Overview of the Labor Market

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Chapter 2

• Overview of the Labor Market

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The labor market allocates workers to jobs and
coordinates employment decisions.

• Buyers - FIRMS
• Sellers - WORKERS

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Labor markets can be defined in various ways

• National labor market
• Regional labor market
• Local labor market

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LABOR FORCE

• all individuals over 16 years of age who are
  either employed, actively seeking work, or
  expecting recall from a layoff

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UNEMPLOYED

• those in the Labor Force who are not employed.

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Distribution of the Population
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U.S. Unemployment Rates
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FLOWS BETWEEN LABOR MARKET STATES (Fig. 2.1)

• employed become unemployed by quitting
  (voluntary) or being laid off (involuntary)
• unemployed become employed by becoming New Hires
  or Recalled Workers
• Exits from the labor force occur because of
  retirement, family reasons, or becoming
  discouraged about finding employment
• Those who enter the labor force are referred to
  as New entrants or Re-entrants.

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Labor Force Participation Rates

• Labor force participation rates (LFPRs) represent
  the percentage of the population that are in the
  labor force
• LFPR labor force / population

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Labor Force Participation Rates

• YEAR TOTAL MALE FEMALE
• 1950 59.9 86.8 33.9
• 1960 60.2 84.0 37.8
• 1970 61.3 80.6 43.4
• 1980 64.2 77.9 51.6
• 1990 66.5 76.4 57.5
• 2000 67.2 74.7 60.2
• 2005 (Dec) 66.0 73.2 59.3

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Labor Force Participation Rates of Women

• YEAR SINGLE DIV/WID MARRIED
• 1900 45.9 32.5 5.6
• 1930 55.2 34.4 11.7
• 1950 53.6 35.5 21.6
• 1970 56.8 40.3 40.5
• 1988 67.7 46.2 56.7

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Labor Force Participation Rates of Older Men And
Older Women Over Time

• 1950 1990
• Age Men Women Men Women
• 50-54 90.6 30.8 88.3 67.5
• 55-59 86.7 25.9 78.7 55.4
• 60-64 79.4 20.5 55.1 36.1
• 65-69 59.8 12.8 27.9 16.9
• 70-74 38.7 6.6 16.7 8.3
• 75-79 24.2 3.5 10.6 4.5
• 80-84 13.2 1.7 6.2 2.2
• 85 6.9 1.2 3.4 1.0

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The distribution of jobs has also changed in the
U.S.

• Jobs in service industries (both in government
  and the private sector) have expanded
• Agricultural jobs have disappeared
• Jobs in manufacturing have also fallen, but not
  by as much
• See Table in inside cover and Figure 2.3

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What about wages, have they increased over time?

• REAL vs. NOMINAL
• current debate over the CPI
• converting dollars from one time period to
  another

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The wage rate is the price of labor per working
hour

• Earnings Wage hours
• Total compensation earnings fringe benefits
• Income total compensation unearned income

• Note
• fringe benefits include vacation days, pensions,
  health insurance, etc.
• unearned income includes interest, dividends,
  government transfers, etc.

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THE LABOR MARKET - -

• Firms combine capital and labor to produce goods
  or services to sell in the market place.

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The amount of labor a firm hires depends upon

• Product demand
• The price of capital
• The price of labor
• Technology

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What happens to quantity demanded when wages
increase?

• Lets do a different example first
• Lets produce Gin and Tonics

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Gin and Tonic - To Make 1 Drink

• 1 shot of gin
• 2 shots of tonic
• 1 scoop of crushed ice

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Gin and Tonic

• For 1 Drink For 100 Drinks
• 1 shot of gin 100 shots of gin
• 2 shots of tonic 200 shots of tonic
• 1 scoop of ice 100 scoops of ice

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Suppose the price of gin increases from
20/gallon to 40/gallon

• If you sold these drinks, what would you do?

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Raise the price and sell fewer drinks?
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For 90 Drinks

• 90 shots of gin
• 180 shots of tonic
• 90 scoops of ice

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Water down your drinks by using more ice and
tonic?
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New Recipe

• For 1 Drink For 100 drinks
• 1/2 shot of gin 50 shots of gin
• 2 1/8 shots of tonic 212.5 shots tonic
• 1 3/8 scoops ice 137.5 scoops ice

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For 90 Drinks (if you sell less)

• 45 shots of gin
• 191.25 shots of tonic
• 123.75 scoops of ice

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Net result

• BEFORE AFTER
• 100 drinks 90 drinks _
• 100 shots of gin 45 shots of gin
• 200 shots of tonic 191.25 shots tonic
• 100 scoops ice 123.75 scoops ice

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GIN and TONIC Combos change as price of gin
increases
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How does this relate to the labor market?

