Introduction to Labor Markets and Discrimination 321...Introduction to Labor Markets and Discrimination Spring 2010 Alicia Rosburg (ISU) Labor Markets and Discrimination Spring 2010

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


Outline

1 Labor Market BasicsLabor DemandLabor SupplyLabor Market EquilibriumBasic Model Issues

2 DiscriminationDefinitions

3 Deviation from Market EquilibriumFour CasesExamples


Labor Market Basics

Factors of Production

Labor is a factor of production

Factors of production are bought and sold in “factor markets” at “factorprices”


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


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


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



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



Graphical Depiction of Total and Marginal Product



Optimal Labor Demand

Profits maximized when marginal benefit equals marginal cost

Marginal benefit of labor: VMPL

Marginal cost of labor: wage (w)




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






Example

Handout 1: Derive the amount of labor that maximizes profits



Example



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



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


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



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)



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.



Time Allocation Budget Line



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



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



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



Labor Supply and Wage Increase to $10



Labor Supply Curves


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



Equilibrium: Supply = Demand

At w*, last worker paid the value of their leisure time, others paidmore than reservation wage

No unemployment at w*



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 (↓)



Curve Shifts and Equilibrium Effects

Demand shifts out → wage ↑ and labor ↑

Supply shifts out → wage ↓ and labor ↑



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(+)]



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



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


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


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


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


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




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




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



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



Circumstance can be unfair, but NOT discrimination unless it has a groupdimension

Undervaluing a group, NOT an individual

Examples?



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



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



Segregation

Segregation - separation of people on the basis of race

Discrimination can occur without segregation

Segregation can occur without discrimination



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


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


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



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



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



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



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



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



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


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?



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?



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?



Sells Representative

Handout 2 - Sales Representative Example



Readings for Next Lecture

Regression Analysis:

BFW Appendix 7A (pgs 250-255)


Documents

Introduction to Labor Markets and Discrimination 321...Introduction to Labor Markets and Discrimination Spring 2010 Alicia Rosburg (ISU) Labor Markets and Discrimination Spring 2010