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LABOR ECONOMICS

Ning GuangjieTel: 23504565

E-mail:seanning@eyou.com

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Chapter 1 INTRODUCTION

1.1 What does labor economics study?

• Labor economics studies how labor markets work. • Such as labor force participation, the firm’s dema

nd for the high-skill workers, wage determination, the human capital investment, the labor mobility, the labor market discrimination, trade Unions and unemployment.

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The actors in the labor market: workers(utility maximum), firms(profit maximum)and government(influence the supply and demand or change the rules of the game)

Learning labor economics can help you have a better understanding of the real labor economic problems and predict the labor market outcomes.

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• The theory helps us understand how the facts are generated, and where the facts can help shape our thinking about the way labor markets work.

• Model: simplify; The realism of assumption

to the extent to which it helps us understand and predict how labor markets work.

 

1.2 Theory and facts

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1.3 The organization of the course

 • Chapter 2 Labor supply • Chapter 3 Labor Demand• Chapter 4 Labor Market Equilibrium• Chapter 5 Human Capital• Chapter 6 Contract and Work Incentive• Chapter 7 Trade Union• Chapter 8 Labor Mobility• Chapter 9 Unemployment• Appendix: An introduction to Regression Analysis

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Chapter 2 Labor SupplyWhether to work and how many hours to work

Labor supply in short run, static labor supply decision, in long run

2.1 Some stylized facts about labor supply

• Measuring the labor force(LF): BLS CPS• The employed(E, a worker must have been at a job w

ith pay for at least 1 hours, or worked at least 15 hours on a non-paid job such as the family farm ), the unemployed(U, a worker must either be on a temporary layoff from a job, or have no job but be actively looking for work in the 4-week period prior to the reference week) , out of the labor force, the population(P)

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LF=E+U,Labor force participation rate=LF/PUnemployment rate=U/LFThe official unemployment rate understated the real condition of unemployment. Discouraged workers, hidden unemployed. Labor force participation rate, Hours of work in the U.S. The participation rate of men declined from nearly 90 percent in 1900 to 76 percent by 1990.An ever-larger fraction of men choose to retire earlier.

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• The huge increase in the labor force participation rate of women.

• A sizable decline in average hours of work per week prior to 1940.

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年劳动时间（小时）的国际比较年份 日本 美国 西德 英国 法国

1975 2043 1881 1678 1923 1830

1980 2162 1893      

1985 2168 1929 1659 1952 1643

1989 2159 1957 1638 1989 1646

资料来源： [ 日 ] 永山武夫：《劳动经济——日本的经营与劳动问题》，第 107 页。

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2.2 The worker’s preferences and budget constraints

Utility function: U=U(C, L) C, consumption of goods. L, consumption of leisure. U=C*L

Indifference curveMarginal utility Marginal rate of substitution in consumption Time constraints: T=L+h L: leisure time; h: work timeBudget constraint: C=wh+V V: non-labor incomeC=(wT+V)-wL budget line the boundary of the worker’s

opportunity setSlope -w

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2.3 To work or not to work? The hours of work decision

• Reservation wage which makes her indifferent between working and not working

• A higher reservation wage makes it less likely that a person will enter the labor force. In addition, for given tastes and non-labor income(that is , for given reservation wage), a person with a higher market wage is more likely to work.

• Figure p31• Commuting costs increase the reservation wage

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Tangency condition: the slope of the indifference curve equals the slope of the

budget line.

• Labor supply function h*=h(w, V)

• Leisure is a normal good: Non-labor income increase and hours of work(fall), reservation wage(rise)

• Income effect

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U0

U1

U2

Hours of leisure

P

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3

50 100

An interior Solution to the labor-leisure Decision

Consumption

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Hours of work when the wage changes: An increase in the wage rate generates both income effect and substitution effect. The income effect reduces hours of work, while the substitution effect increases hours of work.

Substitution effect illustrates what happens to the optimal consumption bundle as the wage increases, holding utility constant. 

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The labor supply curve gives the relationship between the wage rate and hours of work. The upward-sloping segment of the curve implies that substitution effects are stronger initially; the backward-bending segment implies that income effects dominate eventually.

The relationship between hours of work and wage rates for women in U.S has a classic backward-bending shape.

