Labor EconomicsClassic and New

Gregory W. Stutes

Why should I take Labor Econ?

• Most of us will spend 30-40 years of our life working for an income.

• Labor markets help determine our– Wealth– Goods that we can afford– Who we associate with– Vacations– Which schools we will attend– Maybe, even who we will marry

Labor On 2 Levels• Traditional Labor Economics

–We will explore how labor markets work

–As in all of economics, this will be model building with a purpose.• Many of the issues in the debate over

social policy concern the labor market experiences of particular groups.

Questions• Why did the labor force participation of

women rise throughout the past century?

• What is the impact of immigration on the wages and employment opportunities of native-born workers?

• Do minimum wages increase the unemployment rate of less-skilled workers?

Questions

• Do wage and tax subsidies encourage firms to increase their employment?

• What is the impact of occupational safety and health regulation on employment and earnings?

Questions

• Are government subsidies of investment in human capital an effective way to improve the economic well-being of disadvantaged workers?

• Why did inequality rise much more rapidly in the US in the 1980s than other industrialized countries?

Questions

• What is the impact of affirmative action on the earnings of women and minorities and on the number of women and minorities that firms hire?

• What is the economic impact of unions on both their membership and the rest of the economy?

New Labor Economics

• A new part of labors economics is personnel economics– In the past there was no systematic discipline

which to base human resource questions– Always regarded as too soft– Today we have models that can provide detailed

and unambiguous answers

New Labor Economics Questions

• Are high skilled people better worked at a particular job?

• Are highly skilled people worth the additional salary cost?

• How skilled is highly skilled?

Personnel Questions• Which levels of skill should be considered for a

particular job?

• How should skill be defined? Is formal education the key or should we use some other criterion?

• What are the trade-offs between quantity and quality?

Questions

• Are two unskilled workers more or less productive that one skilled worker?

• Do supply conditions matter? Is worker availability an issue?

• How many workers should be hired?

Introduction• WORKERS

– Economists model the worker as an individual who wants to maximize well-being subject to the constraints of time and income.

• This can help us with– Whether to work– How many hours to work– Which skills to acquire– When to quit– Which occupation– Join a union– How much effort to allocate

Introduction

• Firms– Economists model firms as either trying to

maximize profit subject to a production function or minimize costs subject to capital and labor.

• This can help us with– How many and which types of workers should we hire– Length of work week– How much capital to employ– Safe working conditions

Introduction

• Government– The government has its own classes with

Government and Business and Public Economics• We will still need a government to help with

– Tax earnings– Training– Payroll tax– Affirmative action– Illegal labor– Immigration

Introduction

• Methodology– Scientific Method

• Observe• Question• Hypothesize• Test—With a model

– All models have assumptions

– Model—A simplified or idealized description of a particular system, situation, or process.

What makes a good model?

• Clearly and simply explains a principle without extraneous detail

• In economics we generally use math (graphs)

• Equations linking complex factors to study the effects of change

Models• The realities of most situations of interest are

too complicated to truly understand them.

• Take oil as an example– Energy, plastic, asphalt, fertilizer, even shampoo.– To fully understand the crude oil market we

merely need to understand the behavior of all individuals that may use crude oil in some form.

• About 6.5 billion people

Remember the Beginning

• Incentives• Opportunity Costs• Benefits• Looking at the Margin• Trade makes people better off

How is this different from 202/204

• Thinking Like an EconomistEconomics trains you to. . . .

Think in terms of alternatives. Evaluate the cost of individuals and social choices. Examine and understand how certain events and

issues are related.

Positive vs. Normative

• Basics– Role of the labor market is to facilitate voluntary,

mutually beneficial transactions (if all those take place Pareto efficiency)

– Positive Economics is concerned with description and explanation of economic phenomena.

– Normative Economics is concerned with giving advice to practical problems and describing what ought to be.

• Is there truly a distinction?

Efficiency v. Equity

– Efficiency means society gets the most that it can from its scarce resources.

– Equity means the benefits of those resources are distributed fairly among the members of society.

