Introduction to microeconomics
Chapter 12
Labour Markets
Discounting
• (see separate presentation on web site)
Labour Markets Equilibrium
• Selling human labour is not like selling other
goods.
– Workers “rent” their labour services.
• Supply and demand are still the key analytic
tools.
– Supply and demand together determine
equilibrium wage and quantity.
– Shifts in the labour supply and labour demand
curves are analogous to shifts in output markets.
LO1: Marginal Productivity
and Wage in Competitive
Labour Markets
Ch12 -3
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Wage and Salary Determination
• Marginal product of labour - MPL
– The additional output a firm gets by employing one
additional unit of labour.
– It is the benefit in output from hiring one more worker.
• Value of marginal product of labour - VMP
– The dollar value of the additional output a firm gets by
employing one additional unit of labour.
– It is the dollar value benefit from hiring one more worker.
• General rule: a worker’s pay in long-run equilibrium
will be equal to his or her VMP — the net contribution
he or she makes to the employer’s revenue.
LO1: Marginal Productivity
and Wage in Competitive
Labour Markets
Ch12 -4
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Imperfect Information in Labour Market
• People differ in their skills and abilities, and because
those skills and abilities change over time, an individual
worker’s quality cannot be graded easily.
• The true output of individuals is often difficult to
observe directly, particularly if they work as part of a
team.
• Firms and workers often have incentives of their own
to not reveal true information.
• Firms end up paying a wage that reflects what they
expect a typical worker’s level of output to be, given
those observable characteristics.
LO1: Marginal Productivity
and Wage in Competitive
Labour Markets
Ch12 -5
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EXAMPLE 12.2: How many workers will Abitibi hire? (Part 1)
•
•
Abitibi hires workers in a competitive labour market at a wage of $350/week
We assume here that all workers are of the same type or observationally equivalent.
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Limited
LO1: Marginal Productivity and Wage in
Competitive Labour Markets
Law of diminishing returns
Firm will hire 3 workers
VMP = MP × P
VMP>W
VMP<W
Ch12 -6
EXAMPLE 12.3: How many workers will Abitibi hire? (Part 2)
LO1: Marginal Productivity
and Wage in Competitive
Labour Markets
Ch12 -7
© 2012 McGraw-Hill
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Wage and Salary Determination in
Competitive Labour Markets
• When a firm can hire as many workers as it wants
at a given market wage, it will increase hiring
until VMP equals the wage.
• Note: since firms know that productivity varies among
individuals, they have to estimate the expected productivity
of workers, recognizing that some characteristics (e.g.
education) predict expected productivity.
• The wages of a particular type of worker will
depend on expected productivity.
• Competition among firms will tend to equalize
wages among observationally equivalent workers.
LO1: Marginal Productivity
and Wage in Competitive
Labour Markets
Ch12 -8
© 2012 McGraw-Hill
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EXAMPLE 12.4: How many workers will Abitibi hire? (Part 3)
VMP>W
VMP<W
Firm will hire 4 workers
LO1: Marginal Productivity
and Wage in Competitive
Labour Markets
Ch12 -9
© 2012 McGraw-Hill
Ryerson Limited
Change of Employment
• If the wage rises, employment will decline.
• If price of the product rises, employment will
be expanded.
– because the VMP rises with product price.
• If productivity rises employment will rise .
– because the VMP rises with an increase in labour
productivity.
LO1: Marginal Productivity
and Wage in Competitive
Labour Markets
Ch12 -10
© 2012 McGraw-Hill
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Adjusting for inflation
• Assume that you were paid $34,000 per year
in 2010
• You received a raise of 1% in 2011
• How much better off would you be in 2012
than in 2010
• Adjusting for inflation means taking a base
year ($34,000 in 2010) and dividing the target
year (34,000 x 1.01) by CPI.
http://www.bankofcanada.ca/rates/related/inflation-calculator/
12.2 Monopsony And Imperfect
Competition in Labour Markets
Monopsony
• A market with only a single buyer.
– Workers get paid what the firm decides to pay them.
• The firm needs to raise wages if it is to attract more labour.
• The firm’s marginal cost of hiring one more worker is that
worker’s wage plus the cost of increasing wages for existing
employees.
• Marginal labour cost is greater than the wage rate, firm will
hire fewer workers.
