Labor Economics Notes
Chapter 1 Introduction
Labor is different than other markets. Labor can only be rented.
Ways that workers and employers come together follow certain patterns
1) contact between the two (ads, union halls, etc)
2) information is exchanged
3) a contract is executed
4) compensation for working time
5) placement of people in jobs at certain rates of pay.
Labor economics = study of the workings and outcomes of the market for labor
Nonpecuniary factors = factors that accompany a working contract that do not bear exact wage recompense (i.e. working conditions)
Positive economics = study of “what is”
Normative economics = study of “what should be”
Pareto Efficiency = the market is successful in facilitating all possible mutually beneficial transactions
- no more transactions would be undertaken voluntarily
A transaction can be unanimously supported when
- all parties gain by the transaction
- some and no one loses, or
- some gain and some lose, but the gainers compensate the losers fully
When the compensation of losers is possible but does not take place, there are, in fact, losers.
Reasons for market failure:
1) ignorance
2) transaction barriers
3) price distortion nonexistence of market
Government Policies that achieve Pareto Efficiency
1) Public Good
2) Fixing capital market imperfections
3) Establishes market substitutes
4) Fixing the differences in incomes between the classes
Chapter 2 Overview of the labor market
Internal labor market = a formal set of rules and procedures guides and constrains the employment relationship within a firm.
Secondary labor market = jobs that are low paying and unstable
Labor force participation rates are falling for men, but are rising for women.
We have gone from an agricultural society to a serviced – based society in the last century.
The Demand for Labor
Wage Changes = higher wages implies lower employment (scale effects)
- higher wages means that employers will shift to a more capital intensive mode of production
Demand for product = higher demand increases the demand for labor at any wage.
Supply of capital = more capital implies higher demand for labor at any wage and reduces the demand for labor.
Supply of Labor = depends on the wage in a particular industry and the wage of a particular firm
Determination of the Wage
Market clearing wage – the rate at which demand equals supply
Money wages rarely fall once the market-clearing wage has been achieved, but real wages fall readily.
Above-market wages implies the supply of labor exceeds the number of jobs being offered, and there will be widespread unemployment
Overpayment = when wages are above market-clearing prices.
Economic rent = amount by which one’s wage exceeds one’s reservation wage in a particular job.
Chapter 3 The Demand for Labor
Marginal Product is where the Marginal Product equals the change in Q divided by the change in L
Monopolistic Conditions
- firms that have control over the wages they pay to their workers
- this firm is the only one in its market
For the firm, profits are maximized when employment is such that any further one-unit change in labor world have a marginal revenue product equal to marginal expense.
Market Demand Curve = the summation of the labor demanded by all firms in a particular labor market at each level of the real wage
More Than Two Inputs
To minimize costs, a firm should employ all inputs up to the point where the marginal cost of producing an added unit of output is the same regardless of which input is used.
The demand curve for any type of labor is downward sloping.
Substitutes in Production
- two inputs where the greater use in producing output can compensate for the reduced use of the other
- increases in price of the other good may shift the demand curve either way
Gross Compliments
- the scale effect dominates the substitution effect
- increased price in one input shifts demand for the other input to the left
Gross Substitutes
- increased price of one input shifts demand for the other input to the right
- substitution effect, but scale effect dominates
Compliments in Production
- two inputs must be used together
- no substitution effect, only scale
Non Competitive Labor Market
In a Monopoly
- faces a competitive labor market
-
hires workers until its marginal revenue product of labor
equals the wage rate
-
MR/P (MPL) = W/P
-
(MR/P)>1 always because marginal revenue is always less
than a monopoly’s product price.
Level of employment in a monopoly is less, as well as the level of output.
Wages in monopolies may be price taking.
The monopoly may still be a very small part of the labor market (i.e. hiring secretaries).
Monopolies may pay more to
- enhance their utility by paying higher wages and passing costs on to the consumer
-
hide profits, especially if they are unregulated and don’t
want to be.
In a Monopsonistic Market
- face an upward sloping demand curve for labor.
-
To expand it’s workforce, it must increase its wage rate
because it must attract other workers from other workforces
-
Because of this, the marginal expense of hiring workers up to
the point where MRPl = Marginal Expense
-
Wages and employment is less than a competitive market
Wage Increases Mandated on Monopsonists = a nonexistent
question because wages are absolutely set by the firm
Shifts in Labor Supply that Increase LEL
If the labor supply curve shifts left (fewer people willing to work at a given wage)
- in the short run
o new profit maximizing level of employment falls
o new wage increases
- in the long run
o the firm will replace labor with capital and employment will fall even further than in the short run
Mandated Wage Increase for Monopsony
- in the short run
o increases the average cost of labor but decreases the marginal expense for labor. The induces the firm to increase employment
o only happens if the wage increase does not go above a certain level (see pg 85 figure)
- in the long run – two opposing things can happen
o if the wage is no too high, the firm may substitute labor for capital
o some firms may leave the market, and employment may decline
WITH MONOPSONY, ANY INCREASE IN WAGES WILL UNAMBIGUOUSLY INCREASE EMPLOYMENT.
Policy Application, Payroll Taxes
- this section says that the payroll taxes lower employment rates. He really hates them.
- However, the book advocates subsidizing the hire of low income and disadvantaged people through government subsidies.
Chapter 4 – Labor Demand Elasticities
The beginning of the chapter details the way to find the elasticity of the Labor Demand Curve. I will not detail it here, because we are all economic adults and probably already know how to do this. If you don’t by now, it’s not my fault.
Important note about the elasticity of the Labor Demand Curve:
The elasticity of the Labor Demand Curve can change depending on where one is along the curve. In other words, the elasticity of the curve is by no means static.
