woud have to be inreased by a fator of seven in order to generate an inrease in satisfation arge enough to offset the adverse effet of unempoyment. Di Tea, MaCuoh and Oswad (2001) ame to simiar onusions. Using the Euro-arometer data on individua ife satisfation, ordered on a four-point sae for 12 European ountries for the period , they found that, ontroing for the inome oss and other indiret effets, being unempoyed has a strong negative effet on we-being. ased on Di Tea et a s estimated happiness funtion, Frey and Stutzer (2002) auated the ompensation variation for being unempoyed rather than hoding a job and noted that a move from the owest inome quartie to the highest inome quartie woud not be enough to offset the adverse effet of unempoyment, suggesting that unempoyed peope suffer high nonpeuniary osts (p.402). These resuts suggest that being unempoyed signifianty redues peope s we-being, even when reeiving the same inome as when empoyed. As Di Tea, MaCuoh and Oswad (2003, pp ) note eing unempoyed is muh worse than is impied by the drop in inome aone. The eonomist s standard method of judging the disutiity from being aid off fouses on peuniary osses. Aording to our auations, that is a mistake, beause it understates the fu we-being osts, whih aording to the data, appear to be predominanty nonpeuniary. The fats that in advaned industria ountries, where soia safety nets ushion jobessness, some individuas prefer to be empoyed with earnings ess than the unempoyment benefit or to engage in vountary work are evidene of nonpeuniary vaue of empoyment. 4 Furthermore, the presene of nonpeuniary vaue of empoyment is strongy suggested by Muigan s (1998) insightfu empiria study of the dramati inrease in iviian work in the United States during Word War II. Ruing out the hanges in workers budget sets (the after-tax rea wages were substantiay ower than either before or after the war) or other peuniary expanations suh as weath effets of government poiies, wage-indued interpempora substitution, and hanges in the nonmarket prie of time, she onuded that nonpeuniary motives suh as patriotism and hanging disrimination against women an expain the phenomenon. 4 Moffitt (1983) finds strong empiria support for the existene of wefare stigma among eigibe but non-partiipants in AFDC-U, the wefare program for whih famiies with an unempoyed mae were eigibe. 4

7 Finay, using data from the Aaska samon fisheries, whih have been subjet to entry imitations sine 1975, Karpoff (1985) tested the hypothesis that fishermen reeive signifiant nonpeuniary benefits from work by estimating the present vaue of the expeted rent stream from fishing and examining whether permit pries refeted a premium above what monetary inome aone woud suggest. He found that the ontinued presene of many ow-inome fishermen in the fisheries was evidene that they derive nonpeuniary benefits from fishing. 3.0 An Extended Mode of Labor Suppy The findings of the empiria studies ited in the previous setion and those of many others for different ountries and time periods suggest the presene of nonpeuniary benefits from work, thus ontraditing the standard theory s basi assumption that work is merey a burden and soure of disutiity to individuas. In this setion, we inorporate the nonpeuniary benefits of work in the standard mode and derive impiations for vauation of nonwork time and individua abor suppy. Let U = U(, z, m) be the individua utiity funtion, where 0 is onsumption, z 0 is eisure time, and m 0 aptures a the nonpeuniary effets (NPE) of empoyment. We assume that one s invovement with the ommunity, and hene the NPE, inreases with the abor time 0 (i.e. m () > 0). 5 We make the standard assumptions that the utiity funtion is inreasing in eah of its arguments (i.e., U > 0, U > 0, U > 0, U as 0 ) z m at dereasing rates (i.e., U < 0, U < 0, U < 0 ) and that both eisure and NPE are zz mm ompements with onsumption (i.e., U > 0, U > 0). 6 Additionay, athough not essentia z m 5 For anaytia simpiity, and as an approximation to reaity, we are assuming that the nonpeuniary effet of work is a ontinuous and inreasing funtion of the amount of work,. In reaity, it may generay be an inreasing step funtion. Furthermore, beyond the assumption that m () > 0, it is diffiut to be sure about the urvature of this funtion, athough it seems pausibe to assume that beyond ertain eve, the margina vaue of NPE deines as abor time inreases, i.e., that m () beomes an inreasing onave funtion. Aso, we abstrat from the interdependene of preferenes among individuas and the effet it may have on an individua s nonpeuniary vaue of empoyment. For exampe, the nonpeuniary ost of unempoyment an we depend on the rate of unempoyment among peer groups and the degree of adherene to the soia norm of empoyment (see Cark (2003) for an empiria study of this). 6 Wherever no onfusion arises, subsripts denote partia derivatives. 5

