introduction to labor markets and discrimination 321...introduction to labor markets and...
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Introduction to Labor Markets and Discrimination
Spring 2010
Alicia Rosburg (ISU) Labor Markets and Discrimination Spring 2010 1 / 57
Relevant Readings
BFW Chapter 1 including Appendix 1A
KW Chapter 12
Alicia Rosburg (ISU) Labor Markets and Discrimination Spring 2010 2 / 57
Outline
1 Labor Market BasicsLabor DemandLabor SupplyLabor Market EquilibriumBasic Model Issues
2 DiscriminationDefinitions
3 Deviation from Market EquilibriumFour CasesExamples
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Labor Market Basics
Factors of Production
Labor is a factor of production
Factors of production are bought and sold in “factor markets” at “factorprices”
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Labor Market Basics
Factors of Production
Factors of production differ from goods
Derived demand - demand for a factor of production is derived fromthe firm’s output choice
Factor prices and derived demand determine how total income ofeconomy is divided - factor distribution of income
Roles are reversed from goods market:
Firms determine demand
Households determine supply
Alicia Rosburg (ISU) Labor Markets and Discrimination Spring 2010 5 / 57
Labor Market Basics
Factor Price: Wage
Wage is a common signal to both supply (HH) and demand (firm) side:
Demand-side: input price to production
Supply-side: income or source of purchasing power
Real wage: purchasing power of wage = wage in current $
price level
Price level is determined by a price index
Alicia Rosburg (ISU) Labor Markets and Discrimination Spring 2010 6 / 57
Labor Market Basics Labor Demand
Labor Demand Basics
Firms decide how many workers to employ, given market wages andtechnology
Firms pick the employment level that maximizes profit
Assume perfect competition: individual firm cannot influence output price
Output price takers
Alicia Rosburg (ISU) Labor Markets and Discrimination Spring 2010 7 / 57
Labor Market Basics Labor Demand
Labor Demand Basics
Marginal product of labor (MPL): additional output from employingone more worker
Diminishing marginal returns: MPL is decreasing as labor increases(fixed capital)
Value of the marginal product of a factor (VMPL): the monetaryvalue of the additional output from employing one more worker
VMPL = p ∗MPL
where p is the price of the output sold by the employer
Alicia Rosburg (ISU) Labor Markets and Discrimination Spring 2010 8 / 57
Labor Market Basics Labor Demand
Graphical Depiction of Total and Marginal Product
Alicia Rosburg (ISU) Labor Markets and Discrimination Spring 2010 9 / 57
Labor Market Basics Labor Demand
Optimal Labor Demand
Profits maximized when marginal benefit equals marginal cost
Marginal benefit of labor: VMPL
Marginal cost of labor: wage (w)
Alicia Rosburg (ISU) Labor Markets and Discrimination Spring 2010 10 / 57
Labor Market Basics Labor Demand
Optimal Labor Demand
Intuition: Profit-maximizing and price-taking producer will hire additionalworkers only if marginal value is greater than wage rate.
Hire until the value of the marginal product of the LAST employee is equalto the wage rate
VMPL = w
Value of marginal product curve is the firms derived demand curve for labor
Alicia Rosburg (ISU) Labor Markets and Discrimination Spring 2010 11 / 57
Labor Market Basics Labor Demand
Optimal Labor Demand
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Labor Market Basics Labor Demand
Example
Handout 1: Derive the amount of labor that maximizes profits
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Labor Market Basics Labor Demand
Example
Alicia Rosburg (ISU) Labor Markets and Discrimination Spring 2010 14 / 57
Labor Market Basics Labor Demand
Mathematical Derivation
Profit = π = Revenue - Cost
Revenue = price of output * output = p ∗ f (x)
p = market price of outputf (x) = production function
Production function: how much output you can produce for a givenlevel of inputs x
Cost = C = w1x1 + w2x2 + ...+ wnxn = Σiwixi
xi = factor iwi = factor price for factor i
Suppose only factor is labor (L) then:
π = p ∗ f (L)− w ∗ L
Alicia Rosburg (ISU) Labor Markets and Discrimination Spring 2010 15 / 57
Labor Market Basics Labor Demand
Mathematical Derivation cont.
