Economics 324: Labor Economics

1
Economics 324 Labor Economics

• 0. Welcome!
• 1. Go over class webpage (syllabus, requirements,
  etc.)
• Powerpoint slides not a substitute
• 2. For next time, read
• Borjas Ch. 1 (including Appendix), Ch. 2.1 -
  2.6

2
What is Economics?

• Economics is the study of mankind in the
  ordinary business of life. -- Alfred Marshall
  (1890)
• The study of how scarce resources are allocated
  among competing ends (how do people make choices
  when there is scarcity?)
• Macro deals with aggregates GDP, inflation,
  unemployment, exports, imports, government/public
  expenditures, etc.
• Micro deals with behavior of "small" units
  consumers, workers, firms, one industry, etc.
• Labor market is a unique market

3
What is Labor Economics?

• The study of the behavior of employers and
  employees in response to the general incentives
  of wages, prices, profit, non- pecuniary
  aspects of working (e.g., working conditions)
• Big picture questions in Labor econ
• Why are people unemployed? Is it good?
• Why have hours worked in Japan fallen from 2,184
  to 1,919 since 1973?
• Why do women earn 76 cents for every dollar men
  do?
• Is a talented HS student better off going to
  Yale, Davidson, or Rutgers?
• Should we care that CEOs make 300 times the
  average wage?
• Should I go to graduate school now or later? At
  all?
• Do pretty people earn more?
• Does health insurance hinder job mobility?
  Should we care?
• Is immigration good?
• Should the GED be scrapped?
• How have computers changed the wage distribution?
  

4
U.S. Economy at a Glance

• Current state of U.S. labor market is
  http//www.bls.gov/eag/eag.us.htm
• How does North Carolina stack up?
• North Carolinas Economy at a Glance
• Industry at a Glance
• Distribution of employment
• http//www.bls.gov/iag/iaghome.htm

5
Positive vs. Normative Analysis

• Role of the labor market is to facilitate
  voluntary, mutually beneficial transactions (if
  all those take place ? Pareto efficiency)
• Governments role
• Positive analysis
• What is it?
• What does it assume?
• Normative analysis
• What is it?
• Mutually beneficial transactions (mkt) vs.
  Redistributional transactions (govt)
• Employers offering pensions will pay lower wages
  than they would if they did not offer a pension
  plan.
• Employers should not be required to offer
  pensions to workers.

6
Market Failures

• Labor market facilitates voluntary, mutually
  beneficial transactions. When does the market
  fail and we dont see Pareto-improving
  transactions?
• Ignorance smoker in asbestos plant dont know
  of job opening
• Transaction barriers law restricting women
  to lt 40 hours law requiring a 50 OT
  premium simple cost as a barrier to
  moving
• Price distortions taxes subsidies can create
  incorrect prices plumber charging
  15/hr. with 5 tax
• Missing market impossible or not customary to
  transact (e.g., living in the apt.
  below a really bad band)
• Solution is often Government Intervention

7
Government Intervention

• Repeal certain laws
• Public goods
• Some union workers are worried about noise from
  machinery
• A sawmill factory wants to finance the research
  sell its findings
• Problem?
• Capital market imperfections
• Students/workers are worried about getting loans
  for college/job training or some workers would
  like to move to new city
• Government could make loans to help strengthen
  the economy
• Markets are missing
• Resident is worried about the band noise from
  upstairs
• Government could intervene and pass law on noise
  levels
• Concerns?

8
Overview of the Labor Market

• Disputes over efficiency vs. equity
• Buyers are employers, sellers are workers
• Size of the market national, regional, local
• Formal vs. Informal rules and procedures
• Internal labor markets union firms, govt, large
  non-union firms
• Smaller, non-union companies have less formal
  guidelines
• Note that people can be in more than one labor
  market they are not mutually exclusive

9
Definitions

• Employed person working for pay (135 m in 2000)
  BLS link
• Unemployed person not working for pay, but
  actively seeking a job or expecting to be
  recalled from a layoff (6 m)
• OLF not employed and not unemployed (69 m)
• Labor Force those ? 16 who are employed or
  unemployed
• Flows
• OLF ? LF ? LF ? OLF ?
• E ? U ? U ? E ?
• Labor Force Participation Rate LF / (Population
  ? 16)

10
Labor Force Participation

• Labor force participation is on the rise overall
• LFP rates for men are falling, while those
  for women are rising dramatically.
• Avg hours worked per week have also fallen
  substantially.

11
Unemployment Rate

• Unemployment rate U/LF
• If u-rate ? 5, we call the overall labor market
  tight hard for employers to fill jobs if
  u-rate ? 7 is loose
• Loose during Great Depression Tight during WWII
• Trends average u-rate has ? (non-war,
  non-GD years)
• the variance has ?
• Conclusion Labor market is more stable now, but
  at higher level of unemp

12
Distribution of Employment

• Major patterns?
• Agricultural employment has declined
  dramatically, while services has expanded
• Size of government has nearly quadrupled
• Workers and firms adapted, and must continue to
  adapt (demographic)
• These are snapshots and ?miss job transitions
  that occur between time points. 1972-86, 11 of
  manuf jobs destroyed annually, 9 created? 2 net
  loss

13
Earnings and Income

• Wage rate price of labor per hour
• Money youd lose per hour if you had an
  unauthorized absence. So a sick day becomes an
  employee benefit.
• e.g., if paid 100 total comp. for 25 hours 20
  spent working, 5 vacation
• then well call the wage 4/hour. Not 5/hour.
  80 wages, 20 benefit.
• Structure of Compensation
• Wage rate hours worked Earnings
• Earnings Employee benefits Total Compensation
• 70 of Total Compensation is from earnings, on
  average
• Total Compensation Unearned income Income
• Nominal vs. Real wages
• Nominal wage wage in current dollars
• Real wage nominal wage / some measure of prices
• it is used to indicate a level of purchasing
  power, so we can compare across time
• earn 100/day and book costs 50, real wage 2
  books per day