• What happens if the price of labor (the wage)
  changes?

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Wages Rise

• higher cost to produce implies higher price of
  the output.
• consumers buy less.
• firms reduce output.
• Firms hire less labor.
• This is called the SCALE EFFECT.

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Wages Rise

• employers wish to cut costs by adopting new
  technology or using more of relatively cheaper
  inputs such as capital
• as a result, firm use less labor
• This is the SUBSTITUTION EFFECT

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SCALE EFFECT

• The effect on desired employment brought about by
  a change in the scale of production
• The change that would occur if factor proportions
  were held constant, but the level of output
  changed in response to changes in the price of
  the output

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SUBSTITUTION EFFECT

• The substitution of a relatively cheaper input
  for a relatively more expensive input
• Output is held constant, but factor proportions
  change in response to a change in relative factor
  prices

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Graphically
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Market for Gin
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Market for Tonic
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Substitution Effect on Market for Tonic
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Market for Tonic
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Scale effect on market for tonic
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Substitution Effect
Scale effect
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Because the scale effect gt substitution effect,
the demand for tonic falls
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Now, lets look at the market for labor
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The demand schedule shows the relationship
between the wage and the quantity of labor
demanded.
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Labor Demand Schedule

• WAGE
• 6
• 8
• 10
• 12
• 14

• Q of Labor Demanded
• 240
• 210
• 180
• 150
• 120

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We can use a graph to represent the data from the
demand schedule
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Demand for labor
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Changes in the Quantity of Labor Demanded
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A change in the Quantity of Labor Demanded (LD)
is represented by a movement along the labor
demand curve
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If the wage falls from 12 to 6, LD increases
from 150 to 240. We move ALONG the demand curve
(from A to B) and call this an increase in LD
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Changes in the demand for labor
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A change in demand is represented by a shift in
the demand for labor curve
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Decrease in Demand
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Increase in Demand
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What can cause a change in the demand for labor?
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A change in the demand for the output produced by
the labor

• Suppose that the demand for the product rises.
  What happens?
• Price of the good increases producers want to
  produce more need more labor to do so demand
  for labor increases
• Strictly a scale effect since relative prices of
  capital and labor do not change.

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A change in the price of capital

• Suppose that the price of capital falls. What
  will happen?
• First, the cost of production falls the firm
  will want to produce more output
• firm will want to hire more labor the demand for
  labor will increase
• this is called the scale effect

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• BUT the firm will want to substitute the
  relatively cheaper capital for labor.
• Thus, the firm will want to hire less labor
  there is a decrease in the demand for labor
• this is called the substitution effect

The ultimate outcome depends on which effect is
stronger. This, in turn, depends upon the firms
production function, technology, etc.
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We can analyze the demand for labor on three
levels

• from the firms perspective
• from an industrys perspective
• from the entire labor markets perspective

The shapes of the various demand curves will be
different, but all slope downward and all are
subject to both scale and substitution effects.
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We can also differentiate between long-run and
short-run labor demand curves

• Keep in mind that the ability of firms and
  consumers to respond to price changes may be
  limited in the short-run
• The elasticity of demand will likely be different
  between the long-run and the short-run

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LABOR SUPPLY

• Assuming the workers have already made their
  decision to work what occupation will they choose
  and which employer?

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MARKET SUPPLY

• Lets suppose we are analyzing the market for
  sales clerks
• the supply of sales clerks will depend on (among
  other things) the salaries or wages in
  occupations requiring a similar level of skills
• the relative wage (what the person could earn as
  a sales clerk or as a secretary, for example) is
  important

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MARKET SUPPLY

• Holding wages in other occupations constant, as
  the wage of sales clerks increases, the number of
  individual choosing this occupation would
  increase as well
• thus, the supply of labor to a particular market
  (occupation) is upward-sloping