Market Failures• Labor market facilitates voluntary, mutually beneficial

transactions. When does the market fail?– Ignorance: smoker in asbestos plant; don’t know of job

opening– Transaction barriers: law restricting women to < 40 hours

law requiring a 50% OT premium simple cost as a barrier to moving

– Price distortions: taxes can create “incorrect” prices

– Missing market: impossible or not customary to transact (e.g., living in the apt. below a really bad

band)

• Solution is often Government Intervention

Government Intervention• Public goods

– Some union workers are worried about noise from machinery– A sawmill factory wants to finance the research & sell its findings– Problem?

• Capital market imperfections– Students/workers are worried about getting loans for college/job

training or some workers would like to move to new city– Government could make loans to help strengthen the economy

• Markets are missing– Resident is worried about the band noise from upstairs– Government could intervene and pass law on noise levels– Concerns?

Types of Models

• Descriptive– Like our Circular Flow

• Analytical– Assumptions or Axioms– Model—mathematical or logic– Conclusions deduced from the model

– We test these and if they work we use them to describe the real world

Big Problems

• The Assumptions– Too many/Too Few– Are they correct

• Math– Can you really model the world with math

A new look at S&D• Market Supply for a particular industry

• W is an endogenous variable• N and are exogenous variable

– As always, we do this step by step.– Comparative Statics

• Positive effect from wage, W• Negative effect from alternative wages, • Positive effect from population size, N

A new look at S&D

• Demand– Derived Demand

• We do not “want” labor. We want the revenue from selling the products made by the worker.

• Therefore, demand for workers is dependent on the demand for the product itself—Q

• We still need to pay the worker—W• We also need capital—R

Endogenous vs. Exogenous

• The wages and both labor demand and labor supply are determined within the model

• They are endogenous

• The demand for the product itself and the price of capital are outside the model

• They are exogenous

Comparative Statics• All else equal, an increase in the

– Wage, W, lowers the demand for labor

– Demand for the product, Q, increases the demand for labor

– The rental price of capital, R, may increase or decrease the demand for labor

• Gross substitutes• Gross compliments

Change in wages has more than meets the eye

• An increase in the wage causes labor to be more expensive relative to capital.

• Producers have the incentive to use more machines and fewer workers. (Labor-saving machines)

• This is a SUBSTITUTION EFFECT

More than meets the eye• An increase the wage increases the cost of

producing the good

• Good back to 202—What happens when an input price goes up?

• The quantity demand will decrease and we will need fewer workers

• This is a SCALE EFFECT

Substitution and Scale

• Now that we have these two effects we can update the price of capital

• As the price of capital increases, the substitution effects states that we will buy less capital and MORE labor

• As the price of capital increases, the scale effect says we will reduce production and we will buy LESS labor

Substitutes or Compliments

• If the scale effect dominates, we will buy less labor and labor and capital are gross compliments (They move together)

• If the substitution effects dominates, we will buy more labor and labor and capital are gross substitutes (The do not move together)

Labor Market Equilibrium• The wage rate adjusts so that

• Both workers’ and employers’ plans are consistent• Adam Smith

• Surplus and Shortage

Pandemic

• The black death and the rise of the renaissance

Neoclassical Economics• Methodological Individualism

– Human social behavior can be explained by understanding the individual

– Usually works in micro, but we have trouble applying it to macro

• Rational Choice– Individuals maximize utility/profit subject to some

constraints– While not everyone solves max problems, we argue

that people behave as though the solve the problem– People may not be as rational as we assume– Marginal

More Neoclassical

• Equilibrium– A system is in equilibrium if the opposing forces

that act on it are in balance– Your behavior affects my behavior

– We probably will not look at general equilibrium. You will use it in inter macro and if time permits at the end of inter micro

More Neoclassical• Pareto Efficiency

– This is our best attempt to eliminate the normative impact of what is “best”

– And we have a more refined definition than the “getting the most from our scarce resources” of 202

– An allocation is PE if there is no other feasible allocation that can increase the well-being of at least one individual without hurting the well-being of everyone else

Problems With Neoclassical

• Neoclassical is very tractable and generally provides useable results

• It is, however, just a model that has limitations– It does not provide insights into the internal

workings of either the family or the firm

New Institutional Economics

• Gary Becker and the family• Oliver Williamson and the firm

• NIE explains the institutions in terms of the actions and goals of the individuals who participate in them

• NIE uses bounded of limited rationality– We have limited ability to calculate and limited ability

to see all of the possibilities

The US Labor Market

Where are we?