Labor supply elasticityCommuting costs and hours of work. It is unlikely that a person will want to work for just a few hours.

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2.4 Welfare programs and work incentives

• A take-it-or-leave it cash grant• The newer programs often permit the welfare

recipient to work, but reduce the amount of the grant by some specified amount for every dollars earned in the labor market. Taxing the welfare recipient Figure pp50

• Welfare programs reduce labor supply, both in terms of employment probabilities and in terms of hours worked.

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2.5 The non-market sector: household production

• Much of what we call “leisure” is really a form of work.

• Women allocate more hours to the non-market sector than men.

• Household production function• The household’s opportunity frontier

Figure pp54• A division of labor in a household pp56

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• Difference in the market wage rate and marginal product in the household sector

• The increase in the real wage of women, technological changes in household production also reduce the difference in marginal products between husband and wife.

 

2.6 Estimates of the labor supply elasticity

• h=aw+bV+cwelfare+other variable

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a= -0.1 (men) inelastic (annual hours of work) the labor supply becomes more elastic the longer the time period over which the hours-of-work variable is defined.

• Pwomen=aw+bV+cwelfare+dchild+dWhusband+other variable

Other variable includes culture factors and the institutional framework.

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• Women participate more not because they have fewer children; rather, they have fewer children because the rising wage induces them to reduce their time in the household sector and enter the labor market.

• Participation rates are very responsive to changes in the wage. Hours of work not

• Most studies of female labor supply find a positive relationship between a woman’s hours of work and her wage rate. 0.2

 

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2.7 Labor supply over the life cycle

Present value

Lifetime utility =

Marginal utility of hour of leisure in second year =

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• The ratio of marginal utilities equals the ratio of prices(wage)

• Figure pp75

• A person will work few hours in those periods of the life cycle when the wage is low and will work many hours in those periods when the wage is high.

• Wage is relatively low for young workers, increases as the worker matures and accumulates human capital, and then may decline slightly for older workers.

 

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• Participation rates are likely to be low for young workers, high for workers in their prime working years, and low again for older workers.

 

The inter-temporal substitution hypothesis

• Evolutionary wage change is not to an expansion in the lifetime opportunity set. The present value of the worker’s lifetime income unchanged, there are no income effects associated with the process of aging.

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• Compare two workers with different wage profiles, the difference in hours of work between the two workers would be affected by both income and substitution effects.

 

• Elasticity of inter-temporal substitution=change rates in hours as worker ages/change rates in wage as worker ages

• 0.1 is not very responsive

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Retirement

• Pension

• Figure pp85

• Early retirement

• Increase in the wage: income( retire earlier) and substitution effects( retire later).

• Increase in the pension benefits: both effects encourage the worker to retire earlier.

• Mandatory retirement

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• Privately provided pension has had a much greater impact on the work attachment of older workers.

• Earning test(taxes retirees when they earn more than 11160 per year)

• Nearly 20 percent of “retired” persons also hold a job. (Burtless, Moffitt 1985)

• The repeal of the Social Security earning test is not likely to substantially increase labor supply among retirees.

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2.8 Labor supply over the business cycle

Added worker effect the participation rate of secondary workers has a counter-cyclical trend. Make up the loss.

Discouraged worker effectLFPRt= αURt+ other variablesα<0, discouraged worker effect dominates.

Hidden unemployed some of these discouraged workers are, in effect, “taking advantage” of the relatively poor labor market condition to engage in the consumption of leisure activities.

Some of the discouraged workers(hidden unemployed) should not be part of the unemployment statistics.  

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2.9 Fertility• The fertility decisions made by households play

a key role in determining long-run labor supply. Also influences women participation rate. Or vice verse.

• Malthusian model• As per-capita incomes rose, fertility rates did no

t rise; they declined.• Gary Becker: Fertility responds not only to chan

ges in income but also to changes in prices.

 

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• Figure pp94

• The impact of income and prices on he household’s fertility Figure pp95

• Nchild = αPchild +βI+ other variables

• Mother’s wage __forgone earning

• Cost of raising child rises with the increase of income. High quality. 

