Chapter 1 Introduction to Labor Economics Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

1-2 Why study Labor Economics? Human resources allocate substantial time and energy to labor markets. Labor economics studies how labor markets work. Labor economics helps us understand and address many social and economic problems facing modern societies.

1-3 Basics of 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

1-4 Three “Actors” Workers –The most important actor; without workers, there is no “labor”. –Desire to maximize (i.e., to optimize by selecting the best option from available choices). –Supplies more time and effort for higher payoffs, causing an upward sloping labor supply curve.

1-5 Three “Actors” Firms –Decide who to hire and fire. –Motivated to maximize profits. –Relationship between price of labor and the number of workers a firm is willing to hire generates the labor demand curve.

1-6 Three “Actors” Government –Imposes taxes, regulations. –Provides ground rules that guide exchanges made in labor markets.

1-7 Why Do We Need a Theory? Explain and understand how labor markets work. Focus on the essential variables while leaving out other, less crucial, factors. Create a model that helps explain the theory.

1-8 Positive vs. Normative Economics Positive economics –Addresses the facts –Focus on “what is” –Questions answered with the tools of economists Normative economics –Addresses values –Focus on “what should be” –Requires judgments

1-9 Labor market vs. other markets labor services are rented, not sold, labor productivity is affected by pay and working conditions, and the suppliers of labor care about the way in which the labor is used

1-10 Internal labor market A firm uses an internal labor market if: external hiring is used primarily for entry- level jobs, and higher level positions are filled by promotion from within the firm

1-11 Internal labor market Internal labor markets exist because the use of such markets: reduces hiring and training costs, improves employee morale and motivation, and reduces the effect of uncertainty

1-12 Primary vs. Secondary labor markets primary labor market - high wages and stable employment relationships. secondary labor market - low wages and unstable employment relationships

1-13 Labor force and unemployment labor force = noninstitutionalized individuals aged 16 or above who are either working or actively seeking work. unemployed = those who are not working but are “actively looking for job”

1-14 Unemployment rate Discouraged workers are workers who have given up looking for work. An increase in the number of discouraged workers causes the unemployment rate to fall.

1-15 Labor force participation rate the labor force participation rate rises during an expansion and falls during a recession. fluctuations in the labor force participation rate over the course of the business cycle dampen cyclical fluctuations in the unemployment rate

1-16 Sectoral shifts in employment primary sector (agricultural) employment has declined as a share of the labor force, secondary sector (industrial) employment has declined slightly as a share of the labor force, but only in the past few decades, and tertiary sector (service sector) employment has increased as a share of the labor force.

1-17 Reasons for the shifts in employment the primary sector (agriculture) is characterized by rapid growth in labor productivity and a low income elasticity of demand, the secondary sector is characterized by rapid growth in labor productivity and a moderately high income elasticity of demand, and the tertiary sector is characterized by slow growth in labor productivity and a high income elasticity of demand

1-18 Nominal and real wages Nominal wages are not adjusted for inflation and are said to be expressed in terms of “current dollars.” Real wages are wages that have been adjusted to take into account the effect of inflation. Real wages are expressed in terms of dollars from a given base year and are said to be expressed in “constant dollars.”

1-19 Wages, earnings, total compensation and income wage = payment per unit of time earnings = wage x hours total compensation = earnings + fringe benefits fringe benefits = payments-in-kind + deferred compensation income = total compensation + unearned income (or income = earnings + unearned income)

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1-21 The Markets in Which Firms Must Operate

1-22 Demand for labor The labor demand curve is downward sloping due to: a substitution effect, and a scale effect.

1-23 Substitution effect substitution effect - substitution of other resources for a resource that becomes relatively more expensive.

1-24 Scale effect The scale effect associated with a wage increase involves the following steps: higher wages result in higher average and marginal costs of production, leading to an increase in the equilibrium price of the product, leading to a reduction in the quantity of the product demanded, leading to a reduction in the use of all inputs used to produce the product.

1-25 Shifts in labor demand Labor demand may shift due to changes in: the demand for the product, and the prices of other resources.

1-26 Industry demand for labor An industry's demand for labor consists of the total demand for a particular type of worker in a given industry. (An industry consists of all of the firms that produce a given type of output.) An industry's labor demand curve is determined by adding together the labor demand curves for all of the firms in the industry.

1-27 Market demand for labor The market for a given category of labor consists of all of the firms that might hire a given type of labor, regardless of the industry in which the firm operates. The market demand for labor is determined by adding together all of the industry demand for labor curves.

1-28 Market labor supply

1-29 Shifts in market labor supply curve Shifts such as this may be due to: changing wages in other markets, or changes in worker tastes and preferences

1-30 Collective bargaining agreement

1-31 Supply restriction

1-32 Overpaid and underpaid workers economists argue that workers are overpaid if their wage is above the equilibrium, workers are underpaid if their wage is below the equilibrium wage

1-33 Supply and Demand in the Engineering Market Equilibrium 50,000 40,000 30,000 20,00010,00030,000 Labor Supply Curve Labor Demand Curve Earnings ($) Employment

1-34 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.

End of Chapter 1