CH 5: Frictions in the Labor Market Quasi-fixed labor costs –Types of QF costs –Effects of QF costs on hours/workers –Training as a QF cost & consequences of training investments for structure of pay.

Monopsony The firm’s labor supply curve is upward sloping Sources of monopsony: –Mobility costs –Job search and information costs –Small # of competing employers

Monopsony The firm’s labor supply curve is upward sloping LS MEL MRP Profit maximizing wage? Level of employment? MRP vs. W in a monopsony? Perfect competition? Effect of a change in MRP? Perfect competiton vs. monopsony?

Quasi Fixed Labor Costs, Walter Oi (1962). The cyclical behavior of labor markets reveals a number of puzzling features for which there are no truly satisfying explanations. Included among these are 1.occupational differences in the stability of employment and earnings 2.the uneven incidence of unemployment 3.the persistence of differential labor turnover rates 4.discriminatory hiring and firing policies I believe that the major impediment to rational explanations for these phenomena lies in the classical treatment of labor as a purely variable factor.

Quasi-fixed labor costs Examples –Hiring costs –Maintenance of payroll records, issuing checks –Training costs Explicit monetary costs Implicit opportunity costs of trainer’s time and capital used Implicit opportunity cost of trainee’s time

Quasi-fixed labor costs Avg. hours of formal instruction by training personnel 19 hours spent by management in orientation, informal training, extra supervision 59 hours spent by co-workers in informal training 34 hours spent by new worker watching others do work 41 Total153 Source: Ehrenberg and Smith

Employee Benefits

Quasi-fixed labor costs Hiring and training costs are quasi-fixed Some benefits are quasi-fixed, others are not. –pensions Are contributions a fixed dollar amount per employee, % of pay, or % of pay up to a maximum value? –legally required benefits many are % of pay up to a maximum. –health insurance typically, a worker is either covered or not and the employer contribution is independent of incremental hours worked.

Optimal Mix of Workers and Hours  ME M = marginal expense of an additional worker = W*H + Q where W =wage rate, H=hours per week, Q=QFC per worker  ME H = marginal expense of an additional hour of work for all its existing workforce. = W*N where W=wage rate and N=number of workers  MP M = MP of an additional worker for H hours.  MP H = MP of an additional hour of work for N workers.

Optimal Mix of Workers and Hours ME M /MP M = ME H /MP H What should firm do if –QFC rises? –Wage rate rises?

Optimal Mix of Workers and Hours APPLICATIONS –raising the salary cap for payroll taxes –increasing the payroll tax rate on capped payroll taxes. –effect of training costs on likelihood of part-time work. –the over-time premium. –mandatory health insurance coverage for full-time workers –worker preferences for part-time as opposed to full- time work –why do firms sometimes institute mandatory over-time rules would firms ever pay an over-time premium even in the absence of federal legislation?

Training Investments The firm's decision to invest in training a worker in a two- period model: Period 0: pay Z to train the worker pay W0 in wages to the worker worker produces MP0 Period 1: pay W1 in wages to the worker worker produces MP1 If worker is not trained, MP is fixed at MP* in both periods and the worker can receive a wage of W*=MP* at a competing firm.

Training Investments Optimal employment will be at E*

Training Investments How are W0 & W1 determined? Must offer a competitive PV of compensation W0 + W1/(1+r) > W* + W*/(1+r)

Training Investments Examples: Suppose that W*=100 and r=6%. AlternativeW0W1Present value (r=6%) A B C D E Why would the firm be reluctant to offer A or B? Why is worker reluctant to accept C, D, or E?

Training Investments Firms that invest in training will want to –Defer pay –Find ways to restrict mobility of workers

Training Investments GENERAL VERSUS SPECIFIC TRAINING. General training increases productivity at all firms. Specific training increases productivity only at a specific firm (presumably the firm providing the training). If training is general, a firm will have difficulty recouping its investment in training.

Training Investments With general training, firm must pay W1>MP1 in second period unless there is a way to prevent worker from quitting. Since W1>MP1, firm cannot recoup training investments by underpaying in second period With specific training, firm can pay MP1*<W1<MP1 and recoup some of its training investments. Firms can recoup investment in specific training with restricting mobility.

Training Investments How should training investments affect firm layoff behavior if product demand falls? How does the above affect the cyclical nature of productivity? If there are large training costs, firms should be concerned about screening out quitters. –Statistical discrimination –Fringe benefit packages –Discount rates

Investments in Training Employer investments in general training –Armed forces –Sports contracts –Employer pays for employee education while “on the job”