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

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 YEARTOTALMALEFEMALE %86.8%33.9% (Dec)

Labor Force Participation Rates of Women: YEARSINGLE DIV/WIDMARRIED % 32.5%5.6%

Labor Force Participation Rates of Older Men And Older Women Over Time AgeMenWomenMenWomen

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

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 DrinkFor 100 Drinks 1 shot of gin 100 shots of gin 2 shots of tonic 200 shots of tonic 1 scoop of ice 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 90 shots of gin 180 shots of tonic180 shots of tonic 90 scoops of ice 90 scoops of ice

Water down your drinks by using more ice and tonic?

New Recipe For 1 Drink For 100 drinks 1/2 shot of gin 50 shots of gin 2 1/8 shots of tonic shots tonic 1 3/8 scoops ice scoops ice

For 90 Drinks (if you sell less):  45 shots of gin  shots of tonic  scoops of ice

Net result: BEFORE:AFTER: 100 drinks 90 drinks _ 100 shots of gin 45 shots of gin 200 shots of tonic shots tonic 100 scoops ice 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:

Market for Gin

Market for Tonic

Substitution Effect on Market for Tonic

Market for Tonic

Scale effect on market for tonic

Substitution Effect Scale effect

Because the scale effect > substitution effect, the demand for tonic falls

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 $ Q of Labor Demanded

We can use a graph to represent the data from the demand schedule:

Demand for labor

Changes in the Quantity of Labor Demanded:

A change in the Quantity of Labor Demanded (L D ) is represented by a movement along the labor demand curve

If the wage falls from $12 to $6, L D increases from 150 to 240. We move ALONG the demand curve (from A to B) and call this an increase in L D

Changes in the demand for labor:

A change in demand is represented by a shift in the demand for labor curve

Decrease in Demand

Increase in Demand

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.

 from the firm’s perspective  from an industry’s perspective  from the entire labor market’s perspective We can analyze the demand for labor on three levels: 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 short- run  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

 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 MARKET SUPPLY

Market Supply of Labor

Changes in the Quantity of Labor Supplied:

A change in the Quantity of Labor Supplied (L S ) is represented by a movement along the labor supply curve.

If the wage rises from $7 to $9, L s rises from 100 to 150. This is a movement along the labor supply curve (A to B). A B

Changes in the supply of labor:

Increase in Supply

Decrease in Supply

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 non- pecuniary 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? 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).

Back to the labor market:

Equilibrium occurs at the wage where L D = L S

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 L S D1 D2

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. D S L w w* L* minimum wage wmwm LdLd LsLs L s > L d so there is a surplus of labor

What would happen if the minimum wage was set below the equilibrium wage? D S L w w* L* minimum wage wmwm

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 w u and a surplus of labor is created. The surplus of labor is equal to (L s - L d ). L wS D w* wuwu LsLs LdLd

Now, the second case. The supply curve gets shifted to S u and the quantity of labor supplied is fixed. The market wage gets increased to w u. L wS D w* wuwu SuSu

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 w 0. S w L w0w0 w* D

If the workers are part of a competitive labor market, they will all receive the same wage (the market wage) which is w*. S w L w0w0 w* D

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. S w L w0w0 w* D

Economic rent is equal to the market wage minus the worker’s RESERVATION WAGE (the lowest wage he would accept to work). S w L w0w0 w* D Economic rent

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). S w L w0w0 w* D Economic rent A B C