• Benefits and revenue of raising children

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Chapter 3 Labor Demand

Derived demand

 

3.1 The production function Q=f(L, K)

• Marginal product and average product of labor : holding capital constant

• Law of diminishing returns

• Profit maximizationΠ=pf(K,L)-wL-rK

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3.2 The employment decision in the short run

• value of the marginal product VMPL = p. MPL

• VMPL = w MR=MC MRL = MCL

• Figure p107

• Law of diminishing returns sets limits on the size of the firm.

• The competitive firm sets its employment level such that the value of marginal product of labor equals the predetermined wage.

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• The only points that are relevant for the firm’s hiring decision are the ones that lie on the downward-sloping portion of the curve below the point where the VAPE curve intersects the VMPE curve.

• The demand curve for labor DSL=g(w, p, K0)

• Elasticity of labor demand: the percentage change in short-run employment resulting from a 1 percent change in the wage.

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3.3 The employment decision in the long run

• Isoquants and isocosts

• The firm’s optimal combination of inputs MPL/MPK=w/r

• Figure p114

• The cost-minimizing condition stating that the ratio of prices equals the ratio of marginal products, however, does not imply that the firm is maximizing profits. p’s role

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A profit-maximizing firm will not generally want to hold the cost outlay constant when the wage changes. Change of isocost line.

A decrease in the wage rate lowers marginal cost of production. Figure p118Substitution and scale effects. Figure p 121

DLL=g(w, p, K)In the long run, the firm can take full advantage of the economic opportunities introduced by a change in the wage. As a result, the long-run demand curve is more elastic (-1)than the short-run demand curve(-0.4 and –0.5).

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3.4 The substitution and complements

• perfect substitutes and perfect complements

• elasticity of substitution δ=% (K/L)/ %⊿ ⊿(w/r) q positive∣

• The size of the substitution effect depends on the magnitude of the elasticity of substitution.

 

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• Cross-elasticity of factor demandδxy=% Dx/ %⊿Py⊿

• Positive--substitutes; negative—complements• In addition, the sign of the cross-elasticity depends

on the relative strengths of the scale and substitution effects resulting from a change in an input price. Pp129. increase in minimum wage, the number of skilled workers decreased(δxy<0), because that the scale effect dominates, not because skilled workers and unskilled workers are complements.

• Unskilled labor and capital are substitutes and skilled labor and capital are complements.  

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Marshall’s rules of derived demand:

• Labor demand is more elastic the greater the elasticity of substitution.

• Labor demand is more elastic the greater the elasticity of demand for the output.

• Labor demand is more elastic the greater labor’s share in total costs.

• Labor demand is more elastic the greater the supply elasticity of other factors of production, such as capital.

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• Unions and Marshall’s rules. Pp126-127.

• Unions have a greater chance of being successful when the demand curve for labor is inelastic.

• What happens to the wage of input x when the number of workers in group y changes.

• ρxy=% Wx/ % Qy⊿ ⊿ >0, complements; <0, substitutes.

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3.5 Adjustment costs and labor demand

• The cost that firms incur as they adjust the size of their work force are called adjustment costs.

• Asymmetric variable adjustment costs Figure p139

• This asymmetry might arise because of government policies which mandate employers to provide severance pay for workers who are laid off.

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• The costs of adjustment rise at an increasing rate, regardless of whether the firm is contracting or expanding. Marginal cost of adjustment are higher.

• Hiring a large number of workers at the same time exceed the costs incurred when hiring just a few workers at a time.

• It does not pay for the firm to adjust its employment slowly because the fixed adjustment costs are incurred regardless of how many additional workers the firm actually hires. When fixed adjustment costs are sizable, therefore, employment changes in the firm will be relatively sudden and large, if they occur at all.

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If variable adjustment costs are important, employment changes occur slowly.The impact of Job Security Legislation: European countries which impose higher costs on layoffs (such as severance pay)have smaller fluctuations in employment over the business cycle.  Job creation and job destructionSmall firms would have an advantage in creating jobs if they could respond to favorable changes in the marketplace much faster than bigger firms(that is, if small firms face lower adjustment costs when creating new jobs.)

Instead, large firms account for most newly created and newly destroyed manufacturing jobs. 