8 to our anaysis, we assume that U zm 0, impying that eisure and NPE are ompements in the individua s preferenes: the greater the nonpeuniary effets of one s empoyment the better one woud appreiate additiona eisure time. Of ourse, one an think of some extreme preferenes, suh as those of either isoationist or ommunity devout persons, for whih eisure and NPE an be substitutes. Let be the individua s tota avaiabe time per deision period, whih may be a day, week, month, et. This fixed tota time an be aoated between work and eisure, so that T 0 z = T. We an then rewriteu in the redued form of u(,) = U(,T -,m()) The overa, or net, margina utiity of abor time is u / = du / d = U z + Umm ( ) (2) where the first term on the right-hand side is the margina disutiity of abor and the seond term is the margina utiity of abor that arises from the non- peuniary vaue of empoyment. It seems pausibe to think that, at any given onsumption eve, for suffiienty arge vaues of the first term dominates the seond one (impying that at the margin abor beomes a net soure of disutiity, vaues of. So, we assume: That is, u (, ) u/ < 0) and vie versa for suffiienty sma (A1): For eah > 0, there exists a unique() ˆ > 0 suh that > < u(,)/ = -U z +U m m ()= 0 for =() ˆ and u (,) 0 () (3) < > ˆ () ˆ is the threshod abor time, at onsumption eve, so that the margina disutiity of abor exaty offsets its margina utiity. In Figure 1, () ˆ is shown by the dashed urved. Furthermore, we assume that: (A2): u(,) is strity quasi-onave. (A3): As onsumption eve rises, eisure beomes more vauabe than the NPE of work. Formay, we assume u [,()] ˆ = [U mm () - U z ] < 0 for a > 0 (4) (1) 6

9 Noting from (3) that at aong the ( ˆ ) ous, one has m ( ) = Uz / U m, ondition (4) an aso be written as ( ) [,()] ˆ U z Um Uz u = [ ] < 0 a,() ˆ > 0 (4 ) U U m z That is, we assume the eastiity of margina vaue of eisure with respet to onsumption (the seond-term in the braket) exeeds that of the nonpeuniary effets (the first term in the braket). Assumption (A3), as presented formay by (4), together with assumption (A2), impy that () ˆ is dereasing in 7 ; that is, the riher is a househod the ower is the threshod abor time where abor beomes a net soure of disutiity. This seems quite pausibe; the higher the iving standard of a househod the more distastefu beome the additiona working hours (the arger the margina disutiity of work) and therefore the smaer wi be the ritia working time ˆ. Figure 1 beow depits the indifferene urves assoiated with the utiity funtion u(,) under assumptions (A1)-(A3). 8 Above the urve of () ˆ, the indifferene urves sope upward everywhere sine u(,)<0, indiating that, on net, work is a soure of disutiity at the margin. The opposite is true everywhere beow the urve of () ˆ. 9 7 To derive this formay, totay differentiate u [, ()] ˆ to have ˆ = 0 d()/d ˆ = -u [, ()]/u ˆ [, ()]. On 2 2 the other hand, by (A2), u is strity quasi-onave and thus, 2uu u - [u (u ) + u (u ) ] > 0, whih upon substituting u [, ()] ˆ 2 = 0 yieds u (u ) < 0. That is, u [,()] ˆ < 0. Thus, d()/d ˆ = -u [, ()]/u ˆ [, ()] ˆ < 0 u [, ()] ˆ < 0. 8 η η An exampe of a utiity funtion satisfying assumptions (A1)-(A3) is u(,) = + γ (1 - ), where the time endowment is normaized so that T = 1 and [0,1], 0 < η < η <1, γ >0. The indifferene map iustrated in Figure 1 orresponds to this utiity funtion. 9 As depited in Figure 1, it seems pausibe to assume that no matter how high one s onsumption eve, some amount of time aoated to work is aways desirabe (i.e., im () ˆ = 0 ) and that at the subsistene eve of iving ( ) the margina vaue of eisure tends to zero, impying that one woud suppy as muh abor as feasibe (i.e., im () ˆ = T, where 0 < ). 7

10 ˆ() Sope= 1/ w ˆ Higher U Sope = 1/ w T E D C A du/d < 0 0 Sope=1/ w du / d > 0 ŵt Figure 1: abor suppy with nonpeuniary inentives Now, onsider an individua s deision probem. Let w > 0 be the given wage rate in terms of the onsumption good whose prie is normaized to be Max u(,), s.t. w - 0, 0, and T - 0, 0 The Lagrangian is L=u(,)+μ(w - )+ ν(t - ), where μ and ˆ() p = 1. Then the probem is (5) are the Lagrange mutipiers. Given our assumption that u as 0, impying >0, and hene >0, the neessary onditions for optima(, ) are ν u(, )-μ =0; u(, )+μw-ν =0; w - = 0, μ >0; ν(t - ) = 0, ν 0. For the optima (, ), we have the foowing three ases: Case (1): ν =0 so that T, and u(, )<0, (6) Case (2): ν >0 so that = T, and u(, ) 0, (7) Case (3): ν >0 so that = T, and u(, )>0. 8