• Nominal Gross Domestic Product 2011– 15.66 Trillion

• Number of Workers– 142.3 Million

• Median Household Income– About $50,000

U.S. “Economy at a Glance”• Current state of U.S. labor market is …

http://www.bls.gov/eag/eag.us.htm

• How does North Dakota and Minnesota stack up?– North Dakota’s Economy at a Glance

• http://www.bls.gov/eag/eag.nd.htm– Minnesota’s Economy at a Glance

• http://www.bls.gov/eag/eag.mn.htm

• Industry at a Glance• Distribution of employment• http://www.bls.gov/iag/iaghome.htm

Current Population Survey&

Definitions

• Current Population Survey (CPS)– Conducted by the Census for the Bureau of Labor

Statistics (BLS)– Survey of about 50,000 households– Spans 50 years

• Total Civilian Noninstitutional population (TP)– Members of the US population who are at least 16

and not in prison or a mental institution – Sometimes called working-age population

TP = LF + Not in LF

• And LF = E + U– Employment—persons 16 years and over in the civilian

noninstitutional population, who during the reference week• Did any work (at least one hour) as paid employees, worked in

their own business, profession, or on their own farm, or worked 15 hours or more as unpaid workers in an enterprise operated by a member of the family, and,

• All those who were not working but who had jobs or businesses from which they were temporarily absent because of vacation, illness, bad weather, child care problems, maternity or paternity leave, labor-management dispute, job training, or other family or personal reasons, whether they were paid for the time off or were seeking other jobs.

TP = LF + not in LF

• LF = E + U– Unemployed

• Persons 16 years and over who had no employment during their reference week, were available for work, except for temporary illness and had made specific efforts to find employment sometime during the 4-week period ending with the reference week. Persons who were waiting to be recalled to a job which they had been laid off need not have been looking for work to be classified as unemployed.

Not in the Labor Force

• Not in the Labor Force– A person who is part of the working population, but

is neither unemployed nor employed.

– Discouraged Workers• Persons not in the labor force who want and are available

for a job, but are currently not looking for employment because they believe no jobs are available.

– Marginally Attached Workers• Same, but no comment on what they believe

Strange Results

• Can an increase in economic activity increase the unemployment rate?

• YES

The US Labor MarketApril 2009

(thousands)May 2012

(thousands)%

ChangeTotal working population, TP

235,272 242,966 3.27%

Labor Force 154,731 155,007 .18%

Employment 141,007 142,287 .91%

Unemployment 13,724 12,720 -7.32%

Not in Labor Force

80,541 87,958 9.21%

Discouraged Workers

740 830 12.16%

Marginally Attached

2,100 2,423 15.38%

Definitions

• Labor Force Participation Rate LFPR = LF / TP

• Employment Rate ER = E / LF• Unemployment Rate UR = U / LF• Employment-to-population ratio EP = E / TP

E m plo yed U n e m p lo yed

L a bo r Fo rce N o t in th e L ab o r Fo rce

P o pu la tion(> = 1 6 ye a rs o ld )

The US Labor Market II

Variable April 2009 May 2012

Labor Force Participation Rate, LFPR 65.8% 63.8%

Employment-to-population ratio, EP 59.9% 58.6%

Unemployment Rate, UR 8.9% 8.2%

Labor Force Participation

• Labor force participation is on the rise overall• LFP rates for men are falling, while those

for women are rising dramatically.• Avg hours worked per week have also fallen substantially.

