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Reading instructions: Borjas. ch. 4

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1 Reading instructions: Borjas. ch. 4
”Convergence of Regional Wage Levels” (pp ( 4.7 ”Hurricanes and the Labor Market” (pp ) through to make sure you can follow the reasoning as a check that you have understood the theory. Read ”The Mariel boatlift”” through as an illustration of the problems with difference-in-difference estimates. Skip: ”Employment subsidies” (pp ) ”Employer sanctions as a payroll tax” (pp ) ”Health Insurance as a mandated benefit” (pp ) ”Do Natives Respond to Immigration?” (pp )

2 Labour market equlibrium Borjas. ch. 4
Competitive equilibrium: The VMP of the last worker is w*. The VMP of each of the other N-1 workers >w*. The difference (blue triangle) = employer surplus The reservation wage of the last worker is w* The reservation wages of the other N-1 workers < w*. The difference (the orange triangle) = worker surplus W* N Assumption: Employers and workers are price-takers

3 Efficiency W* With a wage that is higher or than w*, employment and the total surplus are smaller. There is also a redistribution from employers and unemployed to employed workers, compared to the equilibrium. wh N’

4 Efficiency W* With a wage that is lower than w* employment the total surplus is smaller. There is also a redistribution from workers to employers compared to the equilibrium. wh N’

5 ”The” labour market consists of many sub-markets
Different localities. regions or industries constitute separate labour markets. But if workers and capital can be moved between them they are interdependent. If the economic and non-economic costs of moving are less than the wage differential: Workers may move to a labour market where wages are higher. Firms may move capital to a labour market where the wage is lower. .

6 Worker mobility between labour markets tends to equalise the wage rate.
High-wage market Low-wage market SH2 SL1 SH1 SL2 wH1 wL1 DH Exercise: Draw a similar diagram showing mobility of capital

7 If workers move to high-wage industries they move to jobs where their productivity is higher. National income increases. In aggregate there is a gain but some workers loose when wages in the high-wage market are reduced. The model assumes that workers in the two labour markets are perfect substitutes. The model abstracts from costs of moving. Empirically: There is evidence that regional differences within countries tend to converge. There is less mobility and convergence between countries. Inter-industry wage differentials are often persistent.

8 Pay-roll taxes Paid by the firm Paid by the worker S W0+t W1+t t W0 D0

9 The level of employment and take-home pay are the same irrespective of whether the pay-roll tax is paid by the employer or employee. Tax paid by workers – supply shift t Tax paid by firm – demand shift The incidence of the tax depends on the slope of the demand and supply curves. I.e. if S completely inelastic. the whole tax is paid by workers.

10 Dead-weight loss (excess burden)
Employment ↓ from E1 to E2 The wage paid  from w1 to w2 the wage received ↓ to w2-t Tax income T DEAD-WEIGHT LOSS A+B W2 A W1 T B W2-t E2 E1

11 (Mandated) benefits The demand curve shifts down by the amount that the mandated benefit costs the employer (C). The supply curye shifts down by the amount that the workers value the benefit (B) If B=0 the effect is the same as a pay-roll tax of C If 0 < B < C employment ↓ but less than with the pay-roll tax. w1+B<w0 If B = C employment doesn’t change and w1+B=w0 If B > C employment and w1+B>w0

12 The Impact of a Mandated Benefit
Dollars w0 S1 D0 D1 E1 E0 P Q Employment S0 w1 w0  C E* w* w* + B R w* + C E1 (a) Cost of mandate exceeds worker’s valuation (b) Cost of mandate equals worker’s valuation

13 Employers usually deduct income tax from salaries and pay to the workers tax account but they also pay mandated ”fees” or payroll taxes. Arbetsgivaravgift Pay roll tax 2005 2009 Old age pension fee (Ålderspensionsavgift) 10,21% Survivor’s pension fee (Efterlevandepensionsavgift) 1,70% Health Insurance fee (Sjukförsäkringsavgift) 10,15% 6,71% Work Injury fee (Arbetsskadeavgift) 0,68% 1% Parental Insurance fee (Föräldraförsäkringsavgift) 2,20% Labour Market Fee (Arbetsmarknadsavgift) 4,45% 2,43% General Wage fee (Allmän löneavgift) 3,07% 7,49% Total Sammanlagt (Jan. 2009) 32,46% 31,42%

14 Labour market equilibrium and immigration
Percent of population born in other country: (More about immigration and the labour market outcomes for immigrants in Sweden after chapters 8 & 9 and in Schröder) Simplest model: Assume immigrants and natives are perfect substitutes in production. (i.e. have same skills & compete for the same jobs.) Sweden 12.4 Finland 3.0 Germany 12.3 France 10.7 Poland 1.8 UK 9.1 Spain 11.1 Switzerland 22.9 Canada 18.9 US 12.9