• Prevalence of monopsony in labour markets has
declined because most people now live in large
urban labour markets with many potential
employers.
LO2: Monopsony and Its Effects on Wages and
Ch12 -13
Distribution of Economic Surplus
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Marginal Labor Cost
• The increase in a monopsonist’s total wage bill
when an extra worker is hired.
– Since firm has to pay a higher wage to attract a new
worker, they usually have to pay the higher wage to all
their current workers too.
– Marginal Labor Cost = wage + (wage
change)*(employment).
• Monopsonist’s produce too little / hire too few.
– The private cost of an additional hire is greater than
the social cost of that hire, since hiring one more
person means having to increase everyone’s wages.
LO2: Monopsony and Its Effects on Wages and
Ch12 -14
Distribution of Economic Surplus
© 2012 McGraw-Hill
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EXAMPLE 12.5: How many workers will Bluenose hire? (Part 4)
•
Bluenose is the only employer on the market, cutting board sells for $30 each.
VMP>MLC
VMP<MLC
Firm will hire 2 workers
LO2: Monopsony and Its Effects on Wages and
Ch12 -15
Distribution of Economic Surplus
© 2012 McGraw-Hill
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Labour Supply and
Marginal Labour Cost for a Monopsonist
The line labelled SSL plots
theThe
number
of workers
to
monopsonist
canwilling
expand
supply
labourthe
at only
aperfectly
given
employment
by wage,
offering
higher
Unlike
competitive
while
line
MLC
indicates
the fromhiring
wages.
For example,
move
employer,
which continues
increase
in
total
labour
cost the market
point
A to
B, IfVMP
the equals
only
until
associated
with
eacha second
company
wants
to hire
wage,
thehiring
monopsonist
continues
additional
employee.
linenot
worker
(Bertram),
it equals
must
only
hiring
until VMPThe
marginal
labelled
VMP
illustrates
that,
as
paylabour
him
$200/week
thanthe
it is
cost,
whichmore
exceeds
more
workers
are added,
the
currently
Alisha,
but it must
marketpaying
wage.
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from
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alsomaximizing
raise
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payhiring
to $300/week.
employment
level
additional
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marginal
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costisoflower
hiringthan
the
monopsonist
Bertram
is $500/week
B’)
the level
that would(point
maximize
total economic
Surplus.
LO2: Monopsony and Its Effects on Wages and
Ch12 -16
Distribution of Economic Surplus
© 2012 McGraw-Hill
Ryerson Limited
Demand and Supply in Competitive
Labour Markets
• The aggregate Demand Curve for labour.
– The sum, over all firms, of how many workers each firm
would hire at a given wage.
– The horizontal sum of each employer’s VMP curve.
• The aggregate Supply Curve of labour.
– The sum, over all persons, of the amount of labour each
person would supply at a given wage.
– Since individuals can move between labour markets, the
Supply Curve for an individual labour market is upward
sloping.
– However, for the economy as a whole the supply curve of
labour may be vertical or even backward bending.
• In each labour market, demand and supply
determine the equilibrium wage and level of
employment.
LO3: Demand and Supply in Competitive Labour
Ch12 -17
Markets
© 2012 McGraw-Hill
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The Occupational Demand for Labour
6
100 150
Employment in
firm 1
(person-hours/day)
(a)
12
D = VMP2 + VMP2
Wage ($/hour)
12
D2 = VMP2
Wage ($/hour)
Wage ($/hour)
D1 = VMP1
6
12
6
50 100
+
Employment in
firm 2
(person-hours/day)
(a)
150
=
250
Total employment
(person-hours/day)
(c)
– If firm 1 and firm 2 are two firms that employ labour in a given
occupation, we generate the demand curve for labour in that
occupation by adding the individual demand curves horizontally.
LO3: Demand
and-18
Supply in Competitive Labour
Ch12
Markets
© 2012 McGraw-Hill
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12.4 Equilibrium - Supply
and Demand
The Effect of an Increase in the Demand for Computer Programmers
Wage ($/hour)
S
W2
W1
D2
D1
L1
L2
Employment of programmers
(person-hours/year)
As increase in the demand for programmers from D1 to D2 results in
an increase in the equilibrium level of employment (from L1 to L2)
and an increase in the equilibrium wage (from W1 to W2).
