Labor Economics
Classic and New
Gregory W. Stutes
Why should I take Labor Econ?
• Most of us will spend 30-40 years of our life
working for an income.
• Labor markets help determine our
– Wealth
– Goods that we can afford
– Who we associate with
– Vacations
– Which schools we will attend
– Maybe, even who we will marry
Labor On 2 Levels
• Traditional Labor Economics
–We will explore how labor markets
work
–As in all of economics, this will be
model building with a purpose.
• Many of the issues in the debate over
social policy concern the labor market
experiences of particular groups.
Questions
• Why did the labor force participation of
women rise throughout the past century?
• What is the impact of immigration on the
wages and employment opportunities of
native-born workers?
• Do minimum wages increase the
unemployment rate of less-skilled workers?
Questions
• Do wage and tax subsidies encourage firms to
increase their employment?
• What is the impact of occupational safety and
health regulation on employment and
earnings?
Questions
• Are government subsidies of investment in
human capital an effective way to improve the
economic well-being of disadvantaged
workers?
• Why did inequality rise much more rapidly in
the US in the 1980s than other industrialized
countries?
Questions
• What is the impact of affirmative action on
the earnings of women and minorities and on
the number of women and minorities that
firms hire?
• What is the economic impact of unions on
both their membership and the rest of the
economy?
New Labor Economics
• A new part of labors economics is personnel
economics
– In the past there was no systematic discipline
which to base human resource questions
– Always regarded as too soft
– Today we have models that can provide detailed
and unambiguous answers
New Labor Economics Questions
• Are high skilled people better worked at a
particular job?
• Are highly skilled people worth the additional
salary cost?
• How skilled is highly skilled?
Personnel Questions
• Which levels of skill should be considered for a
particular job?
• How should skill be defined? Is formal
education the key or should we use some
other criterion?
• What are the trade-offs between quantity and
quality?
Questions
• Are two unskilled workers more or less
productive that one skilled worker?
• Do supply conditions matter? Is worker
availability an issue?
• How many workers should be hired?
Introduction
• WORKERS
– Economists model the worker as an individual
who wants to maximize well-being subject to the
constraints of time and income.
• This can help us with
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Whether to work
How many hours to work
Which skills to acquire
When to quit
Which occupation
Join a union
How much effort to allocate
Introduction
• Firms
– Economists model firms as either trying to
maximize profit subject to a production function
or minimize costs subject to capital and labor.
• This can help us with
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How many and which types of workers should we hire
Length of work week
How much capital to employ
Safe working conditions
Introduction
• Government
– The government has its own classes with
Government and Business and Public Economics
• We will still need a government to help with
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Tax earnings
Training
Payroll tax
Affirmative action
Illegal labor
Immigration
Introduction
• Methodology
– Scientific Method
•
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•
•
Observe
Question
Hypothesize
Test—With a model
– All models have assumptions
– Model—A simplified or idealized description of a
particular system, situation, or process.
What makes a good model?
• Clearly and simply explains a principle without
extraneous detail
• In economics we generally use math (graphs)
• Equations linking complex factors to study the
effects of change
Models
• The realities of most situations of interest are
too complicated to truly understand them.
• Take oil as an example
– Energy, plastic, asphalt, fertilizer, even shampoo.
– To fully understand the crude oil market we
merely need to understand the behavior of all
individuals that may use crude oil in some form.
• About 6.5 billion people
Remember the Beginning
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Incentives
Opportunity Costs
Benefits
Looking at the Margin
Trade makes people better off
How is this different from 202/204
• Thinking Like an Economist
Economics trains you to. . . .
 Think in terms of alternatives.
 Evaluate the cost of individuals and social choices.
 Examine and understand how certain events and
issues are related.
Positive vs. Normative
• Basics
– Role of the labor market is to facilitate voluntary,
mutually beneficial transactions (if all those take
place  Pareto efficiency)
– Positive Economics is concerned with description and
explanation of economic phenomena.
– Normative Economics is concerned with giving advice
to practical problems and describing what ought to
be.
• Is there truly a distinction?
Efficiency v. Equity
– Efficiency means society gets the most that it can
from its scarce resources.
– Equity means the benefits of those resources are
distributed fairly among the members of society.
Market Failures
• Labor market facilitates voluntary, mutually beneficial
transactions. When does the market fail?
