Factor markets labour

1
Lecture 7

• Factor markets (labour)

2
Labour supply evidence from developed economies
3
Labour supply evidence from developed economies
4
Cross-Country Relationship Growth in Female
Labor Force and the Wage, 1960-1980

• Source Jacob Mincer, Intercountry Comparisons
  of Labor Force Trends and of Related
  Developments An Overview, Journal of Labor
  Economics 3 (January 1985, Part 2) S2, S6.

5
Labor supply model

• Framework used to analyze labor supply behavior
  is the Neo-Classical Model of Labor-Leisure
  Choice
• Hence, the main components of the utility
  function are consumption and leisure
• U f(C, L), where
• U is an index
• Higher U means happier person

6
Indifference Curves in the labour supply model
C
500
450
400
40,000 Utils
25,000 Utils
L
125
100
150
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The Budget Constraint

• C wh V
• Consumption equals labor earnings (wages hours)
  plus nonlabor income (V)
• Because of time constraint, rewrite as
• C w(T L) V
• Budget constraint sets boundaries on the workers
  opportunity set of all the consumption baskets
  the worker can afford

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The budget constraint
C w(T L) V
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The Hours of Work Decision

• Individual will choose consumption and leisure to
  maximize utility
• Optimal (interior!) solution is given by the
  point where the budget line is tangent to the
  indifference curve
• At this point the Marginal Rate of Substitution
  between consumption and leisure equals the wage
  rate
• Any other bundle of consumption and leisure given
  the budget constraint would mean the individual
  has less utility

10
In a diagram this looks as follows
C
Slopewhigh
C
C
Slope-wlow
Slope-
L
L
L
Interior solution
Corner solution
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The Effect of a Change in Non-labour Income on
Hours of Work
Hours of Leisure
Leisure is a normal good
Leisure is an inferior good
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The effect of change in the wage rate on hours of
work

• When the Income Effect dominates

Consumption ()
G
U1
R
D
Q
U0
D
F
P
V
E
110
Hours of Leisure
85
75
0
70
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The effect of change in the wage rate on hours of
work

• When the Income Effect dominates

Consumption ()
G
U1
R
D
Q
U0
D
F
P
V
E
110
Hours of Leisure
85
75
0
70
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Labor Supply Curve

• Example of backward bending labor supply

Hours of Work
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Demand versus supply influences Education and
wages, stylized facts
Source Johnson, 1997
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Wage Differential Between College Graduates and
High School Graduates, 1963-2001
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Example of a short-run labor choice of a profit
maximizing firm
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Demand for labour in the short run(perfectly
competitive product and labour markets)

The VMPE(pMP) curve is the labor demand curve,
which is downward sloping
w1
w2
VMPE
E
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Different types of market structure compared

• A firm may have MONOPOLY power in its output
  market
• facing a downward-sloping demand curve
• so the marginal revenue (MRPL) received from
  expanding output is less than the MVPL
• as the firm must reduce price to sell more.
• A firm may face MONOPSONY power in its input
  market
• facing an upward-sloping supply curve for inputs
• so the marginal cost of labour rises with
  employment.

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Different types of market structure compared

MCE
W0
VMPE
MRPE
E3
E1
Employment
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Labour market equilibrium for an industry

• The industry supply curve SLSL slopes up
• higher wages are needed to attract workers into
  the industry
• For a given output demand curve, industry demand
  for labour slopes down
• Equilibrium is W0, L0.

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A shift in product demand
Beginning in equilibrium,
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A change in wages in another industry
Again starting in equilibrium,
an increase in wages in another industry
attracts labour,
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The long run. Production functions and isoquants
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Cost Minimization in the Production of Q
(Wage10 per Hour Price of a Unit of
Capital20)
CostswLrK
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Cost Minimization in the Production of Q
(Wage20 per Hour Price of a Unit of
Capital20)
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The Substitution and Scale Effects of a Wage
Increase
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Different types of labour
Source Alison Booth, 1996
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Education other outcomes
Source KILM, International Labor Office, 2003
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So why doesnt everyone invest in education? The
schooling model
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So why doesnt everyone invest in education? The
self-selection bias