LO3: Demand and Supply in
© 2012 McGraw-Hill
Competitive Labour Markets
Ch12 -20
Ryerson Limited
12.5 Equilibrium and Unemployment
Unemployment
• Searching activity determines unemployment.
– Jobless individuals who have actively looked for work are
classified as unemployed.
– people who have given up looking or who never did look
for work are labelled not in the labour force.
– Imperfect information and optimal search in the labour
market.
– Frictional (search) unemployment.
• Other types of unemployment.
– Structural unemployment , seasonal unemployment, and
cyclical unemployment.
LO4: Labour Market and
Unemployment
Ch12 -22
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12.6 Explaining Differences
in Earnings
Differences in Earnings
• In competitive labour markets, differences in pay tend
to reflect differences in expected productivity.
• Productivity differences may result from differences in:
–
–
–
–
Talent.
Training.
Work effort.
Human capital : skills produced by education, training and
experience that affect a worker’s productivity ( MPL ).
• Human capital theory.
– A theory of pay determination that says a worker’s wage
will be proportional to his or her stock of human capital.
LO5: Factors that Cause
Differences in Earnings
Ch12 -24
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EXAMPLE 12.6: Will Mary be Better-off if She Gets an
MA? (Part I)
• Mary is 22 and has just graduated with a BA in
economics.
• She now has a job as a local manager for a major
corporation.
• Out-of-pocket costs of the MA are $8000 per year
for each year.
• In addition, she would have to forego her current
earnings while in school (opportunity cost).
• The question is, do the future benefits repay the
early costs?
LO5: Factors that Cause
Differences in Earnings
Ch12 -25
© 2012 McGraw-Hill
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Investment in Human Capital
• The decision to acquire training or education can
be analyzed with the same conceptual tools as
decisions to invest in other assets.
• If acquiring skills is costly, when is it worth doing?
– Investment requires comparing costs incurred today
with the value of future benefits.
– The “present value” concept is invaluable because
benefits may be many years in the future, while costs
are immediate.
– Present Value = (Amount of Future Payment) /
discount factor.
LO5: Factors that Cause
Differences in Earnings
Ch12 -26
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EXAMPLE 12.6: Should you get an MA? (Part II)
LO5: Factors that Cause
Differences in Earnings
Ch12 -27
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• The Returns
of an MA in
Economics
•
Costs are incurred
during the period an
MA is being acquired.
Once acquired, the
MA provides benefits
over subsequent
working life.
MA (b)
FIGURE 12.3
Benefits
of MA
BA (a)
Costs
of MA
Net returns
to MA
Benefits
of MA
Costs
of MA
LO5: Factors that Cause
Differences in Earnings
Ch12 -28
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EXAMPLE 12.6: Should Mary get an MA?
• Net present value of her investment, is $8410.
– A positive net present value means that the benefits of the
investment outweigh the costs.
– Manon concludes that it is financially worthwhile to get an MA.
• Three important things determines the present value
calculation
• 1. Costs = opportunity cost (foregone earnings) + out-ofpocket cost (how much she gives up by choosing to invest
in education),
• 2. Benefits = the additional salary Manon forecasts that she
will get from her MA choice (and when she gets it),
• 3. Discount rate = how impatient she is in waiting for future
returns.
LO5: Factors that Cause
Differences in Earnings
Ch12 -29
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Aggregate Effects of Increase in
Schooling
• When some students continue longer in
school this simultaneously:
– Increases the supply of highly skilled workers.
– Decreases the supply of low skilled workers.
– So the wage gap between highly educated and
poorly educated workers tends to shrink.
LO5: Factors that Cause
Differences in Earnings
Ch12 -30
© 2012 McGraw-Hill
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FIGURE 12.6:Wage Effects of an Increase in Postsecondary
Enrollment
– An increase in the supply of postsecondary graduates
reduces the wage gap between high-school and
postsecondary graduates.
LO5: Factors that Cause
Differences in Earnings
Ch12 -31
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Labour Unions
• A group of workers who bargain collectively with
employers for better wages and working conditions.
• Union wage premium for workers with the same
human capital is about 10%.
• Higher wages for unionized workers imply:
– Unionized employers can be more selective in hiring.
– Less turnover, better workplace morale.