– Ignorance: smoker in asbestos plant; don’t know of job
opening
– Transaction barriers: law restricting women to < 40 hours
law requiring a 50% OT premium
simple cost as a barrier to moving
– Price distortions: taxes can create “incorrect” prices
– Missing market: impossible or not customary to transact
(e.g., living in the apt. below a really bad band)
• Solution is often Government Intervention
Government Intervention
• Public goods
– Some union workers are worried about noise from machinery
– A sawmill factory wants to finance the research & sell its findings
– Problem?
• Capital market imperfections
– Students/workers are worried about getting loans for college/job
training or some workers would like to move to new city
– Government could make loans to help strengthen the economy
• Markets are missing
– Resident is worried about the band noise from upstairs
– Government could intervene and pass law on noise levels
– Concerns?
Types of Models
• Descriptive
– Like our Circular Flow
• Analytical
– Assumptions or Axioms
– Model—mathematical or logic
– Conclusions deduced from the model
– We test these and if they work we use them to
describe the real world
Big Problems
• The Assumptions
– Too many/Too Few
– Are they correct
• Math
– Can you really model the world with math
A new look at S&D
• Market Supply for a particular industry
– 𝐿𝑠 = 𝑆(𝑊, 𝑁, 𝑊 𝐴 )
• W is an endogenous variable
• N and 𝑊 𝐴 are exogenous variable
– As always, we do this step by step.
– Comparative Statics
• Positive effect from wage, W
• Negative effect from alternative wages, 𝑊 𝐴
• Positive effect from population size, N
A new look at S&D
• Demand
– Derived Demand
• We do not “want” labor. We want the revenue from
selling the products made by the worker.
• Therefore, demand for workers is dependent on the
demand for the product itself—Q
• We still need to pay the worker—W
• We also need capital—R
– 𝐿𝑑 = 𝐷(𝑊, 𝑄, 𝑅)
Endogenous vs. Exogenous
• The wages and both labor demand and labor
supply are determined within the model
• They are endogenous
• The demand for the product itself and the
price of capital are outside the model
• They are exogenous
Comparative Statics
• All else equal, an increase in the
– Wage, W, lowers the demand for labor
– Demand for the product, Q, increases the
demand for labor
– The rental price of capital, R, may increase or
decrease the demand for labor
• Gross substitutes
• Gross compliments
Change in wages has more than meets
the eye
• An increase in the wage causes labor to be
more expensive relative to capital.
• Producers have the incentive to use more
machines and fewer workers. (Labor-saving
machines)
• This is a SUBSTITUTION EFFECT
More than meets the eye
• An increase the wage increases the cost of
producing the good
• Good back to 202—What happens when an input
price goes up?
• The quantity demand will decrease and we will
need fewer workers
• This is a SCALE EFFECT
Substitution and Scale
• Now that we have these two effects we can
update the price of capital
• As the price of capital increases, the substitution
effects states that we will buy less capital and
MORE labor
• As the price of capital increases, the scale effect
says we will reduce production and we will buy
LESS labor
Substitutes or Compliments
• If the scale effect dominates, we will buy less
labor and labor and capital are gross
compliments (They move together)
• If the substitution effects dominates, we will
buy more labor and labor and capital are gross
substitutes (The do not move together)
Labor Market Equilibrium
• The wage rate adjusts so that
𝑆
𝐷
•𝐿 = 𝐿 = 𝐿
• Both workers’ and employers’ plans are consistent
• Adam Smith
• Surplus and Shortage
Pandemic
• The black death and the rise of the
renaissance
Neoclassical Economics
• Methodological Individualism
– Human social behavior can be explained by
understanding the individual
– Usually works in micro, but we have trouble applying
it to macro
• Rational Choice
– Individuals maximize utility/profit subject to some
constraints
– While not everyone solves max problems, we argue
that people behave as though the solve the problem
– People may not be as rational as we assume
– Marginal
More Neoclassical
• Equilibrium
– A system is in equilibrium if the opposing forces
that act on it are in balance
– Your behavior affects my behavior
– We probably will not look at general equilibrium.
You will use it in inter macro and if time permits at
the end of inter micro
More Neoclassical
• Pareto Efficiency
– This is our best attempt to eliminate the
normative impact of what is “best”
– And we have a more refined definition than the
“getting the most from our scarce resources” of
202
– An allocation is PE if there is no other feasible
allocation that can increase the well-being of at
least one individual without hurting the well-being
of everyone else
Problems With Neoclassical
• Neoclassical is very tractable and generally
provides useable results
• It is, however, just a model that has limitations
– It does not provide insights into the internal
workings of either the family or the firm
New Institutional Economics
• Gary Becker and the family
• Oliver Williamson and the firm
• NIE explains the institutions in terms of the
actions and goals of the individuals who
participate in them
• NIE uses bounded of limited rationality
– We have limited ability to calculate and limited
ability to see all of the possibilities
The US Labor Market
Where are we?
