Chapter 1- Introduction to Labor Economics 1-1 An Economic Study of the Labor Market 1-2 Actors in the Labor Market 1-3 Why do we need a theory? Give a brief overview of the presentation. Describe the major focus of the presentation and why it is important. Introduce each of the major topics. To provide a road map for the audience, you can repeat this Overview slide throughout the presentation, highlighting the particular topic you will discuss next.

Why study Labor Economics? Human resources allocate substantial time and energy to labor markets. Labor economics  How labor markets work. Why care about labour markets? Personal Involvement Social Policy Issues (Labor market experience of subgroups, Worker-Firm relationship, etc.)

Policy issues examined Why did LFPR of women  tremendously throughout the century? Impact of income assistance programs of government on incentive to work Impact of immigration on wages & employment of the opportunities of native born workers Are government subsidies of investments on human capital an effective way to improve economic well-being of disadvantaged workers?

1-1 An Economic Story of the Labor Market Mainly interested in the story of the labor markets: Actors and interaction between these actors b) Labour market outcomes Main approach followed: Present factors & observed outcomes Develop theories that provide a framework to explain the stylized facts & outcomes Verify predictive power of theories & modify the theoretical model accordingly

1-2 The Actors in the Labor Market Participants are assigned motives: Workers look for the “best” job. Firms look for profits. Government uses regulation to achieve goals of public policy. Minimum wages Occupational safety

A) Workers The most important actor; without workers, there is no “labor”. Desire to maximize utility (i.e., to optimize by selecting the best option from available choices  Work vs Leisure). Adding up individuals’ decisions  Labour Supply in the economy, and Qty & Qlty of skills available to employers Supplies more time and effort for higher payoffs, causing an upward sloping labor supply curve: w  qLs

B) Firms Decide who to hire and fire. Motivated to maximize profits (π). Demand for input(s): Derived Demand Objective: max π = TR – TC = p*q – TC(q) where q=output Relationship between price of labor and the # of workers a firm is willing to hire generates the labor demand curve.

C) Government Provides ground rules that guide exchanges made in labor markets: i.e: Minimum wage, occupational safety regulations, mandatory retirement, etc. Imposes taxes, regulations. Interaction of A, B and C determines: Distribution of occupations, skills, wages in the economy Labor turnover, structural employment

Supply and Demand in the Engineering Labor Market Caution: Ls slope Equilibrium Disequilibrium Transition to eq. Involuntary emp. Government Taxes Min wage Immigration laws Equilibrium 50,000 40,000 30,000 20,000 10,000 Labor Supply Curve Labor Demand Earnings ($) Employment

Trans-Alaskan Pipeline D0 D1 S0 Earnings ($) Employment w1 w0 E1 E0 Shock: Discovery of oil in Prudhoe Bay, Alaska Oil reserves:10 bill. Barrels Discovery in a remote & frigid location of Alaska Solution: Build a 48-inch pipeline across 789 mile stretch from Northern Alaska to southern port

Trans-Alaskan Pipeline Construction: Started in 1974, continued until 1977 Employed 25,000 workers Upon completion, employment reduced to a skeleton maintenance crew Types of workers: Skilled (engineers) Unskilled (construction) D0 D1 S0 Earnings ($) Employment w1 w0 E1 E0 Alaskan residents  Skilled workers (Scarce), Unskilled workers (Abundant) Question: Construction of the pipeline  Impact on the labor market for skilled workers

Trans-Alaskan Pipeline D0 D1 S0 Earnings ($) Employment w1 w0 E1 E0 Neo-classical theory predicts… An increase in wages An increase in employment Temporary effects since demand is expected to return to initial level in the LR

Wages and Employment in the Alaskan Labor Market, 1968-1984 Why did we observe these outcomes? Upward sloping Ls (region and outside) Implicit willingness to work in the market Homework: How would the implications of the construction of the pipeline differ for the skilled and unskilled workers?

1-3 Why Do We Need a Theory? In the previous section: Use theory to develop a framework and analyze the impact of an event (i.e. construction of a pipeline) Theory  Model  Predictions of Outcomes Verification  Calibration Explain and understand how labor markets work. Focus on the essential variables while leaving out other, less crucial, factors: Simple vs Complex  Other factors

Positive vs. Normative Economics Positive economics Addresses the facts Focus on “what is” Questions answered with the tools of economists Ex: What is the impact of pipeline (if built) on wages? Ex2: What is the impact of minimum wages? Normative economics Addresses values Focus on “what should be” Requires judgments Ex: Should we build the pipeline? Should there be min wage?

Positive vs. Normative Economics Real life problems: Interaction of positive and normative Debate: Immigration of 10 million workers Reduce the income of native born workers by $ 25 billion Increase economic surplus of firms by $40 billion Positive: What is the impact of admitting immigrant workers? $15 billion additional economic surplus  net gain Normative: Should we admit 10 million immigrant workers? Admitting immigrant workers results in changes in the distribution of income among subgroups: Native Born (Lose), Immigrants & Firms (Gain) Answer: Whether we should admit them or not depends on the national interest: Who matters more? (Social Preferences)

Positive vs. Normative Economics Government’s role Use public policy to move away from normative towards positive questions Taxation: Redistribution of income/surplus Possible to make everyone better off!  Pareto improvement

Summary Labor economics studies how labor markets work. Models in labor economics typically contain three actors: workers, firms, and governments. A good theory should have realistic assumptions and can be tested with real-world data. The tools of economics are helpful in answering positive questions.

Appendix: Regression Analysis Log Wage Slope = b Change in log wage Years of Schooling Change in schooling a

Scatter Diagram: Wages and Schooling by Occupation, 2001

Choosing Among Lines Summarizing Trends in the Data

The Best-Fit Regression Line

Multiple Regression Extending regression analysis to include multiple independent variables Each estimated coefficient shows the impact of a particular variable on the dependent variable, other things constant Standard errors of the regression coefficients are used to evaluate significance of the relations between each particular variable and the dependent variable