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Real wages of U.S. workers(non-supervisory
workers in private sector)

• What happened to real wages from 1980 to 2003?
• Nominal Real wages 1980 1990 2003
• Avg hourly earnings 6.84 10.19 15.38
• CPI (base 1982-84 100) 82.4 130.7 184.0
• Avg hourly earnings 8.30 7.80 8.36 in
  1982-84 dollars
• Avg hourly earnings 15.27 14.35 15.38 in
  2003 dollars
• Nominal wages rising, but prices of good/services
  also rising,
• ? need to deflate by CPI (fixed bundle of food,
  housing, clothing, etc.)
• Set cost of our bundle in the base period
  (1982-1984) 100. 1 in 2003 appears to buy
  less than one-third what a 1980 1 did.
• Conclusion Real wages were stagnant from 1980 to
  2003.
• Problems with using a fixed bundle?

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Economics 324 Labor Economics

• Any questions?
• For next time, read Rizzo Blumenthal rest of
  Chapter 2.
• Presenter for Rizzo Blumenthal?
• Motivation
• Literature review (whats new in their paper)
• Theory/Conceptual framework
• Empirical specification
• Results
• Implications
• Problem presenters for 2.7 and 2.8?

16
Labor Supply Theory and Evidence
In order that people may be happy in their work,
they must not do too much of it. Herman
Melville

• Model of labor-leisure choice
• Goal is to identify factors that determine
  whether a person works and, if so, how much she
  works
• Representative individual has utility function, U
  f (C, L)
• C is composite consumption good, L is leisure
  hours
• Utility function transforms consumption of goods
  leisure into an index measuring the level of
  satisfaction ?
• We assume that more is better
• We assume the person endeavors to maximize
  utility
• Indifference curve is the locus of points (C,L)
  that yield the same level of utility

17
Properties of Indifference Curves

• ICs are downward-sloping
• Higher IC indicates higher utility
• ICs do not intersect
• ICs are convex to the origin
• Marginal utility of consumption the change in
  utility resulting from an additional 1 spent on
  goods, holding leisure constant
• Marginal utility of leisure the
  change in utility resulting from consuming an
  additional hour of leisure, holding consumption
  constant

C
U 750
U 500
Leisure (hours)
U XY U 10X ½Y ½ MUX and MUY?
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Slope of an Indifference Curve

• Slope measures the rate at which a person is
  willing to give up leisure time for more
  consumption, holding U constant
• Total derivative of U U(C,L) is
• Solve for dC/dL
• In words, the absolute value of the slope of an
  IC is the ratio of the marginal utilities, and we
  call this the Marginal Rate of Substitution
• Slope is steep when lots of C, little L, but
  flatter when little C lots of L

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Time and Budget Constraints

• Time constraint T L h
• Ignoring household sector for now
• V non-labor income
• w hourly wage rate
• Budget constraint is the boundary of the workers
  opportunity set.
• C ? wh V cant consume more than your
  income
• Assume w constant, but note that marginal wage
  rate (wage received for last hour worked) can
  depend on hours worked (OT premium is higher,
  part-time wage often lower)

C
(wTV)
E
V
Leisure (hours)
T
0
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Time and Budget Constraints

• Combine the budget and time constraints to get
• wT V C wL
• This says that full income (potential income if
  worked T hours) is spent on consumption and
  leisure
• Rewrite so its easier to graph
• C (wT V) - wL
• Point E is the endowment point. This person
  can consume V of goods services even if they
  use all their time for leisure.

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To Work or Not to Work?

• Reservation wage is the wage at which a worker is
  indifferent between working and not working.
• In other words, it is the minimum increase in
  income that makes a worker indifferent between
  remaining at point E and working that first hour.
• A person will work if the market wage gt
  reservation wage
• Predictions
• a higher reservation wage makes a person less
  likely to enter LF
• the higher your market wage, the more likely you
  are to work (ceteris paribus, for given tastes
  and V)
• This positive correlation between offered wages
  and LFP rates helps explain the dramatic increase
  in female LFP
• What if you commute 30 minutes from Statesville?
  (time costs)
• How do monetary commuting costs affect the
  reservation wage?

22
Commuting Costs and Reservation Wage

• How do monetary commuting costs affect the
  reservation wage?
• Start with V non-labor income
• best utility level is U0
• Monetary commuting costs would be parking, tolls,
  car insurance, maintenance, gas, etc.
• Slope of line aE1 is the reservation wage in the
  presence of commuting costs
• Its greater than WRES without commuting costs
• Conclusion Commuting costs increase the
  reservation wage

C
(wTV)
a
E0
V
U0
V - Costs
E1
L
T
0
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Optimal Labor-Leisure Choice example

• Suppose Jacks utility function is given by U
  L? C?
• Find the demand function for leisure hours, L
  L (w, V, T)
• Assuming ? ¾, ? ¼, V 0, T 400 and w
  4 what are the initial optimal values?
• Now suppose welfare program passed giving 200 of
  income if you dont work at all. As you earn
  income benefits are scaled back 0.20 per dollar
  earned.
• What is the break-even point and what are the
  effects on labor supply?
• Decompose, graphically and numerically, the
  change in demand due to the subsidy and tax into
  the substitution and income effects.
• What if U L¼ C¾ ?

h L C U
Initial
subsidy
Tax SE
Tax IE