1. 1 Labor Market Equilibrium (Week 6)

2. 2 Textbook reading Borjas, Chapters 4 and 5. Ehrenberg & Smith, Chapter 8. Cahuc & Zylberberg, Chapter 5.

3. 3 Additional readings A. Roy, “Some Thoughts on the Distribution of Earnings.” Oxford Economic Papers (1951). J. Heckman and B. Honore, “The Empirical Content of the Roy Model.” Econometrica (1990). G. Borjas, “Self-Selection and the Earnings of Immigrants.” American Economic Review (1987). J. Roback, “Wages, Rent and the Quality of Life”. Journal of Political Economy (1982).

4. 4 Why study labor market equilibrium? Main questions: –Why do wages differ? Across workers, jobs, industries, regions… –Why do wages and employment go up and down? Basic (competitive) model: LD=LS –Equilibrium level of employment and wages. We will start from there, derive its implications, then extend it to more realistic settings.

5. 5 Competitive labor markets Main assumptions: –Transparency (perfect information). –Free entry (no market power). LD=LS –Equilibrium level of employment and wage. –Given the demand for the final good, the prices of other factors, technology, public programs, etc.

6. “A competitive economy where a homogeneous group of workers and firms can enter and exit the market has a single equilibrium wage across all labor markets” 6

7. 7 In equilibrium, No pressure for wages to go up or down. No unemployment. Efficiency: –Output is maximized. In a given labor market, wages are the same for all workers and jobs, even though: –Workers may differ in their “taste for work” and their non-labor income. –Firms can differ in their production function.

8. 8 All jobs are the same In the basic model, all jobs are the same: –They all pay the same wage. –Workers are indifferent between different firms. –Implicit assumption: non-wage characteristics of jobs are the same across firms.

9. 9 What are wages a function of? Characteristics of workers and jobs. LS: demography, distribution of non-labor income, public programs, etc. LD: demand for the final good, capital markets, regulations, etc.

10. 10 Implications Even the basic, competitive model generates interesting implications. Allowing us to think about the effects of a number of policies. –Minimum wages –Payroll taxes –International trade –Migration –etc.

11. 11 Extensions In practice, there are additional reasons why different workers get paid different wages: –Workers’ have different skills: formal education, experience, innate ability, … –Jobs vary in how demanding they are (how hard or unpleasant): non-wage characteristics. We can incorporate these dimensions of heterogeneity in the competitive model.

12. 12 Heterogeneity in workers’ skills The Roy model focuses on heterogeneity of skills or talents across workers. –Self-selection. The human capital model stresses that workers can choose to invest in increasing their productivity.

13. 13 Non-wage characteristics of the job The compensating differentials model focuses on the “difficulty” of a job. –“Hedonic theory of wages”.

14. 14 What if the LM is not competitive? Social norms Imperfect information Market power –Monopsony –Monopoly