LABOR ECONOMICS INTRODUCTION Summer 2006 Julien Prat

Why study Labor Economics? One may easily argue that labor markets crucially determine macroeconomic outcomes: two thirds  Labor income are quite stable across developed countries and account for about two thirds of national income.  The vast majority of households draw most of their incomes from wage payments.  Differences in job creation between the US and Europe explain a significant share of the differences in output growth.

Source: Bentolila and Saint-Paul, Explaining Movements in the Labor Share, 2003.

Decreasing Labor Shares

Fluctuating Labor Shares

Growth Accounting Source: Pissarides and Vallanti, The Impact of TFP Growth on Steady- State Unemployment, 2005.

Why Labor Economics as a specific field? The persistence of unemployment is at odds with the market-clearing equilibrium condition commonly assumed in economics. It points to the need for a specific framework as it is obvious that labor differs from other input factors in many respects.

Frictions: an important specificity of labor markets coexist Unemployment cannot be reduced to an “excess supply of labor” since unfilled vacancies and searching workers coexist. To explain this phenomenon economists refer to frictions:  Due to the high degree of heterogeneity and differentiation of workers and jobs, matching is time and resources consuming for both job seekers and firms.  Screening is necessary due to the prevalence of informational asymmetries between employers and employees (employers do not observe all the characteristics of workers and vice-versa).  Due to coordination failures some open vacancies may end up with more than one applicant and some with none.  Workers face important mobility costs which hinder the reallocation process across sub-markets.

Other important specificities of labor markets motivate As opposed to machines, efficient work is not automatically extracted from workers. This raises the question of how to motivate workers. bargaining The repartition of the revenues occurs through a bargaining process between employees and employers. legislations Given their obvious social implications, legislations in the labor markets are numerous. As a result the labor markets are very different from “Walrasian” markets. …

Plan of the course PART I General Frameworks Competitive Model Search-Matching Model and Equilibrium Unemployment PART II Other Issues Minimum Wage The Motivation of Workers and Efficiency Wages Bargaining Theory and the Hold-up problem Collective Bargaining and Unions On-the-job Search and Wage Dispersion

Competitive Model Competitive model:  Derivation of Supply and Demand: Supply: Substitution and Income Effects. Demand: Complementarity/Substitutability between Labor and Capital.  Limits of the competitive model: Persistence of Unemployment. Counterfactual predictions about the business- cycle fluctuations of Employment and Wages.

Search and Matching Models Search models capture the notion of frictional unemployment. Because it is resources consuming for workers and firms to find a job, unemployment naturally arises. The search-matching model extends the search mechanism to macro dimension.

US Average Monthly Labor Flows (Source: Blanchard, Macroeconomics).

Model of Efficiency Wages. The model of Shapiro and Stiglitz starts from the observation that wages must be high enough to motivate workers:  It generates an equilibrium rate of unemployment.  It delivers plausible predictions about the business-cycle fluctuations of Employment and Wages.

Bargaining Models Analyze the process through which revenues are allocated between workers and firms:  Theoretical foundation of the bargaining game by Nash and Rubinstein.  Investment specificity and the hold-up problem. Bargaining between unions and firms:  Union Model of McDonald and Solow.  We will see that this model also delivers plausible predictions about the business-cycle fluctuations of Employment and Wages.

On-the-job search While working, employees can search for alternative employment opportunities. This option induces employers to compete by using their monopsonic power in order to attract workers. We will see that employers-competition may explain why similar workers employed in similar jobs receive different wages.