Transcript Chapter 2

Chapter 2
Overview of the Labor
Market
The labor market allocates
workers to jobs and coordinates
employment decisions.
 Buyers
- FIRMS
 Sellers - WORKERS
Labor markets can be defined in
various ways:
 National
labor market
 Regional labor market
 Local labor market
LABOR FORCE
 all
individuals over 16 years of age
who are either employed, actively
seeking work, or expecting recall
from a layoff
UNEMPLOYED
 those
in the Labor Force who are not
employed.
Distribution of the Population
Labor Force Breakdown
Population
In Labor Force
Employed
Unemployed
Not In Labor Force
Retired
InSchool
At Home
U.S. Unemployment Rates
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.

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]
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
Labor Force Participation Rates
of Women:
YEAR
1900
1930
1950
1970
1988
SINGLE DIV/WID
45.9% 32.5%
55.2
34.4
53.6
35.5
56.8
40.3
67.7
46.2
MARRIED
5.6%
11.7
21.6
40.5
56.7
Labor Force Participation Rates of
Older Men And Older Women Over
Time
1950
Age
50-54
55-59
60-64
65-69
70-74
75-79
80-84
85+
Men
90.6
86.7
79.4
59.8
38.7
24.2
13.2
6.9
1990
Women
30.8
25.9
20.5
12.8
6.6
3.5
1.7
1.2
Men
88.3
78.7
55.1
27.9
16.7
10.6
6.2
3.4
Women
67.5
55.4
36.1
16.9
8.3
4.5
2.2
1.0
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
What about wages, have they
increased over time?
 REAL
vs. NOMINAL
 current debate over the CPI
 converting dollars from one time
period to another
 CPIA 
Value of X in Year A = 
 Value of X in Year B
 CPIB 
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.
THE LABOR MARKET -  Firms
combine capital and labor to
produce goods or services to sell in
the market place.
The amount of labor a firm hires
depends upon:
 Product
demand
 The price of capital
 The price of labor
 Technology
What happens to quantity
demanded when wages
increase?
 Let’s
do a different example first
 Let’s produce “Gin and Tonics”
Gin and Tonic - To Make 1 Drink:
1 shot of gin
 2 shots of tonic
 1 scoop of crushed
ice

Gin and Tonic
For 1 Drink
1 shot of gin
2 shots of tonic
1 scoop of ice
For 100 Drinks
100 shots of gin
200 shots of tonic
100 scoops of ice
Suppose the price of gin increases
from $20/gallon to $40/gallon:
 If
you sold these drinks, what
would you do?
Raise the price and sell
fewer drinks?
For 90 Drinks
• 90 shots of gin
• 180 shots of tonic
• 90 scoops of ice
Water down your drinks
by using more ice and
tonic?
New Recipe
For 1 Drink
1/2 shot of gin
2 1/8 shots of tonic
1 3/8 scoops ice
For 100 drinks
50 shots of gin
212.5 shots tonic
137.5 scoops ice
For 90 Drinks (if you sell less):
45 shots of gin
 191.25 shots of tonic
 123.75 scoops of ice