– Unionized employers may invest more in capital
equipment.
• Implication: higher productivity in unionized firms could offset
higher wages.
LO5: Factors that Cause
Differences in Earnings
Ch12 -32
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Winner-Take-All Markets
• Winner-take-all labour market.
– One in which small differences in human capital
translate into large differences in pay.
– Economic naturalist 12.2: Why does Lady Gaga
earn millions more than singers of only slightly
lesser ability?
LO5: Factors that Cause
Differences in Earnings
Ch12 -33
© 2012 McGraw-Hill
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Compensating Wage Differentials
• Compensating Wage Differential.
– Difference in the wage rate due to the
attractiveness of a job’s working conditions,
compared to other jobs that require the same
level and type of skill.
– But tastes differ (e.g. for outside/inside work) so
it’s often hard to predict the impact of
compensating differentials.
LO5: Factors that Cause
Differences in Earnings
Ch12 -34
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12.7 Discrimination in the Labour Market
Discrimination by Employers
• Occurs when employers have an arbitrary
preference for one group of workers, even
though all groups are equally productive.
• Competitive forces may take time to erode
discrimination.
• Consumer attitudes (especially in the service sector) may
enforce stereotyping.
• An employer who stereotypes and does not hire
disadvantaged workers will never be proved wrong.
• Employers who go against industry norms may be perceived
as more risky to deal with.
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LO6: Effects of Stereotypes and discrimination in the Labour
Ch12 -36
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Market
Discrimination: Both Unfair and Economically
Inefficient
• Inequity to the individuals who are denied equal
opportunity.
• Inefficient for economy because peoples’ skills are
not fully used.
• Canadian Public Policy on Discrimination.
– Legislation against discrimination
– Employment Equity Programs.
• Objective: to help women and minorities get into nontraditional jobs and so prove, by experience, that
traditional misconceptions are incorrect
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LO6: Effects of Stereotypes and discrimination in the Labour
Ch12 -37
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Market
Are women discriminated in labour
markets
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Less than Men - YouTube.mp4
Statistical discrimination
• Based on lack of information - employers don't know
workers ability and used average ability as the standard
• Differing level of information about the sub-groups
– Group A is compared to group B.
– Assume two groups, A and B, have average test scores well
above the average for the entire population,
– But group A's estimate is considered more reliable,
– If two people, one from A and one from B interview for a job,
using statistical discrimination, A is hired, because it is perceived
that his group score is a good estimate, but group B's group
score more likely to be "luck".
– Conversely, if the two groups are below average, B is hired,
because group A's negative score is believed to be a better
estimate.
Statistical discrimination may be
tolerated
• Older people are charged more for life insurance,
• college diploma is required for a job (because it is believed that
college graduates perform, on average, better).
Some well-documented instances of statistical discrimination for
involuntary group membership also do exist and are tolerated.
• Many countries allow auto insurance companies to charge men and
women with identical driving records different rates (or factor in
gender when deciding whether to deny coverage).
• Statistical discrimination less tolerated when it is applied to
protected groups. For example, it has been suggested that home
mortgage lending discrimination against immigrants may be partly
caused by statistical discrimination
• Red-lining occurs when residents in certain areas are required to
pay higher interest for their mortgages.
Chapter Summary
• The long-run equilibrium pay in a competitive labour market will be
equal to the value of the marginal product (VMP).
• Firms that purchase labour in competitive labour markets face a
constant wage, and they will hire labour up to the point at which
VMP equals the market wage.
• Unlike the perfectly competitive employer, the monopsonist can
expand employment only by offering higher wages.
• The monopsonist continues hiring until VMP equals marginal labour
cost, which exceeds the market wage.
• The profit-maximizing employment level for the monopsonist is
lower than the level that would maximize total economic surplus.
Chapter Summary
Ch12 -41
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Chapter Summary
• Human capital theory says that an individual’s VMP is
proportional to his stock of human capital.
• Earnings typically increase with education, age &
experience (but to different degrees in some contexts).
• Other earning differentials can rise due to different
working hours per year, union membership, differences
in working conditions (compensation wage
differentials).
• The theory of employer discrimination holds that part
of the observed wage gaps are the result of continued
stereotypes of employee productivity on the part of
employers.
Chapter Summary
Ch12 -42
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