Question

1. Why does the current labor supply depend on the real interest rate?

2. Why does the current labor supply depend on the consumer’s lifetime wealth?

Answer 1

Labour supply is affected by the real interest rate because of the intertemporal income and substitution effects. The money saved now is able to earn an interest in future which encourages savings and discourages consumption. Since the consumer is also a worker supplying labour in the labour market, the real wages earned are a function of interest rate.

In a similar way labour supply, not only depends on the current income, but on the other resources such as accumulated wealth. This indicates that the current labour supply is a function of life and wealth and not only current income. This lifetime income is actually the present discounted value which is again using the rate of interest.