15 Short run 1: Immigrants and natives are perfect substitutes
Immigration: Labour supply: S1→ S2 Total empl.: N1 → E2 Native empl. N1 → N2 Wage: W1 → W2 (N is empl. of native workers) S2 W1 W2 E2 N2 N1

16 Short run 2: Immigrants and natives are perfect complements
The labour market for natives: Immigration increases the MP of native workers. the demand curve shifts outwards. Increase in native employment and wage S D2 D1

17 Long run In the longer run. the capital stock adjusts
Lower wages increase profits Higher profits → more investment Expansion of production → demand curve for labour shifts outwards The long term reduction in wages is smaller than in the short term

18 Assumptions: Capital stock expands until the rate of return on capital is the same as before (r is constant in the long run) There are constant returns to scale in production in the long run Under these assumptions in the long run: The capital/labour ratio returns to the pre- immigration level The wage rate returns to the pre-immigration level! but we don’t know how long the long run is.

19 Are immigrant and native workers complements or substitutes?
In other words, are wages higher or lower when there is immigration? How to find out? Compare wages in places/regions with smaller or larger proportions of immigrants? Problems: Heterogeneity (other things differ between the places too…) Reverse causality (immigrants may choose to go where wages are higher). Mitigating effects (natives may move out due to the decrease in wage. whereby keeping it smaller)

20 ”A natural experiment” and difference-in-difference estimates
In Cubans were allowed to emigrate to the US. Most went to Florida. The population of Miami  7%. But unemployment and wages developed ≈ as in comparable cities. The criterion is not ”change in wages and employment in Miami”. It is these changes compared to cities where other conditions were similar (difference-in-difference comparison). Question mark: Would there have been large differences in development of unemployment between Miami and these cities in later year without influx of immigrants?

21 A digression on difference-in-difference estimates
Example: Two cities. A and B. Two sectors: M and S In year 1: wM=120. wS=80 A B Share of workforce (%) M 40 60 S Wage 96 104

22 If wages increase by 10 % in both sectors the wage differential from year 1 to year 2 will be 9.6 in A and 10.4 in B. Difference-in-difference comparison (in %) will correctly show that the wage dynamic is the same in A and B. If wages increase by 20 % in sector M and 10 % in sector S in both cities: Wage Y1 Wage Y2 Percent difference A % B % Difference-in-difference 17%-15% = 2% What conclusions should we draw?

23 Immigration surplus 1 S1 S2 Assumptions: Inelastic labour supply
Immigrant & native workers are perfect substitutes B w1 A A – what workers get without immigration B Employers’ surplus w2 N M

24 Immigration surplus 2 S1 S2 A –native workers’ income
B – immigrant workers’ income C – Employers’ surplus C w1 w2 A B

25 Immigration surplus S1 S2 A+B gain of employers
A loss of native workers B immigration surplus for natives (workers and employers) w1 A B w2

26 The (short run) decrease in wages implies a transfer from native labour to capital.
The increase in employment with a lower wage increases the profit part of national income by the immigration surplus = = ½*Δw* ΔE (Note that this is an increase in GNP, not GNP/capita).

27 Distributional effects of immigration
The wages of different skill groups are differently affected by immigration. US studies find a negative relation between immigration in a skill group and its wage growth that there is greater impact on the wages of native workers with lower education that the aggregate long-run effect is zero but for workers with low and high education it is negative and workers with middle education it is positive.

28 Cobweb model Supply and demand tend to adjust to wage changes – but it takes time. The supply of labour with a particular skill has very low elasticity in the short run. Getting people to move takes time. Re- training to add skills takes longer and education of new workers longer still.

29 D2 S Example: Assume that there is an increase in the demand for computer programmers (an outward shift in the demand curve) W1 W* D2 W0 D1

30 Market forms Perfect competition Monopoly
Monopsony (discriminating and not discriminating) There is some degree of monopoly power if the firm faces a downward-sloping demand curve for its product. There is some degree of monopsony power if the firm faces an upward-sloping labour supply curve

31 A profit maximising firm employs more workers until the marginal revenue from hiring one more unit of labour (marginal revenue product. MRPE) = the marginal cost of hiring one more unit of labour (MCE) For the perfectly competitive firm MR=p (product price) so MRPE = p*MPE and MCE =w For the monopsonist MCE >w For the monopolist MR < p

32 Monopoly and labour demand
From MRPE = MR*MPE MRPE = w MR < p It follows that w < p *MPE =VMPE

33 Aggregate production when input price increases
Perfect competition Monopoly MC2 D D MC2 MC1 p2 p1 MC1 MR 33

34 Since MPE is decreasing, a higher MPE for the monopolist means that it employs less workers. With a monopoly, employment will be lower than in perfect competition. w VMPE MRPE

35 Public sector: The public sector has elements of both monopoly and monopsony but is not profit maximising.


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