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

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

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?

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 Carolina’s “Economy at a Glance”

• Industry at a Glance• Distribution of employment

• http://www.bls.gov/iag/iaghome.htm

Positive vs. Normative Analysis• Role of the labor market is to facilitate voluntary, mutually beneficial

transactions (if all those take place Pareto efficiency)

• Government’s 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.

Market Failures• Labor market facilitates voluntary, mutually beneficial transactions.

When does the “market fail” and we don’t see Pareto-improving transactions?

– Ignorance: smoker in asbestos plant; don’t know of job opening

– Transaction barriers: law restricting women to < 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

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?

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

Definitions

E m p loyed U n em p loyed

L ab or F orce N ot in th e L ab or F orce

P op u la tion(> = 1 6 years o ld )

• 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)

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.

0102030405060708090

100

1950 1960 1970 1980 1997

TotalMenWomen

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

0

5

10

15

20

25

30

1900

1910

1920

1930

1940

1950

1960

1970

1980

1990

U-rate

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

0

10

20

30

40

50

60

% o

f E

mp

loym

ent Agriculture

Manufacturing

Services (non-govt)Govt services

Earnings and Income• Wage rate = price of labor per hour

– Money you’d 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 we’ll 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

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?

Economics 324: Labor Economics

1. Any questions?

2. For next time, read Rizzo & Blumenthal & rest of Chapter 2.

3. Presenter for Rizzo & Blumenthal?• Motivation

• Literature review (what’s new in their paper)

• Theory/Conceptual framework

• Empirical specification

• Results

• Implications

4. Problem presenters for 2.7 and 2.8?

Labor Supply: Theory and Evidence

• 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

In order that people may be happy in their work, they must not do too much of it. – Herman Melville

Properties of Indifference Curves• IC’s are downward-sloping• Higher IC indicates higher utility• IC’s do not intersect• IC’s 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

Leisure (hours)

U = 500

U = 750

U = XY

U = 10X ½Y ½

MUX and MUY?

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

C

U = 500

L

AdCC

UdL

L

UdU

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 worker’s opportunity set.

C wh + V … “can’t 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

Leisure(hours)

T

(wT+V)

EV

0

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 it’s 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.

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 > 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?

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

– It’s greater than WRES without commuting costs

• Conclusion: Commuting costs increase the reservation wage

C

LT

(wT+V)

E0

V - Costs

0

V

E1

U0

a

Optimal Labor-Leisure Choice example• Suppose Jack’s 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 don’t 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 ?

C

LeisureT

(wT+V)

E0V

0

U = ?

C* = ?

L* = ?Work

h* = ?

h L C U

Initial

subsidy

Tax: SE

Tax: IE