• Assuming discount rate of 10
• Willie No school 20,00020,000/1.138,182
• Willie school 040,000/1.136,364
• Wendy No school 15,00015,000/1.128,636
• Wendy school 041,000/1.137,273

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Post-School Human Capital Investments

• Three important properties of age-earnings
  profiles
• Highly educated workers earn more than less
  educated workers
• Earnings rise over time at a decreasing rate
• The age-earnings profiles of different education
  cohorts diverge over time (they fan outwards)
• Earnings increase faster for more educated workers

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Age-Earnings Profiles
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Age-Earnings Profiles
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On-The-Job Training

• Most workers augment their human capital stock
  through on-the-job training (OJT) after
  completing education investments
• Two types of OJT
• General training that is useful at all firms
  once it is acquired
• Specific training that is useful only at the
  firm where it is acquired

36
The Acquisition of Human Capital Over the Life
Cycle
The marginal revenue of an efficiency unit of
human capital declines as the worker ages (so
that MR20, the marginal revenue of a unit
acquired at age 20, lies above MR30). At each
age, the worker equates the marginal revenue with
the marginal cost, so that more units are
acquired when the worker is younger.
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The Discrimination Coefficient ( Becker)

• Taste discrimination an economic concept that
  essentially translates the notion of racial
  prejudice
• Even though it costs wb dollars to hire one
  person-hour of black labor, the employer will act
  as if it costs wb(1d) dollars, where d is
  positive and called the discrimination
  coefficient
• Racial prejudice causes employers to blindly
  perceive the costs of hiring blacks as higher
  than their true costs

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Employer Discrimination

• If blacks and whites are perfect substitutes,
  employers have a segregated work force (an
  implication of the Becker model)
• Discrimination does not pay
• Employers hire the wrong color worker and/or they
  hire the wrong number of workers

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The Employment Decision of a Firm That Does Not
Discriminate
If the market-determined black wage is less than
the white wage, a firm that does not discriminate
will hire only blacks. It hires black workers up
to the point where the black wage equals the
value of marginal product of labor, or EB.
40
The Employment Decision of a Prejudiced Firm
Firms that discriminate can be either white firms
(if the discrimination coefficient is very high)
or black firms (if the discrimination coefficient
is relatively low). A white firm hires white
workers up to the point where the white wage
equals the value of marginal product. A black
firm hires black workers up to the point where
the utility-adjusted black wage equals the value
of marginal product. Firms that discriminate
hire fewer workers than firms that do not
discriminate.
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The Employment Decision of a Prejudiced Firm
Firms that discriminate can be either white firms
(if the discrimination coefficient is very high)
or black firms (if the discrimination coefficient
is relatively low). A white firm hires white
workers up to the point where the white wage
equals the value of marginal product. A black
firm hires black workers up to the point where
the utility-adjusted black wage equals the value
of marginal product. Firms that discriminate
hire fewer workers than firms that do not
discriminate.
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Determination of Black/White Wage Ratio in the
Labour Market
If the black-white wage ratio is very high, no
firm in the labor market will want to hire
blacks. As the black-white wage ratio falls,
more and more firms are compensated for their
disutility and the demand for black workers
rises. The equilibrium black-white wage ratio is
given by the intersection of supply and demand,
and equals (wB/wW). If some firms prefer to hire
blacks, they would be willing to hire blacks even
if the black-white wage ratio exceeds 1, shifting
the demand curve up to D?. If the supply of
blacks is sufficiently small, it is then possible
for the black-white wage ratio to exceed 1.
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Some fun studies.

• Researchers have found discrimination on all
  kinds of counts (age, race, gender, religion.
  even beauty!)
• Hammermesh and
• Biddle found that beauty
• pays off a lot in terms of
• both getting a job and
• getting a higher pay
• Question why do women tend to get lower pay than
  men?

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Unions in the labour market
Wage
With no union, the industry faces a horizontal
labour supply curve at the wage W0.
W0
The differential is larger for any given
reduction in industry employment, the more
inelastic is industry labour demand
Employment