11 The three ases distinguished in (7) are presented graphiay in Figure 1. As we show in the foowing setions, these ases enabe us to obtain severa new insights about abor suppy deisions. 3.1 Vaue of Leisure/Nonwork Time We note that in Case (1), at the optimum, the net margina utiity of abor is negative, u(, )<0, thus resembing the assumption of the standard mode of abor-eisure hoie where abor is regarded ony as a soure of disutiity. This ase haraterizes an interior soution whih satisfies the ondition u u = (shown by point A in Figure 1), and (, ) 1 (, ) w inudes the boundary soution at u( wt, T) 1 u( wt, T) = w, where 1 w = T (at point ) satisfying the ondition is the sope of the budget ine O in Figure 1. Athough at first sight this ondition appears to be the famiiar optimaity ondition of the standard theory, requiring the equaity of the margina rate of substitution of onsumption for eisure [ MRS u = = ] with the prie ratio ( 1 ), there is, however, a subte w dz d (, ) z, d d u (, ) differene beause in our mode u (, ) = -U +U m() represents the net effet of an z m additiona unit of work on utiity. To see this differene more eary, et us substitute for u(,) = -U z+umm() and rea that u equivaent (inverse) form of MRS d d (, ) U z m z, dz d u(, ) U U U to rewrite the optimaity ondition in the u U m() = = = = w (8) In ontrast to our mode, the standard theory, by ignoring the margina nonpeuniary vaue of work, inorrety equates the margina opportunity ost of eisure with the wage rate aone (i.e., U U z = w ) whereas in fat the opportunity ost of an additiona unit of eisure onsists of the foregone wage rate and the margina nonpeuniary vaue of work. As suh, it 9

12 is equa to the wage rate pus the margina nonpeuniary vaue of work, expressed in terms of units of onsumption good (i.e., Um m() ). Thus, from (8) we have U U z Um m() Um m() = w+ = [1 + ] w U U U w whih eads us to the foowing proposition. Proposition 1: y ignoring the NPE of work and equating the vaue of eisure time with the wage rate, the standard abor theory under-estimates (over-estimates) the true vaue of eisure time when there are nonpeuniary benefits (osts) assoiated with work. This resut has important impiations for vauation of time aoated to nonwork ativities (suh as rereationa, do-it-yoursef, and househod ativities) or in ost-benefit assessment of unempoyment, retirement, and disabiity ompensation shemes, and the ike. It shows that vauing nonwork time at the individua s wage rate (as presribed by the standard theory) suffers from a downward (upward) bias when the time spent on work invoves nonpeuniary benefits (osts), eading to more (ess) time to be aoated to suh ativities, or to ess (more) unempoyment/disabiity/retirement ompensation payment, than woud be optima. 10 Interestingy, onsistent with Proposition 1, in a survey of the empiria studies of trave-time vauation in the iterature on demand for rereation servies and on transportation panning, Cesario (1976) noted that the avaiabe estimates of the vaue of trave time had been onsistenty substantiay ess than the wage rate- ranging between one-forth and onehaf of the wage rate- eading him to onude that It is ear from these findings that the use of the margina wage rate for the vaue of trave-time vaues in rereation benefit estimation is inappropriate, both from the theoretia and pratia points of view. (P.37). Cesario s theoretia justifiation for the trave-time vaue being ess than the wage rate hinged on his assumption that there is aways disutiity (or, more preisey, nonpeuniary osts) assoiated with work. Athough this assumption is unneessariy too narrow, in terms of the Um m() resut furnished in (8 ) it impies < 0 and hene a vaue of eisure time ess than the Uw 10 Visusi (1993, p.1943) notes that prior to 1980s, the U.S. Federa agenies suh as Oupationa Safety and Heath Administration (OSHA) and EPA woud use the estimates of vaue of ife based on assessing ony the ost present vaue of the earnings of the deeased and ignoring the nonpeuniary aspets of ife, thus eading to dramati underestimation of the benefit vaue. (8 ) 10

13 wage rate. 11 ased on the empiria resuts surveyed, Cesario (1976) assumed the opportunity ost of trave time to be equa to one-third of the wage rate, and used this assumption to generate benefit estimates for a set of parks in the northeastern United States. On the other hand, testing this assumption versus the hypothesis of the wage rate as the opportunity ost of time, Smith, et a (1983) found that neither hypothesis was unambiguousy superior to the other as approximations for the opportunity ost of nonwork (eisure) time. In fat, estimating the mutipe fator reating the opportunity ost of nonwork time to the wage rate, Smith et a found that tweve of the twenty-two estimated vaues for this mutipe were negative and a majority of the remaining estimates were greater than unity, eading them to the onusion that both hypotheses shoud be rejeted and that the estimation of the mutipe reating these opportunity osts to the wage rate is not a trivia task. Moving beyond a judgmenta guess for this mutipe wi be diffiut within the onstraints of existing data (p.276). Against this bakground, our resut presented in (8 ) and Proposition 1 an be viewed as providing a genera theoretia basis whih reonies these ambiguous, and seemingy onfiting empiria findings as speia ases resting on some set of restritive assumptions. This is seen eary one we note that depending on whether we assume (1) individuas preferenes to be identia or heterogeneous, (2) nonpeuniary effets assoiated with work are positive or negative, or (3) nonpeuniary effets assoiated with trave itsef are positive Um m() or negative, and on aowing for the mutipe fator [1 + ] to be a noninear funtion Uw of the wage rate, our resut in (8 ) an be onsistent with empiria estimations of trave-time vaues that are ess than, greater than, or, for that matter, equa to, the wage rate, and estimated vaues that an be inreasing, onstant, or dereasing in the wage rate. For instane, when trave time ompetes with other nonwork (eisure) ativities in aoation of the eisure time, z, and if we assume that a typia individua derives nonpeuniary benefits 11 eker (1965) aso notes that the vaue of nonwork time may deviate from the wage rate but for different reasons than that in the present mode; namey, the onstraint of the period in whih time is spent (i.e., the timing of the time spent) and the indiret positive effet of onsumption of eisure goods or servies on a person s produtivity. For exampe, he hods that the vaue of nonwork time is often ess [than the wage rate] on week-ends and in the evenings beause many firms are osed then (p.503), and is aso ess when it is spent on suh ativities as seeping, eating, reading, taking a hair ut, ommuting, rereation, or in genera on produtive onsumption. 11

