Labor supply with Friedman-Savage preferences

Abstract

Purpose – Some labor supply curves exhibit inflection points at which they bend backward or fall forward; thus, some workers alternate between increasing and decreasing their labor hours as wages increase. No consensus has yet been reached on the underlying motive for such behavioral inconsistencies. This paper aims to develop a unified theory to explain each of these variations in labor supply. Design/methodology/approach – The author employs a simple model of labor supply with additively separable utility over income and leisure. The sub-utility function for income is of the Friedman-Savage type, exhibiting preferences that alternate between increasing and diminishing marginal utility of income. Findings – Labor supply curves slope downward where relative risk aversion is strong, and upward where relative risk aversion is weak or negative. Thus, utility functions with inflection points can form the basis of labor supply curves with inflection points. Research limitations/implications – Friedman-Savage utility can explain virtually any observed labor supply functions, including convex, backward-bending, forward-falling, and inverted-S curves. Practical implications – Inflection points on the labor supply curve can create multiple and unstable market equilibria. Labor-market policies, including legislation pertaining to minimum wages and collective bargaining, and policies to enhance education and economic security, may reduce aversion to risk and thereby decrease the prevalence of unstable equilibria. Originality/value – This paper unites two lines of research – labor supply and Friedman-Savage utility – which have, rather remarkably, been separate to date. In doing so, it provides a new application of the classic Friedman-Savage paradigm, and a new explanation of labor supply curves with negatively-sloped regions.