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3.6 The distinction between workers and hours

An increase in health insurance premiums would then discourage the firm from adding to its work force. In contract, legislation mandating employers to pay an overtime premium mainly affects the cost of lengthening the workweek. The substitution effect arising from an increase in the fixed costs of hiring. Figure p147Employing fewer workers and lengthening the workweek.  

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Chapter4 Labor Market Equilibrium

 4.1 Equilibrium in a single competitive labor

market

• efficient allocation

• competitive equilibrium across labor markets linked by migration. As a result, a single wage is formed.

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• As long as either workers or firms are free to enter and exit labor markets, therefore, a competitive economy will be characterized by a single wage.

• Convergence of regional wage levels. The states with the lowest wages in 1950 experienced the fastest wage growth subsequently.

• Two countries which have roughly similar endowments of human capital, the wage gap between these countries narrows over time.  

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4.2 The cobweb model

• figure p163

• Because new engineers are not produced instantaneously and because students might misforecast future opportunities in the market, a cobweb is created as the labor market adjusts to the increase in demand.

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• Students choose an engineering career based entirely on the wage they currently observe in the engineering market, and do not attempt to “look into the future”. Irrational expectations.

• If students have rational expectations, they would be much more hesitant to enter the engineering labor market when current wages are high and much more willing to enter when current wages are low.

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4.3 Policy application: • Payroll taxes assessed on employers shifts down t

he demand curve and reduces the equilibrium wage. If the supply curve of labor is perfectly inelastic, the tax is paid entirely out of worker’s wages.

• Employment subsidies• The impact of minimum wages• In 1991, the wage floor was set at $4.25.• It is easy to verify that the unemployment rate is la

rger the higher the minimum wage and the more elastic the demand and supply curves.

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However, there is a great deal of noncompliance with the minimum wage law. Firms caught breaking the law face only trivial penalties.

Only 43 percent of non-supervisory workers in the economy were in the covered sector when the FLAS was first enacted. Covered about 88 percent of all workers by 1990. Figure p 168

If workers migrate to uncovered sector, if workers migrate to covered sector.

Free entry and exit of workers in and out labor markets can equilibrate real wages in an economy despite the best intentions of governments.

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• ΠWmin=Wu, Πis the probability that a worker who enters the covered sector gets a job there, Wu is the wage in the uncovered sector.

• Do minimum wages really displace workers?

 

4.4 Noncompetitive labor markets: Monopsony and Monopoly

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• A monopsony is a firm that faces an upward-sloping supply curve of labor. In contrast to a competitive firm that can hire as much labor as it wants at the going price, a monopsonist must pay higher wages in order to attract more workers.

• Perfectly discriminating monopsonist can hire different workers at different wages.

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• Figure p175• VMP equals the marginal cost of labor(suppl

y curve of labor), The monopsonist hires the same number of workers as a competitive market, but the wage is not the competitive wage. Only the last worker receive that wage, all others receive lower wages, with each worker receiving his or her reservation wage.

• Non-discriminating monopsonist must pay all workers the same wage, regardless of the worker’s reservation wage.

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• Marginal cost of labor curve is upward sloping and lies above the supply curve.

• Figure p177 Workers are paid less than their marginal product and are, in this sense, “exploited”.

• A well-designed minimum wage can increase both wages and employment when imposed on a monopsonist. Figure 178

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Monopsony, professional sports and the Coase theorem.A Player cannot become a “free agent” until he has played in the major leagues for a number of years.

The allocation of players to teams in a world where all players have free agency is identical to the allocation that would be observed when the team owns the rights to the players(monopsony, pay salaries below the competitive wage). As long as the relevant parties can bargain easily, the allocation of resources is independent of the allocation of property rights. (Coase theorem)

Free agency led to a significant transfer in income from the owners to the players(keep the rewards of their productivity).  

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• Monopoly in output market, MR<AR, Marginal revenue product(MRP)<VMP

• The monopolist hires fewer workers than would be hired in a competitive market.

• Figure p182

 

4.5 Wage and employment in the public sector

By 1992, Nearly 1 in 7 workers in U.S. was employed directly by the government.

Are they over-paid?

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• The workers employed in the federal government earned approximately 10-15 percent more than equally skilled private sector workers during the 1970s.

• The wage gap between workers in the competitive sector and workers in state and local government is much smaller.