14 both from work and from trave itsef, then our extended theory predits the vaue of trave time to exeed that of eisure, whih in turn wi be greater than the individua s wage rate. In the opposite ase, where the typia individua has preferenes suh that there are nonpeuniary osts assoiated with both work and trave, then our theoretia resut suggests that the trave time vaue wi be ess than the opportunity ost of eisure whih itsef wi be ess than the wage rate. At the maroeonomi eve, the resut provides a theoretia basis for the empiria findings noted in Setion 2; namey, the wefare oss from unempoyment is muh more than what the oss of wages aone predits. In a simiar vein, it an expain why some peope resist retirement or being aid off despite being offered finaniay attrative retirement or unempoyment benefit pakages. Furthermore, reaing that the margina opportunity ost of eisure, represents an individua s suppy (reservation) prie of abor, the resut, U U U z U, aso U m() z m = w +, U shows that in meeting one s reservation prie of abor, the monetary reward (wage) and nonpeuniary inentives are substitutes. An important poiy impiation of this resut is that a firm or empoyer may be abe to pay ower ompensations by taking ations to reate and enhane empoyees nonpeuniary work motivation, or by empoying workers who intrinsiay identify themseves with the firm s goa or idea. Inversey, when empoyees of a firm or an oupation do not derive nonpeuniary benefits from their jobs, or may even inur nonpeuniary osts, a firm may need to pay a premium wage (rent) to keep them motivated. Rea-word observations supporting this resut abound. For exampe, reognizing the tradeoff between saary and prestige, highy prestigious institutions may pay a reativey ower ompensation to attrat their empoyees (it has been said that for years Harvard University was notorious for asking new fauty reruited to take a pay ut to join it). Empoyment with miitary offers another exampe. As Akerof and Kranton (2005) emphasize miitary offiers are trained to identify themseves with the goas of miitary and beieve in servie before sef, so that they are wiing to trade off monetary rewards for nonpeuniary gains of being a miitary offier. This trade off between nonpeuniary and monetary inentives in miitary ontrasts with that usuay observed among iviian 12

15 empoyees, and, as Akerof and Kranton note, may expain why in the United States for a omparabe position and rank miitary pay was signifianty ess than iviian pay unti reent times. Other notabe exampes where empoyees strongy trade off monetary rewards for nonpeuniary work inentives are nurses, poiemen, firefighters, artists, pubi-servie minded bureaurats and poitiians, and not-for profits organizations working for pubi or humanitarian auses. In fat, vountary work is an extreme ase where peope suppy abor without any monetary inentives. Conversey, most peope shy away from oupations deemed personay or soiay stigmati, and those who hoose suh jobs demand omparativey muh higher monetary rewards (wage rates) in ompensation for a ak of, or negative, nonpeuniary inentive. Exampes of these kinds of jobs are those inked to rimina or soiay and personay undignified ativities suh as drug traffiking, money aundering, prostitution, and other underground ativities. 12 It is interesting to note in passing that our resut goes somewhat against the wage effiieny resut in the standard iterature (see Shapiro and Stigitz (1984)). Aording to the atter, to indue effiient suppy of effort, a firm makes unempoyment, the onsequene of shirking, more osty by offering a worker a rent beyond the market wage rate (or worker s reservation wage). On the ontrary, our resut impies that a suffiienty arge nonpeuniary vaue of empoyment, rather than high wages, an provide the inentive for a worker not to ose his job, and, in fat, given the substitutabiity of this inentive for monetary inentive, when a worker s nonpeuniary inentive is substantia, a firm may even pay a ower wage rate than otherwise the market woud offer. The impiation of this ontrast between our resut and the wage effiieny is onsistent with the interesting resut furnished by Heyes (2005); namey, for jobs that onfer signifiant nonpeuniary benefits (that is, voationintensive jobs suh as nursing and teahing), the effiieny wage theory an in fat ead to a redution in the average quaity of appiants attrated: higher wages may attrat wrong sort of individuas-those who are driven prinipay by higher wages but have no intrinsi motivation or a voation. 12 It shoud be noted that in emphasizing the nonpeuniary work inentives we are fousing on soiopsyhoogia fators affeting an individua s utiity and not on work onditions, suh as ease or diffiuty of a job, its stimuating or boring nature, the prospets of progress in the job, et., whih are more or ess refeted in the wage rate. Thus, as Akerof and Kranton (2003, P. 23) note Fast food workers in Harem and Washington Heights-despite the grease, heat, disrespet from ustomers (espeiay teenagers), and ow wages- sti take pride that they earn their money. 13