Hicks-Marshall Laws of Derived Demand
The Own-Wage elasticity of demand is high when:
1) the price elasticity of demand for the product being produced is high
2) when other factors of production can easily be substituted for labor
3) when supply of other factors of production is highly elastic
4) when the cost of employing the category of labor is a large share of total production.
The first three laws always hold, but the fourth has some exceptions.
Another implication of rules 1,2,3: wage Elasticities will be higher in the long run than in the short run.
Rule 4:exception occurs when it is easier for employers to substitute other factors of production for the category of labor than it is for customers to substitute other products for the product being produced.
Estimates of Own-Wage Labor Demand Elasticities
-short-term estimates have elasticities at -.53 (inelastic), holding K constant
-long run elasticities estimates are at or close to unitary, holding output constant
Unions get better wages if their workers are skilled (and thus have an inelastic demand curve).
Cross Wage Elasticity of Demand
- the elasticity of demand for input j with respect to the price of K
- if cross elasticities are positive, they are gross substitutes
- if cross elasticities are negative, they are gross compliments
Question: Can the Law of Derived Demand be applied to cross elasticities?
Answer: No, however, the underlying technological or market conditions of the Hicks-Marshall laws can be used to understand them.
The Scale Effect
- the share of the total costs devoted to the productive factor whose price is changing will influence the size of the scale effect
- the greater the price elasticity of product demand, the greater the scale effect (and the likelihood of gross compliments)
The Substitution Effect
- the substitution effect will be greater when the category of labor whose price has changed is easily substituted for other factors in production.
- More elastic factor supply curves leads to a greater substitution effect.
Estimates Relating to Cross Elasticity
1) labor and energy are substitutes in production
2) labor and materials are probably substitutes in production
3) don’t know if skilled and unskilled labor are substitutes or compliments with capital
4) skilled labor is more likely to be a gross compliment with capital
5) unemployment associated with substitution is more likely in unskilled labor
6) the extent of immigration (either complimentary or substitutability) that effects wages is small
In number 1 and 2 above, the degree of substitutability is small.
Chapter 5 – Quasi-fixed Labor Costs and Their Effects on Demand
Quasi-fixed costs are not strictly proportional to the number of hours worked (they are on a per worker basis).
Non Wage Labor Costs
- hiring costs (advertising, screening, etc.)
- training costs
o explicit: monetary costs of employing individuals to serve as trainers, etc. and the cost of materials
o implicit
§ opportunity costs of training using capital equipment
§ opportunity costs of training using the trainee’s time
If firms choose to hire experienced workers, they cut down on implicit training costs, but they have to pay a higher wage. If they hire inexperienced workers, they save on hourly wage but spend more time training and risk losing that worker to a higher paying employer.
Employee Benefits
- legally required: social security
- privately provided: holiday pay, sick-leave
Total benefits comprise 30% of an employee’s compensation, with 6.3% ($10,900) of that.
The Employment/Hours Trade Off
- To minimize the cost of producing at any given level of production, its average workweek and it’s employment level will be equal
Present Value
Present value is explained here, but, again, one should have learned this in intermediate micro, so I will ask the reader to defer to an intermediate micro book here.
The Multiperiod Demand for Labor
- An employer must consider the present value of the marginal expense of labor. To maximize profits at current level, a firm should employ labor up until the point that adding an additional employee yields as much as it costs.
o This essentially says that MR=MC=P, but in a multi period context.
-
The net expense to the firm of hiring an additional worker in
the initial period must be greater than zero.
The firm must have a new surplus to be profitable.
A subsequent period surplus can exist only if real wages in that period lie
below the MP of period 1.
Constraints on Multiperiod Wage Offers
- package offers that are consistent with other market offers: if an employer wished to vary wages according to time periods, the employer would have to have to total the value of the 2 time periods equal to the current competitive market wage. However, some pay schedules are unattractive to firms, and the others are not good to workers, so this will not happen in the real world.
General and Specific Training
- general training: training that increases an individual’s productivity to any employer
- specific training: training that increases an individual’s productivity only at the firm in which he or she is currently employed.
- Employees have to pay for general training while employers have to bear at least some of the cost of specific training.
Specific Training and the Wage Profile
For wage streams offered to employees it must meet three conditions:
1) it must not incur wage and training expenses whose present value is larger than that of it’s worker’s marginal products
2) the wage stream must at least be as large as alternate employers
3) it must offer post-training wages high enough to discourage its trained workers from quitting after training. However, if workers are less mobile this after training wage can be less.
Implications of the Theory
- layoffs: firms that invest in a large amount of specific training are less likely in laying off employees, even in a recession.
- Labor productivity: labor hoarding in a recession causes measured productivity to fall. The converse is true in a booming economy.
- Minimum wage effects: a rise in minimum wage that does not allow for a lower wage in the training period means that employers will have little incentive to offer specific training. Thus, a higher minimum wage may reduce the number of jobs with job training and reduce their rates of wage growth.
Hiring Investments
- use of credentials: firms should obtain a workforce of a given quality at the lowest possible cost.
o Credentials as Signals: idea that a certain group or type of individual based on certain characteristics
o This is a form of statistical discrimination.
- The total cost of hiring, training, and employing workers may be lower for some firms when hiring standards are used than when firms rely on more intensive investigations of applicants.
- Drawbacks: credentials may be only loosely related to actual productivity on the job.
Internal Labor Markets
- firm hires within it’s current employees at lower level positions
- this is a way of getting around the uncertainly of statistical discrimination – a bad employee cannot do much damage
- costs to the firm include not having a large labor pool to choose from in hiring. However, this is not a disadvantage if a firm needs an employee with a lot of specific training to that firm.
- Firms with internal labor markets tend to have more motivated employees with an attachment to the firm.