Goal: Find quantity of labor that maximizes profits
Calculus approach: Take derivative of profit with respect to L and setequal to 0
p ∗ ∂f (L)
∂L− w = 0
p ∗MPL = w
VMPL = w
Hire until wage equals value of marginal product of labor - same asintuition provided earlier
Alicia Rosburg (ISU) Labor Markets and Discrimination Spring 2010 16 / 57
Labor Market Basics Labor Supply
Labor Supply Basics
Workers decide how much and where to allocate their time given marketwages
Choose occupation and number of hours that maximizes utility
Workers evaluate marginal value of time
Value both consumption and leisure time
Work additional hour if marginal utility from consuming goods purchasedwith hourly wage exceeds marginal utility of an additional hour of leisure
Alicia Rosburg (ISU) Labor Markets and Discrimination Spring 2010 17 / 57
Labor Market Basics Labor Supply
Labor Supply Basics cont.
Maximize utility (U) which is represented by an indifference curve
“Map” of consumer preferences
All combinations of goods or time allocations that make a personequally better off
Time allocation budget line: tradeoff between leisure and income usedfor consumption of goods
Given the time allocation budget line, household will choose leisure andwork levels that maximize utility (i.e. highest indifference curve)
Alicia Rosburg (ISU) Labor Markets and Discrimination Spring 2010 18 / 57
Labor Market Basics Labor Supply
Time Allocation Example
Suppose wage rate is $8 per hour and have 80 hours a week to allocatebetween work and leisure.
If devote all time to work get $640 in income to purchaseconsumption goods and 0 hours of leisure
If devote all time to leisure get no income for consumption
Optimal leisure and labor time determined by tangency of time allocationbudget line and utility curve.
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Labor Market Basics Labor Supply
Time Allocation Budget Line
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Labor Market Basics Labor Supply
MRS
Marginal rate of substitution (MRS): the rate at which a consumer iswilling to give up one good in exchange for another good whilemaintaining the same level of satisfaction
Slope of the indifference curve
MRS12 = MU1MU2
=∂U∂z1∂U∂z2
Alicia Rosburg (ISU) Labor Markets and Discrimination Spring 2010 21 / 57
Labor Market Basics Labor Supply
Utility Maximization
From the graph we can see that utility is maximized when the utility curveis tangent to the time allocation line
Slope of utility = slope of time allocation line
MRS12 = MU1MU2
= w
MRS equal to the wage rate
Alicia Rosburg (ISU) Labor Markets and Discrimination Spring 2010 22 / 57
Labor Market Basics Labor Supply
Labor Supply and Wage Increase
A wage increase does not necessarily increase hours of work
Two conflicting effects:
Substitution effect:
Change in the opportunity cost of leisure in terms of other goodsRelative cost of leisure increases when wage increasesDecreased leisure time and increased labor time
Income effect:
Consumer richer for each hour of workLeisure is a normal good - increased consumption with incomeIncreased leisure and decreased labor
→ Total affect on hours of work indeterminant
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Labor Market Basics Labor Supply
Labor Supply and Wage Increase to $10
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Labor Market Basics Labor Supply
Labor Supply Curves
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Labor Market Basics Labor Market Equilibrium
Market Demand and Supply
Market demand for labor is the aggregate of individual firm demands ateach wage
As price increases for an input, the firm demands less of that input asthey substitute to a relatively cheaper input
As wage increases, substitute machines for labor
Market supply for labor is the aggregate of household labor supplies ateach wage
As wage increases, more potential workers enter the market and totalsupply will increase
Typically do not have backward-bending market supply curves
Alicia Rosburg (ISU) Labor Markets and Discrimination Spring 2010 26 / 57
Labor Market Basics Labor Market Equilibrium
Equilibrium: Supply = Demand
At w*, last worker paid the value of their leisure time, others paidmore than reservation wage
No unemployment at w*
Alicia Rosburg (ISU) Labor Markets and Discrimination Spring 2010 27 / 57
Labor Market Basics Labor Market Equilibrium
