Philipp, Thomas
(1994)
Labour supply and the "law of demand".
PhD thesis, London School of Economics and Political Science.
Abstract
The well-known "law of supply and demand" says that an increase in the price of a commodity leads to a decrease in the aggregate demand for this commodity and an increase in aggregate supply. There is, however, no theoretical foundation for this "law". Empirical evidence, on the other hand, should be interpreted with care. If one estimates the parameters of certain functional forms for demand and supply functions, then the results may simply be consequences of the parametric assumptions made in estimation. The first chapter of the thesis discusses the implications of the assumption of profit and utility maximisation for the properties of demand and supply functions. It explains why economic rationality on the microlevel does not, in general, lead to macroeconomic regularities and suggests replacing the consumption sector of the neoclassical equilibrium model by a large population of individually small consumers. Such a population will be explored in the second chapter. The chapter is a direct outgrowth of a basic contribution by W. Hildenbrand: "On the Law of Demand", Econometrica 1983. In W. Hildenbrand's model the market demand function is defined by integrating an individual demand function with respect to an exogenously given income distribution. We build into the model an individual labour supply function and then compare the matrix of aggregate income effects studied by W. Hildenbrand with that obtained by integrating the individual demand function with respect to a distribution of wage rates. The empirical part of the thesis analyses the labour supply and earnings data in the U.K. Family Expenditure Survey 1970-85. Using non- parametric smoothing methods, the elasticity of labour supply with respect to the wage rate is estimated for several groups of workers. The estimations for full-time workers confirm the famous "downward sloping" labour supply function. The estimated elasticities for the entire population of workers for the years 1970-85 have the mean value 0.2 and the standard deviation 0.02.
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