16 3.2. Labor Suppy in the Extended Mode Returning to Case (2) in (7), we note that, as in Case (1), the net effet of abor on utiity is negative. However, Case (2) represents orner soutions haraterized by the inequaity u T > u T (, ) 1 (, ) w (point C), and inudes the border ase (point D) where at the optimum u(, )=u(wt,t)=0. y the definition of ˆ (), point D must be at the intersetion of the urve of ˆ () and the budget ine and therefore satisfies T = ˆ( wt ). We denote by ˆ 1 wˆ ( T)/ T the ritia wage rate that satisfies this ondition. In Figure 1, the 1 inverse of this wage rate ( ) is the sope of the budget ine OD. Thus, for a the wage rates ŵ ying in between those orresponding to the sopes of budget ines O and OD, that is, for wˆ w w, the optimum abor suppy is = T and u(wt,t) 0. Of speia interest is Case (3) sine, in ontrast to Case (1) and Case (2), here abor is a net soure of utiity, u(, )>0. Point E represents a typia soution orresponding to this ase. Reaing that at the border point D, ˆ 1 wˆ ( T)/ T, Case (3) hods if w< wˆ. We thus an state: Proposition 2: One the standard theory is extended to inude the nonpeuniary effets of empoyment in the individua s utiity funtion, then for suffiienty ow wage rates ( ˆ 1 w< wˆ = ( T)/ T ) empoyment beomes a net soure of utiity, induing the individua to suppy abor to the extent feasibe. Aordingy, our extended mode impies a abor suppy urve that differs starky from the one derived under the assumptions of the standard mode. In the standard, the abor suppy urve starts with an upward soping setion, that is, the abor suppy initiay inreases z with the wage rate ( > 0, or, equivaenty, < 0 for w > 0 ), impying that at ow wage w w rates eisure is a norma good in that it has a downward soping demand urve. Then, beyond a suffiienty high wage rate, it an beome bakward bending z ( < 0, or, equivaenty, > 0 for w> w > 0 ), impying that eisure beomes a Giffen w w good! In ontrast, in our mode the abor suppy urve begins with a vertia setion at 14

17 = T (perfety ineasti abor suppy) at wage rates beow (or equivaenty at inomes beow wt), athough, for w> w the abor suppy urve oud take various shapes inuding bakward bending, depending on individua s preferenes for onsumption, eisure, and nonpeuniary vaue of work. w That for wage rates ess than the abor suppy urve is vertia at = T is easy to w expain. We rea that at the wage rate w, orresponding to the boundary soution at point, abor suppy is = T. We aso rea from ondition (4) that u [,()] ˆ = [Umm () - U z ] < 0 for a > 0. So, as the wage rate fas beow w, and hene inome fas beow = w T, the net margina utiity of abor, u (, ) = -U +U m(), z m inreases, and exeeds u ( w T, T ) < 0, thus induing an inrease in abor suppy. ut, sine the tota time avaiabiity onstraint is binding, we have w = T for a wage rates ess than. It is important, however, to note that the vertia abor suppy urve at = T onsists of two different segments eah presenting a different regime. One regime pertains to wage rates w > w> wˆ, or, equivaenty, to inome eves wt> > wt ˆ, for whih, the margina vaue of eisure ( U >0) is sti arge enough to dominate that of NPE ( U m ( ) > 0 ) and hene yied z m z u = -U +U m()<0. The other regime pertains to wage rates beow ŵ or, equivaenty, to inome eves beow ŵt. In this regime, the margina vaue of eisure ( U >0) for a very poor individua beomes so sma that it is dominated by the margina vaue of NPE, thus rendering the net margina effet of work on utiity positive ( u m = -U +U m()>0 ). z m Figures 2.a and 2.b beow depit two exampes of the abor suppy urve impied by our mode. Figure 2.a represents the abor suppy urve of an individua who, due to nonpeuniary vaue of work, suppies as many hours of work as possibe when the wage rate is at or beow w. However, if she has a target inome or a ertain onsumption standard represented by wt, she redues her work hours as the wage rate rises above w, athough she aways works a minimum of hours no matter how high the wage rate may beome. This may refet the abor suppy behavior of poor or ow-inome individuas or z 15