Net result:
BEFORE:
100 drinks
100 shots of gin
200 shots of tonic
100 scoops ice
AFTER:
90 drinks
_
45 shots of gin
191.25 shots tonic
123.75 scoops ice
GIN and TONIC
Combos change as
price of gin increases
How does this relate to
the labor market?
What happens if the price
of labor (the wage)
changes?
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.
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
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
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
Graphically:
Price
35
Market for Gin
30
25
20
15
10
D0
5
0
0
10 20
30
40
45 60
70
80 90 100 110 120 130 140
Gin
Price
35
30
25
20
15
10
D0
5
0
0
10
20 30
40
45
60
70 80
90 100 110 120 130 140
Gin
Price
16
14
Market for Tonic
12
10
8
6
4
D0
2
0
145 151 157 163 169 176 182 188 194 200 206 212 218 225 231
Tonic
Price
16
14
Substitution Effect on
Market for Tonic
12
10
8
6
4
D1
2
D0
0
145 151 157 163 169 176 182 188 194 200 206 212 218 225 231
Tonic
Price
16
14
Market for Tonic
12
10
8
6
4
D0
2
0
145 151 157 163 169 176 182 188 194 200 206 212 218 225 231
Tonic
Price
16
14
Scale effect on
market for tonic
12
10
8
6
4
2
D2
D0
0
145 151 157 163 169 176 182 188 194 200 206 212 218 225 231
Tonic
P 16
14
12
Substitution Effect
10
8
6
Scale effect
4
2
D1
D2
D0
0
145 151 157 163 169 176 182 188 194 200 206 212 218 225 231
Tonic
P 16
14
12
Because the scale effect
> substitution effect, the
demand for tonic falls
10
8
6
4
2
D4
D0
0
145 151 157 163 169 176 182 188 194 200 206 212 218 225 231
Tonic
Now, let’s look at the
market for labor:
The demand schedule
shows the relationship
between the wage and
the quantity of labor
demanded.
Labor Demand Schedule:
WAGE
$ 6
8
10
12
14
Q of Labor Demanded
240
210
180
150
120
We can use a graph to
represent the data from
the demand schedule:
Wage
24
22
Demand for labor
20
18
16
14
12
10
8
6
4
LD
2
0
0
30
60
90 120 150 180 210 240 270 300 330
Labor
Changes in the
Quantity of Labor
Demanded:
A change in the Quantity
D
of Labor Demanded (L )
is represented by a
movement along the
labor demand curve
Wage
24
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
22
20
18
16
14
A
12
10
8
B
6
4
L
D
0
2
0
0
30
60
90
120 150 180 210 240 270 300 330
Labor
Changes in the
demand for labor:
A change in demand is
represented by a shift
in the demand for labor
curve
W 16
14
Decrease in Demand
12
10
8
6
4
2
L
0
1
2
3
4
5
6
7
8
9
10
11
12
13
D
1
14
L
15
L
D
0
W 16
Increase in Demand
14
12
10
8
6
L
4
2
D
1
LD0
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
L
What can cause a
change in the demand
for labor?
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.
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
 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 firm’s
production function, technology, etc.
We can analyze the demand for
labor on three levels:
 from
the firm’s perspective
 from an industry’s perspective
 from the entire labor market’s
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.
We can also differentiate
between long-run and short-run
labor demand curves
 Keep
in mind that the ability of firm’s
and consumers to respond to price
changes may be limited in the shortrun
 The elasticity of demand will likely be
different between the long-run and
the short-run
LABOR SUPPLY
 Assuming
the workers have already
made their decision to work what
occupation will they choose and
which employer?
MARKET SUPPLY
Let’s 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
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
wage
LS0
Market Supply of Labor
11
10
9
8
7
6
5
4
3
2
1
0
0
50
100
150
200
Labor
Changes in the
Quantity of Labor
Supplied:
A change in the Quantity
S
of Labor Supplied (L ) is
represented by a
movement along the labor
supply curve.
wage
11
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).
S0
10
B
9
8
A
7
6
5
4
3
2
1
0
0
50
100
150
200
Labor
Changes in the supply
of labor:
wage
S0
Increase in Supply
11
10
S1
9
8
7
6
5
4
3
2
1
0
0
50
100
150
200
Labor
wage
S0
Decrease in Supply
13
12
S2
11
10
9
8
7
6
5
4
3
2
1
0
0
50
100
150
200
Labor
What can cause a
change in the supply of
labor?
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
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
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
A change in the nonpecuniary 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?
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
The Supply of Labor to
a Firm
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
 let’s suppose that the market wage is
$6
The supply of labor that the firm sees is
horizontal at the market wage (perfectly
elastic).
wage
8
6
S
L
firm
4
2
0
0
10
20
30
40
labor
Back to the labor
market:
Equilibrium occurs at the
D
S
wage where L = L
S
W 16
14
12
10
8
6
4
D
2
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
L
S
W 16
14
12
10
8
6
4
D
2
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
L
S
W 16
14
12
10
8
6
4
D
2
0
1
2
3
4
5
6
7
8
9
10 11
12 13 14 15
L
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?
w
S
D2
D1
L
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
How does the minimum
wage affect the labor
market?
The minimum wage is a price floor.
w
S
wm
minimum wage
w*
Ls > Ld so there is
a surplus of labor
D
Ld
L*
Ls
L
What would happen if the minimum
wage was set below the equilibrium
wage?
w
S
w*
minimum wage
wm
D
L*
L
How do unions affect
the labor market?
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
Let’s 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
Ld
Ls
L
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.
w
Su
S
wu
w*
D
L
Last topic: Economic
Rents
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*
w0
D
L
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
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
Economic rent is equal to the market wage
minus the worker’s RESERVATION WAGE (the
lowest wage he would accept to work).
w
S
w*
Economic rent
D
w0
L
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
w*
S
B
C
Economic rent
D
w0 A
L