CHAPTER 5 - Fiscal Policy and the Labor Market

Abstract

This chapter discusses the general-equilibrium relation between fiscal policy and labor market activity. The analysis presented in the chapter takes explicit account of the ways in which the fiscal authorities dispose of their tax revenues. The chapter presents a general-equilibrium model of the labor-supply decision. In this model, workers decide whether to work and, if they work, how many hours to work. The fraction of potential workers who are employed and the average number of hours worked by each employed person depend on the real before-tax wage rate, the shares of each type of government spending in the national product, the marginal valuation of each type of spending, and the distribution of government benefits between workers and nonworkers. The chapter presents a derivation of an aggregate demand function for private manhours and presents in a tabulated form the effects of various policy changes on private-sector man-hours, the employment ratio, average hours, the real before-tax wage rate, and the real after-tax wage rate in the year of the change.