18 househods 13. In the Appendix we show that for the speifi exampe of the utiity funtion noted in footnote 7, i.e., η η u(,)= + γ (1- ), the abor suppy urve woud indeed ook ike that pitured in Figure 2.a. Figure 2.b, on the other hand, presents the abor suppy urve of an individua who, as in the previous ase, works as muh as possibe when the wage rate is ess than or equa to w, and redues his abor suppy for the medium wage rates between w and w. ut, perhaps beause he has no target inome eve or is strongy driven by nonpeuniary vaue of his work, the bakward bending suppy urve reverses its diretion at suffiienty high wage rates, so that the individua inreases his work hours as his wage rate inreases beyond a ertain (presumaby very high) eve, w. The individua, however, hooses to enjoy some minimum eisure time ( ) no matter how high his wage rate may beome. Some empiria evidene for this type of abor suppy behavior is noted by Morgan (1968, p.33) who found that [T]he very highest inome peope are so driven to work, but by fores other than the monetary rewards, that they are deterred itte if at a by the bite of inome taxes on those rewards. T Tˆ w w w ( ) w w u < 0 w ŵ = Τ u > 0 ŵ ˆΤ =Τ Figure 2.a Figure 2.b 13 For some empiria evidene of the negativey-soped abor suppy urve see, for exampe, Camerer et a. (1997)(2002) and Morgan (1968). 16

19 Two further questions of interest are: First, how is the individua s abor suppy affeted by the extent of the NPE an individua derives from empoyment? Speifiay, does a greater NPE impy a greater individua abor suppy? Seond, as a speia interesting ase of this question, woud abor suppy aways be greater if the individua derives positive NPE from work than if, as assumed in the standard theory, she does not? To answer these questions, et, as before, m ( ) apture a the NPE as a funtion of time worked, where it is assumed that m ( ) > 0 and m ( ) 0. The extent to whih the individua onsiders these effets is indiated by the parameter α [0,1]. Thus, α = 0 if, as assumed in the standard theory, the individua does not onsider the NPE of her working time, and α = 1 if she fuy takes these effets into aount. More generay, et n = α m( ) be the extent to whih the individua aounts for the NPE, and Uzn (,, ) be her utiity funtion, whih she maximizes subjet to the time and budget onstraints given in (5). Denoting the vaue funtion by v (, α) max U( wt,, αm ( )), the first and seond order onditions for a oay unique interior optimum are v α = wu U + Uα m (, )/ z n ( ) 0 = (9) 2 2 v (, α)/ < 0, (9 ) where for notationa onveniene the arguments of the utiity funtion are omitted. Differentiating (9) totay, we have 2 2 v (, α) v (, α) d + d 0 2 α = α (10) and therefore = α v (, α)/ 2 v (, α)/ α 2 2 (10 ) Reaing from the seond order ondition (9 ) that the same as that of 2 2 v (, α)/ < 0, the sign of / α is 2 v (, α) m ( ) Un = = m ( ) Un + m( ) wun Unz + Unnαm ( ) α (11) 17

20 Sine by assumption U n > 0and U > 0, the sign of zn is generay ambiguous. However, α when the utiity funtion is additivey separabe in n, impyingu = U = 0, equation (11) simpifies to 2 v (, α) αm ( ) U nn = m ( ) Un 1+ (11 ) α Un U nn Denoting by εn αm ( ) the eastiity of the margina utiity of NPE, then from (9 ) U and (10 ), it foows that n > < = 0 εn = 1 (12) α < > Thus, by (12), the answer to the first question posed above an be stated as Proposition 3: If individua preferenes are additivey separabe in nonpeuniary effets of empoyment, then the greater the nonpeuniary effets (i.e., the argerα ) the greater wi be individua abor suppy, provided that the eastiity of the margina utiity of NPE is ess than unity. 14 n zn The additivey separabe preferenes in Proposition 3 an generay take the form S N S of Uzn (,, ) = U (, z) + U () n, whereu (, z) is the standard utiity funtion where utiity depends ony on onsumption and eisure, and N U ( n) denotes the utiity from NPE of N empoyment. This has a number of interesting impiations. For exampe, whenu ( n) =, that is, the utiity of nonpeuniary effets the individua derives from work is simpy a fat amount and hene invariant with hours of work, then U n 0 in (11 ) so that, by (10 ), the nonpeuniary inentive woud not affet abor suppy, athough it woud sti pay a key roe in individua s empoyment hoie. It is aso ear that if the utiity of NPE inreases N ineary with hours worked, i.e. U ( n) = β n, β > 0, then ε = 0 for a n > 0, so that, by (12), the individua wi suppy more abor than she woud in the absene of nonpeuniary work inentive. n 14 Whie we have foused on the positive non-peuniary effets of empoyment, it shoud be ear that the reverse of the resut furnished in Proposition 3 hods when the individua assoiates negative nonpeuniary effets with work, thus exaerbating the disutiity of work. 18

