CH 5: Frictions in the Labor Market

• Quasi-fixed labor costs – Types of QF costs– Effects of QF costs on hours/workers– Training as a QF cost & consequences of training

investments for structure of pay.

Monopsony• The firm’s labor supply curve is upward sloping• Sources of monopsony:

– Mobility costs– Job search and information costs– Small # of competing employers

Monopsony• The firm’s labor supply curve is upward sloping

LS

MEL

MRP

•Profit maximizing wage? Level of employment?

• MRP vs. W in a monopsony? Perfect competition?

•Effect of a change in MRP? Perfect competiton vs. monopsony?

Quasi Fixed Labor Costs, Walter Oi (1962).

The cyclical behavior of labor markets reveals a number of puzzling features for which there are no truly satisfying explanations. Included among these are1. occupational differences in the stability of employment and

earnings 2. the uneven incidence of unemployment3. the persistence of differential labor turnover rates4. discriminatory hiring and firing policies

I believe that the major impediment to rational explanations for these phenomena lies in the classical treatment of labor as a purely variable factor.

Quasi-fixed labor costs

• Examples– Hiring costs– Maintenance of payroll records, issuing

checks– Training costs

• Explicit monetary costs• Implicit opportunity costs of trainer’s time and

capital used• Implicit opportunity cost of trainee’s time

Quasi-fixed labor costsAvg. hours of formal instruction by training personnel

19

hours spent by management in orientation, informal training, extra supervision

59

hours spent by co-workers in informal training

34

hours spent by new worker watching others do work

41

Total 153Source: Ehrenberg and Smith

Employee Benefits

Quasi-fixed labor costs• Hiring and training costs are quasi-fixed • Some benefits are quasi-fixed, others are not.

– pensions • Are contributions a fixed dollar amount per

employee, % of pay, or % of pay up to a maximum value?

– legally required benefits • many are % of pay up to a maximum.

– health insurance • typically, a worker is either covered or not and the employer

contribution is independent of incremental hours worked.

Optimal Mix of Workers and Hours

MEM = marginal expense of an additional worker

= W*H + Q where W =wage rate, H=hours per week, Q=QFC per worker

MEH = marginal expense of an additional hour of work for all its existing workforce.

= W*N where W=wage rate and N=number of workers

MPM = MP of an additional worker for H hours.

MPH = MP of an additional hour of work for N workers.

Optimal Mix of Workers and Hours

MEM /MPM = MEH /MPH

What should firm do if – QFC rises?– Wage rate rises?

Optimal Mix of Workers and Hours• APPLICATIONS

– raising the salary cap for payroll taxes– increasing the payroll tax rate on capped payroll

taxes.– effect of training costs on likelihood of part-time work.– the over-time premium.– mandatory health insurance coverage for full-time

workers– worker preferences for part-time as opposed to full-

time work– why do firms sometimes institute mandatory over-time

rules• would firms ever pay an over-time premium even

in the absence of federal legislation?

Training InvestmentsThe firm's decision to invest in training a worker in a two-

period model:Period 0:• pay Z to train the worker• pay W0 in wages to the worker• worker produces MP0

Period 1:• pay W1 in wages to the worker• worker produces MP1

If worker is not trained, MP is fixed at MP* in both periods and the worker can receive a wage of W*=MP* at a competing firm.

Training Investments

Optimal employment will be at E*

Training Investments• How are W0 & W1 determined?• Must offer a competitive PV of

compensation• W0 + W1/(1+r) > W* + W*/(1+r)

Training InvestmentsExamples: Suppose that W*=100 and r=6%.

Alternative W0 W1 Present value (r=6%)•A 128 70 194•B 100 100 194•C 81 120 194•D 62 140 194•E 43 160 194Why would the firm be reluctant to offer A or B?Why is worker reluctant to accept C, D, or E?

Training Investments

• Firms that invest in training will want to– Defer pay– Find ways to restrict mobility of workers

Training InvestmentsGENERAL VERSUS SPECIFIC TRAINING.

• General training increases productivity at all firms.

• Specific training increases productivity only at a specific firm (presumably the firm providing the training).

• If training is general, a firm will have difficulty recouping its investment in training.

Training Investments• With general training, firm must pay W1>MP1

in second period unless there is a way to prevent worker from quitting.

• Since W1>MP1, firm cannot recoup training investments by underpaying in second period

• With specific training, firm can pay MP1*<W1<MP1 and recoup some of its training investments. Firms can recoup investment in specific training with restricting mobility.

Training Investments

• How should training investments affect firm layoff behavior if product demand falls?

• How does the above affect the cyclical nature of productivity?

• If there are large training costs, firms should be concerned about screening out quitters. – Statistical discrimination – Fringe benefit packages– Discount rates

Investments in Training

• Employer investments in general training– Armed forces– Sports contracts – Employer pays for employee education

while “on the job”