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Market Supply of Labor
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Changes in the Quantity of Labor Supplied
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A change in the Quantity of Labor Supplied (LS)
is represented by a movement along the labor
supply curve.
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If the wage rises from 7 to 9, Ls rises from
100 to 150. This is a movement along the labor
supply curve (A to B).
B
A
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Changes in the supply of labor
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Increase in Supply
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Decrease in Supply
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What can cause a change in the supply of labor?
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A change in the wage of an alternative occupation

• Suppose that we again are looking at the market
  for sales clerks. What would happen if the wages
  paid to secretaries increases?
• the supply of sales clerks would decrease
• the quantity of secretaries supplied would
  increase

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A change in non-labor income

• Non-labor income would include interest,
  dividends, lottery prizes, and earnings of other
  family members
• Suppose that you win 1 million dollars from
  Publishers Clearinghouse? What will happen to
  your labor supply?
• there would be a decrease in labor supply

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A change in household productivity

• Suppose that Judy just gave birth to a beautiful
  baby girl. She enjoys taking care of her baby.
  What may happen to her labor supply?
• it may decrease

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A change in the non-pecuniary aspects of a job

• Non-pecuniary aspects of a job include any
  characteristics of a job which are not
  money-related such as working conditions, job
  flexibility, etc.
• Suppose that you are deciding between 2
  different jobs. All aspects between them are
  identical except that one requires you to be in
  the office from 8 to 5, Monday through Friday
  while the other allows you to complete your 40
  hours of work whenever you choose. Which job is
  more appealing?

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A change in tastes and preferences for work

• this can also be thought of as a change in tastes
  and preferences for leisure
• What happens as your leisure time becomes more
  valuable to you?
• the amount of labor you are willing to supply
  falls

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The Supply of Labor to a Firm
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Again, suppose that we are looking at the market
for sales clerks

• Suppose that you own a retail clothing store.
  What does the supply of sales clerks look like to
  your firm?
• If the labor market is competitive (lots of firms
  just like yours), you would have to pay the going
  market wage to attract workers
• lets suppose that the market wage is 6

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The supply of labor that the firm sees is
horizontal at the market wage (perfectly elastic).
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Back to the labor market
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Equilibrium occurs at the wage where LD LS
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Changes in equilibrium can occur if either the
demand or supply curve shifts

• What happens to the market wage if the demand for
  labor increases?

S
w
D2
D1
L
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You should be able to analyze the changes in the
equilibrium wage and quantity of labor hired for
each of the following (including why the changes
occur)

• an increase in the demand for labor
• a decrease in the demand for labor
• an increase in the supply of labor
• a decrease in the supply of labor
• any combination of shifts in both the supply of
  and demand for labor

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How does the minimum wage affect the labor market?
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The minimum wage is a price floor.
w
S
minimum wage
wm
w
Ls gt Ld so there is a surplus of labor
D
L
L
Ld
Ls
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What would happen if the minimum wage was set
below the equilibrium wage?
w
S
w
minimum wage
wm
D
L
L
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How do unions affect the labor market?
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Unions can affect the labor market in two ways

• raising the market wage and creating a contract
  which does not allow any workers to be paid any
  wage other than the union wage
• limiting the supply of workers to the market so
  that the supply of labor is perfectly inelastic

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Lets look at the first case. The wage gets
increased to wu and a surplus of labor is
created. The surplus of labor is equal to (Ls -
Ld).
w
S
wu
w
D
L
Ls
Ld
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Now, the second case. The supply curve gets
shifted to Su and the quantity of labor supplied
is fixed. The market wage gets increased to wu.
Su
w
S
wu
w
D
L
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Last topic Economic Rents
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The labor supply curve represents willingness to
work at various levels of the wage rate. Note
that, in order to entice anyone to work, the wage
rate must be above w0.
w
S
w
D
w0
L
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If the workers are part of a competitive labor
market, they will all receive the same wage (the
market wage) which is w.
w
S
w
D
w0
L
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Workers who were willing to work for less than w
will receive a benefit from participating as part
of the labor market. This is called economic
rent.
w
S
w
D
w0
L
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Economic rent is equal to the market wage minus
the workers RESERVATION WAGE (the lowest wage he
would accept to work).
w
S
w
Economic rent
D
w0
L
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For the market as a whole, economic rent will be
the triangle ABC (below the wage, above the
supply, up to the quantity of labor hired).
w
S
B
w
C
D
Economic rent
w0
A
L