21 Furthermore, to answer the seond question posed above, we note that for the speia ase when the individua does not take any of the NPE of her empoyment into aount, α = 0 U nn, and heneεn = αm ( ) = 0, so that, by (12), U n > α 0 0 α =. Thus, Coroary 1: When preferenes are additivey separabe in nonpeuniary effets of empoyment, the individua s abor suppy wi be greater when she takes the nonpeuniary effets into aount ( α > 0) than when, as assumed in the standard theory, she does not ( α = 0 ). 4. Non-wage Inome and Nonpeuniary Effet of Empoyment So far we have assumed that the individua s inome derives entirey from working hours suppied. One woud ike, however, to know how woud (a) non-wage inome (for exampe, inome derived from weath or transfers), and (b) vountary work affet abor suppy in the presene of nonpeuniary work inentives. In partiuar, does, as intuition suggests, non-wage inome ounterat the nonpeuniary effets of work to resut in redued individua abor suppy? How does non-wage inome affet abor suppy when abor is suppied vountariy? (a) The Effet of Non-wage Inome Denoting the non-wage inome by π > 0, it aters the individua s budget onstraint in the optimization probem (5) to π + w 0, 0 (13) but eaves the optimaity onditions (6) unhanged. Figure 3 depits the optima hoies orresponding to different ases. 19

22 ˆ() Sope= 1/w Sope= 1/w T E D A A du/d < 0 ˆ() 0 π ˆ du/d > 0 π π +w T Figure 3: abor suppy with nonpeuniary inentives and non-wage inome Our interest is to determine the sign of. Obviousy ony Case (1) that π haraterizes an interior soution is the reevant ase for this purpose. Reaing from (7) that for this ase ν = 0 and using the first two optimaity onditions in (6) and the new budget onstraint (10), we have at the optimum, (, ), that u w wu w ( π +, ) + ( π +, ) = 0 (14) Ceary, in order for an interior optimum to exist, for any given non-wage inome, π 0, the wage rate must exeed a ritia minimum eve w ( π ), orresponding to the wage rate for the boundary optimum at. That is, we must have w> w ( π ), where w ( π ) is the soution to u ( π + w T, T) + w u ( π + w T, T) = 0 (14 ) Differentiating (14) totay with respet to andπ, and omitting the (, ) arguments of the funtions, we have 2 2wu + w u + u = π u + wu (15) 20

23 Reaing that at the optimum u < 0, u < 0 and that by assumption u < 0 and u 0, it foows from (15 ) that < 0. Thus, π Proposition 4: For any π 0, as ong as w> w ( π ), an inrease in the individua s non-wage inome indues a redution in her abor suppy. This resut is in aord with the standard mode and therefore shoud ome as no surprise. Given that abor is a soure of disutiity for the ase under question, a higher nonwage inome motivates the individua to substitute eisure for onsumption. On the other hand, for any non-wage inome π, a wage rate ess than the orresponding minimum wage, w< w ( ) π, indues the individua to suppy abor as muh as possibe (orner soutions, = T, in Case (2) and Case (3)). So, a question of interest is whether an inrease in the nonwage inome woud enarge or redue the range of wage rates for whih abor woud be fuy and perfety ineastiay suppied. The answer to this question depends on the sign of w ( ) π π, whih an be determined by differentiating (14 ) totay with respet to w and π, and simpifying to yied π ε + (1 ) ε dw u + wu 1 = = dπ Tu + u + T wu T π 1 ε + (1 ) ε u u where ε and ε are the magnitudes of the eastiities of the margina utiity u u of onsumption with respet to abor and onsumption, respetivey, evauated at the optimum ( π + wtt, ). Sine the numerator in (16) is positive, it foows that Proposition 5: inome wi (16) w ( π ) > 0, impying that an inrease in the individua s non-wage π < enarge the range of wage rates for whih she wi suppy abor fuy, depending shrink π < on whetherε + (1 ) ε 1 >. 21

24 This is a rather striking resut, for eonomi intuition woud suggest that a higher non-wage inome raises the margina vaue of eisure and thus shoud neessitate a higher wage rate in order to motivate the individua to suppy as many work hours as possibe. That is, one woud normay expet w ( π ) > 0 π to be aways the ase. Noting that, by substituting u U z Uz Um from (4 ), one has ε = = ( ), we an identify the onditions under whih u u U U z m this woud indeed be the ase. Namey, if individua preferenes are suh that: (i) additiona onsumption is not muh vaued (impying a sma vaue of ε ), or (ii) eisure is not muh vaued (sma U z ), or (iii) onsumption vaue is amost equay raised by an inrease in the amount of eisure or in nonpeuniary effet of work (the atter two onditions impying a sma vaue forε ), or (iv) if the individua derives a arge portion of his inome from non-wage π soures, or (v) a ombination of these onditions so that ε + (1 ) ε < 1. These seem to fit we the ase of a rih, workahoi person. Surprisingy, however, as Proposition 4 indiates, the opposite ase may aso hod if an inrease in the non-wage inome, and hene onsumption, owers the margina utiity of onsumption signifianty and makes work so unpeasant (or equivaenty, raises the vaue of eisure so strongy) that ony a redution in the wage rate an ounterat these effets to motivate the individua to work as muh as she did before the non-wage inome inrease. This rather ounter-intuitive ase is more ikey to hod for a very poor individua who depends predominanty on wage inome for her iveihood and attahes itte nonpeuniary vaue to work. Some speia ases of preferenes that support eah of the two opposite effets in Proposition 4 are noteworthy. One is the ase where individua preferenes are additivey separabe in onsumption, impying u = ε = 0, so that Reaing that foowing w ( π ) > π < 0 (1 ) ε 1 (16 ) π < > u ε measures the degree of reative risk aversion, we an state the u 22