Potential Shifters
Demand Shifters
price of product (↑)price of substitutes (↑)MP of workers (education, experience) (↑)demand for product (↑)price of complementary inputs (↓)
Supply Shifters
population (↑)taste for leisure (↓)taste for home time (↓)wages elsewhere (↓)bad non-pecuniary aspects of job (↓)
Alicia Rosburg (ISU) Labor Markets and Discrimination Spring 2010 28 / 57
Labor Market Basics Labor Market Equilibrium
Curve Shifts and Equilibrium Effects
Demand shifts out → wage ↑ and labor ↑
Supply shifts out → wage ↓ and labor ↑
Alicia Rosburg (ISU) Labor Markets and Discrimination Spring 2010 29 / 57
Labor Market Basics Labor Market Equilibrium
Wage Determination Model
Using the demand and supply shift effects, we can predict how variousfactors effect wages
Wage = f[output price (+), productivity (+), substitute output price (+),complement price (-), good job attributes(-), bad job attributes (+),competition (-), wages in other jobs(+)]
Alicia Rosburg (ISU) Labor Markets and Discrimination Spring 2010 30 / 57
Labor Market Basics Labor Market Equilibrium
Stable Equilibrium
All persons willing to work at going rate are able to find employment andall employers willing to hire someone at going rate are able to find workers
Since firms who maximize profits set VMPL equal to the wage rate,equally productive individuals should earn the same wage
Alicia Rosburg (ISU) Labor Markets and Discrimination Spring 2010 31 / 57
Labor Market Basics Labor Market Equilibrium
Underlying Assumptions
1 People have rational preferences among outcomes that can beidentified and associated with a value
2 Individuals maximize utility and firms maximize profits
3 People act independently on the basis of full and relevant information
Alicia Rosburg (ISU) Labor Markets and Discrimination Spring 2010 32 / 57
Labor Market Basics Basic Model Issues
Violations of Underlying Assumptions
People do not always behave rationally
People do not always make choices that maximize utility or profits
Lack of full information
Uncertainty
Alicia Rosburg (ISU) Labor Markets and Discrimination Spring 2010 33 / 57
Labor Market Basics Basic Model Issues
Violations of Underlying Assumptions cont.
Free markets operate in a frictionless market and have have nodiscrimination
→ Discrimination is a market failure
Alicia Rosburg (ISU) Labor Markets and Discrimination Spring 2010 34 / 57
Discrimination
Discrimination
Discrimination is a departure from a freely functioning labor marketequilibrium
Wage no longer equals marginal productivity
Wage differentials does not imply discrimination
Compensating differentials (cover later)
Human capital differences (education, experience, etc.)
Discrimination can function on either side of the market:
Demand side: depressed output price or restricted marginalproductivity
Supply side: job rationing
Alicia Rosburg (ISU) Labor Markets and Discrimination Spring 2010 35 / 57
Discrimination Definitions
Discrimination Definitions
Websters Dictionary:
To make a distinction; to use good judgment
To make a difference in treatment or favor on a basis other thanindividual merit
Discrimination, in this definition, can be viewed as positive or negative
Positive connotation - A discriminating person is someone who hasmore information and uses this information to make their decision
Negative connotation - A discriminating person is someone whoknows less about the ability of individuals and uses information ongroup characteristics to make decision
Alicia Rosburg (ISU) Labor Markets and Discrimination Spring 2010 36 / 57
Discrimination Definitions
Discrimination Definitions
Dictionary.com:
Treatment or consideration of, or making a distinction in favor of oragainst, a person or thing based on the group, class, or category towhich that person or thing belongs rather than on individual merit
Alicia Rosburg (ISU) Labor Markets and Discrimination Spring 2010 37 / 57
Discrimination Definitions
Discrimination Definitions
Economic Definitions
To offer different transaction terms to individuals based on
Group membership or attribute (antagonism, BFW pg 203)Accurate knowledge of group differences (statistical)Subjectively held opinions regarding relevant criteria (institutional orunconscious)
When two equally qualified individuals are treated differently solely ontheir group identity (gender, race, age, disability, etc.)
