Chapter 5: Nonwage labor costs
Nonwage labor costs
Nonwage labor costs include:
 hiring costs,
 training costs, and
 employee benefits.
Hiring costs
Hiring costs include the costs associated with:
 placing advertisements,
 selecting candidates for interviews,
 interviewing candidates,
 selecting candidates for job offers,
 negotiating job offers, and
 processing the worker's employment (filling out
W4 forms, I9 forms, and adding the worker to
the company's insurance and pension plans) in
the human resources department of the firm.
Hiring costs differences across
firms


In the secondary labor market, hiring
costs are generally relatively low.
Hiring costs in the primary labor
market, however, can be very
substantial, particularly when a firm is
operating in a national labor market.
Training costs
Training costs include:
 the explicit cost of hiring trainers and using
materials (such as manuals, videotapes, and
capital equipment) for training purposes,
 the implicit cost of using other workers, raw
materials, and capital during informal on-thejob training, and
 the opportunity cost of the trainee's time
during training.
Training costs and wage offers


low wages - higher turnover rates and
lower quality applicants, leading to
higher training costs.
high wages - lower turnover rates and
higher quality applicants, leading to
lower training costs
Employee benefits

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legally mandated social insurance
programs (such as social security and
unemployment compensation), and
privately provided benefits such as
health insurance, vacation pay, and
pension plans.
Quasi-fixed costs

Quasi-fixed costs are costs that vary
with the number of workers hired by
the firm, but not with hours worked per
employee.
Optimal mix of employment
and hours
Firms may increase their use of labor by:
 adding additional workers,
 increasing the length of the workweek,
or
 some combination of increases in hours
and increases in the number of
workers.
Production function
Q=f(M,H)
where: Q = quantity of output
M = number of workers
H = length of average work week


MP of M declines as M increases
MP of H declines as H increases
Optimal mix of M and H
Effect of an increase in
mandated overtime premium



equivalent to an increase in MEH
substitution effect: M increases and H
decreases
scale effect: M and H both decrease
Effect of an increase in
mandated overtime premium
In a more complete model, other effects would occur:
 a substitution of capital and other inputs for labor,
 increased noncompliance,
 only limited substitution of less skilled unemployed
workers for the skilled workers who tend to work
overtime hours,
 increased moonlighting, and
 a decline in the base rate of compensation in those
industries that use significant amounts of overtime.
Part-time employment and
mandated benefits


The quasi-fixed costs associated with
full-time employees is usually higher
than the quasi-fixed costs associated
with part-time employees.
Mandatory health insurance would
reduce the use of part-time
employment.
Multi-period demand for labor

firms may lose money during a training
period if they can receive a sufficient
return on the training investment in
subsequent periods.
Present value
The present value of a future payment is lower when:
• the payment is received in the more-distant future, and/or
• the interest rate is relatively high.
Two period model: definitions






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Wo = wage during training
W1 = post-training wage
W* = wage if no training is received (the
same in each period)
Z = hiring and training cost (paid during the
training period)
MPo = marginal product during training
MP1 = marginal product after training
MP* = marginal product if no training is
received (assumed to be the same in each
period)
Shifts in MP due to training
Optimal employment when
training costs are present
PV(MRP) = PV(MFC)
Definitions:
 PVP = MPo + MP1/(1+r), and
 PVE = Wo + Z + W1/(1+r).

Optimal employment:
 PVP=PVE
 MPo + MP1/(1+r) = Wo + Z + W1/(1+r)
Optimal employment when
training costs are present
Optimal employment when
training costs are present


Wo + Z - MPo = (MP1 - W1) / (1 + r),
or
NCo = G
General and firm-specific
training


General training is training that raises a
worker's productivity in more than one
firm.
Firm-specific training increases the
worker's productivity only in the current
firm.
Costs of general training



Since general training raises the
productivity of the worker in more than
one firm, the costs (and benefits) of
general training are expected to be
borne by the worker.
Wo = MPo - Z, and
W1 = MP1
Costs of firm-specific training




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If workers bear the costs, there is no reason
for the firm to keep the worker.
If firms bear the costs, there is no reason for
workers to stay.
It is expected that the costs of (and benefits
from) firm-specific training will be shared.
MPo - Z < Wo < MP*
MP* < W1 < MP1
Layoffs, productivity, and
training

a firm will be more reluctant to lay off
workers who have received training
investments paid for by the firm,
Layoffs, productivity, and
training



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a firm will be more reluctant to lay off
workers who have received training
investments paid for by the firm,
firms are more likely to rely on overtime
rather than using additional employees in
those markets in which firms pay a
substantial share of training costs,
productivity falls during a recession, and
rises during an expansion.
Minimum wage and training
costs



For workers to bear part or all of the cost of
their training, they must be paid less during
the training period.
The minimum wage sets a floor on this wage
that limits the ability of workers to bear the
costs of such training by accepting a lower
wage.
Firms faced with such a system may respond
by providing less training, thereby limiting the
rate of growth of earnings for minimum-wage
workers.
Credentials, Signals, and
statistical discrimination

Firms have imperfect information and
may make decisions based on
observable worker characteristics.
Credentials, Signals, and
statistical discrimination



Firms have imperfect information and
may make decisions based on
observable worker characteristics.
This may lead to statistical
discrimination.
Statistical discrimination is expected to
be less severe when internal labor
markets are used.