0102030405060708090

100

1950 1960 1970 1980 1997

TotalMenWomen

Labor Force Participation Rates by Gender, 1950–2004 and today

• And today– 2012 63.8% 70.3% (73.2%) 57.8% (59.4)

Unemployment Rate

• Unemployment rate = U/LF• If u-rate 5%, we call the overall labor market “tight” – hard for

employers to fill jobs ; if u-rate 7% is “loose” • Loose during Great Depression; Tight during WWII• Trends: average u-rate has (non-war, non-GD years) the variance has • Conclusion: Labor market is more stable now, but at higher level of unemp

0

5

10

15

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25

30

1900

1910

1920

1930

1940

1950

1960

1970

1980

1990

U-rate

Distribution of Employment

• Major patterns?• Agricultural employment has declined dramatically,

while services has expanded• Size of government has nearly quadrupled• Workers and firms adapted, and must continue to adapt (demographic) • These are “snapshots” and miss job transitions that occur between time

points. 1972-86, 11% of manuf jobs destroyed annually, 9% created 2% net loss

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20

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40

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% o

f Em

ploy

men

t Agriculture

Manufacturing

Services (non-govt)Govt services

Industries and Occupations• Agricultural employment has decreased drastically while

employment in services has gone up• Goods producing jobs kept pace with with increased

employment till 1970 and started declining after that• Largest increase in the service sector• Large increase in government sector• Movement from “primary” via “secondary” to “tertiary”

sectors• Arrival of the Post-industrial state

Unemployment and Long-Term Unemployment, Selected European and North American Countries,

2003

Relationship between Wages, Earnings, Compensation, and Income

Earnings and Compensation• Total Compensation—Sum of all types of

employee compensation: wages and salaries, non wage cash payments, and fringe benefits– Benefits—health insurance, paid vacation,

overtime pay, and paid sick leave• Gross Total Earnings—Earnings for a period of

time (like a year) before any deductions (like taxes).

• Straight-time gross earnings—Earnings net of payroll deductions, but exclude overtime and other monetary payment

Earnings and Income• Straight-time Wage rate = price of labor per hour

– Money you’d lose per hour if you had an unauthorized absence. So a sick day becomes an “employee benefit”.

– e.g., if paid $100 total comp. for 25 hours: 20 spent working, 5 vacation– then we’ll call the wage $4/hour. Not $5/hour. $80 wages, $20

benefit.• Structure of Compensation

– Wage rate * hours worked = Earnings– Earnings + Employee benefits = Total Compensation– 70% of Total Compensation is from earnings, on average– Total Compensation + Unearned income = Income

• Nominal vs. Real wages– Nominal wage = wage in current dollars– Real wage = nominal wage / some measure of prices

• it is used to indicate a level of purchasing power, so we can compare across time

• earn $100/day and book costs $50, real wage = 2 books per day

Real wages of U.S. workers(non-supervisory workers in private sector)

• What happened to real wages from 1980 to 2003?• Nominal & Real wages 1980 1990 2003 2012

– Avg hourly earnings $6.80 $10.19 $15.38 $20.12– CPI (base = 1982-84 = 100) 82.4 130.7 184.0

224.6– Avg hourly earnings $8.30 $7.80 $8.36 $10.24

in 1982-84 dollars– Avg hourly earnings $15.27 $14.35 $15.38 $16.48

in 2003 dollars• Nominal wages rising, but prices of good/services also rising,

need to deflate by CPI (fixed bundle of food, housing, clothing, etc.)• Set cost of our “bundle” in the base period (1982-1984) = 100.

$1 in 2003 appears to buy less than *one-third* what a 1980 $1 did.• Conclusion: Real wages were stagnant from 1980 to 2003.• Problems with using a fixed bundle?

The Earnings of Labor

• Nominal and Real Wages• Nominal wage is what workers get paid in

current dollars• Real wages are a better measure since they

indicate the purchasing power of those nominal wages

• Real Wage = (Nominal Wage/Price Index)*100

Consumer Price Index

• Tracks the cost of a fixed basket of goods

• Problems with CPI– Substitution bias– Introduction of new goods– Unmeasured quality changes

Dollar Figures from Different Years

• Do the following to convert dollar values from year T into today’s dollars:

Dollar Figures from Different Times

• Do the following to convert (inflate) Babe Ruth’s wages in 1931 to dollars in 2005:

Salary Salary Price level in 2005Price level in 19312005 1931=

=

=

$80,.

$

000 195152

1,026,316