When two individuals with identical observed characteristics besidesgroup membership have systematically different outcomes
Alicia Rosburg (ISU) Labor Markets and Discrimination Spring 2010 38 / 57
Discrimination Definitions
Sources of Discrimination
Access to skills and training
Segregation in schoolsBarriers to entry (ex: cost)
Output price
Access to inputs
USDA withheld extension services to black farmers
Restriction of job entry
UnionsOccupational licensing restrictions
Quality of equipment
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Discrimination Definitions
Circumstance can be unfair, but NOT discrimination unless it has a groupdimension
Undervaluing a group, NOT an individual
Examples?
Alicia Rosburg (ISU) Labor Markets and Discrimination Spring 2010 40 / 57
Discrimination Definitions
Discrimination versus Prejudice
Discrimination - Treating people differently based on innatecharacteristics (discriminatory outcomes)
Prejudice - Dislike, distaste, or misperception based on innatecharacteristics (discriminatory attitudes/feelings)
Prejudice may or may not cause discriminationDiscrimination may not be a result of prejudiceExamples?
Contrary to many legal matters, it is not the intent that matters, it isthe outcome that matters
Alicia Rosburg (ISU) Labor Markets and Discrimination Spring 2010 41 / 57
Discrimination Definitions
Profiling
Profiling - the use of specific characteristics, as race or age, to makegeneralizations about a person, as whether he or she may be engaged inillegal activity
Type of discrimination
Blacks more likely to be stopped, questioned or searched – racialprofiling
Profiling can occur without prejudice
Alicia Rosburg (ISU) Labor Markets and Discrimination Spring 2010 42 / 57
Discrimination Definitions
Segregation
Segregation - separation of people on the basis of race
Discrimination can occur without segregation
Segregation can occur without discrimination
Alicia Rosburg (ISU) Labor Markets and Discrimination Spring 2010 43 / 57
Discrimination Definitions
Labor Market Discrimination
Wage discrimination - prices paid by employers for given productivecharacteristics are systematically different for different demographicgroups
Occupational discrimination - members of specific group with thesame education and productive potential are forced in lower-payingoccupations or levels of responsibilities by employers who reserve thehigher-paying jobs for members of a different group
Occupational segregation does not imply occupational discrimination
Alicia Rosburg (ISU) Labor Markets and Discrimination Spring 2010 44 / 57
Deviation from Market Equilibrium
Deviation from Market Equilibrium
What factors would lead to wage differences across markets, groups, orjobs?
Are wage differences evidence of discrimination?
When market is away from equilibrium, discriminatory job rationing ispossible.
Cases:
1 Wage setting union
2 Cyclical downturns
3 Compensating Differentials
4 Skill Differences
Alicia Rosburg (ISU) Labor Markets and Discrimination Spring 2010 45 / 57
Deviation from Market Equilibrium Four Cases
1. Wage Setting Union
Union sets w > w∗H’ = notional demand
H” = notional supply
Demand side is constrainingthe equilibrium
Unemployment rate = (H′′−H′)H′′
= fraction wanting to supplylabor at market wage but donot have a job
Only discrimination if accessto rationed jobs is preferentialfor or against a group
Alicia Rosburg (ISU) Labor Markets and Discrimination Spring 2010 46 / 57
Deviation from Market Equilibrium Four Cases
2. Cyclical Downturn
In recession, labor demandfalls to H’ at current wages
Reluctance to reduce nominalwages (unions, contracts)
Who loses jobs?