25 Coroary 2: When individua preferenes are additivey separabe in onsumption, an inrease in the non-wage inome is more ikey to enarge (shrink) the range of wage rates for whih abor is suppied fuy, the ess (more) risk averse and/or the ess (more) dependent the individua is on wage inome for iveihood. 1 1 In partiuar, for the isoeasti utiity funtion, u () = ε, withε 1, a higher non-wage 1 ε inome enarges the wage range for whih abor is fuy suppied. (b) Vountary Work Vountary work an take a wide variety of forms, inuding work for harity and reigious institutions, work to promote a pubi ause suh as eduation, poitia awareness, promotion of soia and eonomi equaity, redution of poverty, prevention of diseases, promotion of peae, or soidarity with one s group or ommunity, among many others. The ommon feature of a suh works is that the individua suppies abor without reeiving monetary rewards. Instead, it is the nonpeuniary benefits that motivate peope to engage in vountary work. Aordingy, the deision about how muh vountary work to suppy presents a speia ase of our mode when w = 0 so that the budget onstraint simpifies to = π. For this speia ase, the neessary optimaity ondition redues to U (, T, m( )) u (, ) = 0. ut, as we aready know from (3), the impiit soution to this equation is none but = ˆ( ), whih for any (or equivaenty any non-wage inome π ) gives the suppy of abor that maximizes utiity by equating the margina utiity of eisure with that of nonpeuniary effet of abor, i.e. u (, ) / = U + U m ( ) = 0. Thus, the urve abeed ˆ( ) in Figure 3 represents z m the optima deision about the amount of vountary work. As is noted from point D in Figure 3, there is a ritia non-wage inome eve ˆ π (= onsumption eve ĉ ), determined by ˆ 1 ˆ π = ˆ = ( T), whih separates interior soutions from orner soutions. Furthermore, sine ˆ( ) is a dereasing funtion of ( = π ), it is ear that < 0 for π > ˆ π. Thus, we have π Proposition 6: When an individua hooses vountary work, there is a ritia non-wage inome eve ˆ 1 ˆ π = ˆ = ( T) suh that for any inome at or beow this eve the individua wi aways suppy work as muh as possibe, whie for inome eves above it she wi hoose to enjoy a eve of eisure that inreases with her inome. 23

26 This proposition suggests a theoretia predition that seems onsistent with asua observations; namey, other things being equa, one shoud expet rih peope to suppy ess vountary work than poor peope do. The eonomi intuition for this hypothesis is ear: rih peope vaue eisure and an afford to spend time on eisure, more than poor peope do. They aso tend to derive nonpeuniary benefits more from other soures (for exampe, donating money to haritabe institutions, poitia parties, and aike) than from doing vountary work. 5. Conuding Remarks We have shown that one the standard theory of individua abor suppy is extended to aow for soio-psyhoogia (nonpeuniary) work inentives, severa new and important insights emerge about individua abor suppy deisions. First, we have seen that the opportunity ost of nonwork/eisure time onsists of a peuniary omponent (the wage rate) and a nonpeuniary eement, and an individua trades off one for the other in making abor suppy deision and empoyment hoies. This resut has important impiations for vauation of individua s nonwork time and an hep to expain many phenomena that in the ontext of standard theory may seem puzzing. For exampe, it tes us that,, ontrary to what is ustomary in ost-benefit anayses of nonwork ativities, vauing nonwork time at individua s wage rate understates (overstates) its true vaue when time spent on work renders nonpeuniary benefits (osts).. It an aso hep expaining (i) why it an be diffiut to indue eary retirement even when attrative unempoyment (or retirement) benefits are avaiabe, (ii) why the iviian abor suppy was at a reord high (Muigan (1998) during Word War II despite a signifiant derease in aftertax rea wages (iii) why permit pries exeed the present vaue of the expeted stream of rents from fishing in imited-entry fisheries, and why poor fishermen ontinue fishing rather than seing their permits (Karpoff (1985)), and why, in ontrast to wage effiieny theory, offering high wage rates in voation-intensive professions may redue the quaity of andidates. At the same, this resut suggests a broad guide for firms to improve the effiieny of their empoyment strategies by taking ations that enhane their workers nonpeuniary inentives. Suh ations oud inude, for exampe, offering (a) workers paid hid are on site, (b) fexibe working hours inuding teeommuting, () job training ourses that an have positive nonpeuniary effets by heping to foster a sense of earning new things even if 24