Discrimination if layoffs arebased on favoritism orpreferential treatment of agroup
Discrimination moreprevalent in downturns andless in upturns
Alicia Rosburg (ISU) Labor Markets and Discrimination Spring 2010 47 / 57
Deviation from Market Equilibrium Four Cases
3. Compensating Wage Differentials
Compensating differential: wage required to compensate a worker foraccepting a bad job attribute or the wage reduction a worker would acceptto get a good job attribute
Dangerous jobs
Undesirable jobs
Alicia Rosburg (ISU) Labor Markets and Discrimination Spring 2010 48 / 57
Deviation from Market Equilibrium Four Cases
Nonfatal work related injuries per 1000 workersMost Injurious Least Injurious
117 Production Assistants 0.7 Typists99 Data/sales workers 0.7 Education administrators79 Structural metalworkers 0.7 Economist75 Non-construction Laborers 0.6 Library clerks70 Public transportation 0.6 Data processing
attendants equipment repairers62 Machine feeders and 0.5 Management analysts
off-bearers62 Construction and extractive 0.4 Child care workers
trades helpers55 Punching and stamping 0.4 Correctional institution
machine operators officers54 Construction laborers 0.4 Securities and financial
services salespeople
Alicia Rosburg (ISU) Labor Markets and Discrimination Spring 2010 49 / 57
Deviation from Market Equilibrium Four Cases
3. Compensating Differentials
2 occupations where one has preferable attributes
Workers in risky job need compensation → supply curve shifts
S = initial supply (wages equal)
S’ = supply with risk rating
Displaced workers from risky job obtain non-risky job at lower wage
Wage difference: w ′′−w ′ → does not necessarily imply discrimination
Alicia Rosburg (ISU) Labor Markets and Discrimination Spring 2010 50 / 57
Deviation from Market Equilibrium Four Cases
4. Skill Differences
Human Capital: Skills embodied in the worker that improves labor
Examples: education, on-the-job training, knowledge
Suppose there are 2 jobs, one of which requires more schooling (ex:business versus construction)
Worker will need to be compensated for additional schooling
Supply of business workers falls (shifts left)
Some workers shift to construction → supply shifts right
Additional skills raises workers’ marginal productivity so demand forskilled workers also increases
Alicia Rosburg (ISU) Labor Markets and Discrimination Spring 2010 51 / 57
Deviation from Market Equilibrium Four Cases
4. Skill Differences
Wage differential = w ′′ − w ′
Reflects differences in cost of skill acquisition and productivity
Discrimination only if unequal access to education or training
Alicia Rosburg (ISU) Labor Markets and Discrimination Spring 2010 52 / 57
Deviation from Market Equilibrium Examples
Taxi Cab Situation
Consider a taxi driver driving down a one-way street late at night in adangerous part of town. Two people hail the cab at the same time but ondifferent sides of the street. Since it is a one-way street, their is nodifference to the cab-driver which side of the street a person in on. On theleft-hand side a little old lady hails the cab driver. On the right-hand sidea tall African American teenage boy wearing a hood hails the cab driver.The taxi driver unhesitatingly picks up the little old lady.
Did the cab driver discriminate? Did the cab driver engage in racialprofiling?
Does it make a difference if the cab driver was a women or a man?
What if the cab driver had more information (neighborhood, recentcrime, knew one of the potential customers, etc.)?
What would you do?
Alicia Rosburg (ISU) Labor Markets and Discrimination Spring 2010 53 / 57
Deviation from Market Equilibrium Examples
Video Game StoreSuppose you are a cop in a large metropolitan area. You get a report thata a video game store has been robbed. Witnesses saw someone leaving thescene wearing a black baseball cap and heading towards the local grocerystore. You are in the immediate area and the grocery store agrees to lockdown the doors. You find four people wearing a black baseball cap:
Teenage girl
Teenage boy
Middle-aged man
Middle-aged woman
Suppose the optimal interrogation technique is to interview from leastinnocent to most guilty. What order would you interview the four peopleand why?
Alicia Rosburg (ISU) Labor Markets and Discrimination Spring 2010 54 / 57
Deviation from Market Equilibrium Examples
Video Game Store cont.
Did you make your decision based on age or sex?
Would you consider it profiling if the police used age or sex as adeterminant of interview order?
Alicia Rosburg (ISU) Labor Markets and Discrimination Spring 2010 55 / 57
Deviation from Market Equilibrium Examples
Sells Representative
Handout 2 - Sales Representative Example
Alicia Rosburg (ISU) Labor Markets and Discrimination Spring 2010 56 / 57
Deviation from Market Equilibrium Examples
Readings for Next Lecture
Regression Analysis:
BFW Appendix 7A (pgs 250-255)
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