• Nominal Gross Domestic Product 2011
– 15.66 Trillion
• Number of Workers
– 142.3 Million
• Median Household Income
– About $50,000
U.S. “Economy at a Glance”
• Current state of U.S. labor market is …
http://www.bls.gov/eag/eag.us.htm
• How does North Dakota and Minnesota stack up?
– North Dakota’s Economy at a Glance
• http://www.bls.gov/eag/eag.nd.htm
– Minnesota’s Economy at a Glance
• http://www.bls.gov/eag/eag.mn.htm
• Industry at a Glance
• Distribution of employment
• http://www.bls.gov/iag/iaghome.htm
Current Population Survey
&
Definitions
• Current Population Survey (CPS)
– Conducted by the Census for the Bureau of Labor
Statistics (BLS)
– Survey of about 50,000 households
– Spans 50 years
• Total Civilian Noninstitutional population (TP)
– Members of the US population who are at least 16
and not in prison or a mental institution
– Sometimes called working-age population
TP = LF + Not in LF
• And LF = E + U
– Employment—persons 16 years and over in the civilian
noninstitutional population, who during the reference
week
• Did any work (at least one hour) as paid employees, worked in
their own business, profession, or on their own farm, or worked 15
hours or more as unpaid workers in an enterprise operated by a
member of the family, and,
• All those who were not working but who had jobs or businesses
from which they were temporarily absent because of vacation,
illness, bad weather, child care problems, maternity or paternity
leave, labor-management dispute, job training, or other family or
personal reasons, whether they were paid for the time off or were
seeking other jobs.
TP = LF + not in LF
• LF = E + U
– Unemployed
• Persons 16 years and over who had no employment
during their reference week, were available for work,
except for temporary illness and had made specific
efforts to find employment sometime during the 4week period ending with the reference week. Persons
who were waiting to be recalled to a job which they
had been laid off need not have been looking for work
to be classified as unemployed.
Not in the Labor Force
• Not in the Labor Force
– A person who is part of the working population, but is
neither unemployed nor employed.
– Discouraged Workers
• Persons not in the labor force who want and are available for
a job, but are currently not looking for employment because
they believe no jobs are available.
– Marginally Attached Workers
• Same, but no comment on what they believe
Strange Results
• Can an increase in economic activity increase
the unemployment rate?
• YES
The US Labor Market
April 2009
(thousands)
May 2012
(thousands)
%
Change
Total working
population, TP
235,272
242,966
3.27%
Labor Force
154,731
155,007
.18%
Employment
141,007
142,287
.91%
Unemployment
13,724
12,720
-7.32%
80,541
87,958
9.21%
740
830
12.16%
2,100
2,423
15.38%
Not in Labor
Force
Discouraged
Workers
Marginally
Attached
Definitions
Population
(>= 16 years old)
Labor Force
Employed
•
•
•
•
Not in the Labor Force
Unemployed
Labor Force Participation Rate LFPR = LF / TP
Employment Rate ER = E / LF
Unemployment Rate UR = U / LF
Employment-to-population ratio EP = E / TP
The US Labor Market II
Variable
April 2009
May 2012
Labor Force Participation Rate, LFPR
65.8%
63.8%
Employment-to-population ratio, EP
59.9%
58.6%
Unemployment Rate, UR
8.9%
8.2%
Labor Force Participation
100
90
80
70
60
50
40
30
20
10
0
1950
•
•
•
Total
Men
Women
1960
1970
1980
1997
Labor force participation is on the rise overall
LFP rates for men are falling,
those for women are rising dramatically.
Avg hours worked per week have also fallen substantially.
while
Labor Force Participation Rates by Gender,
1950–2004 and today
• And today
– 2012
63.8%
70.3% (73.2%) 57.8% (59.4)
Unemployment Rate
30
25
20
15
U-rate
10
5
1990
1980
1970
1960
1950
1940
1930
1920
1910
1900
0
• Unemployment rate = U/LF
• If u-rate  5%, we call the overall labor market “tight” – hard for
employers to fill jobs ; if u-rate  7% is “loose”
• Loose during Great Depression; Tight during WWII
• Trends: average u-rate has  (non-war, non-GD years)
the variance has 
• Conclusion: Labor market is more stable now, but at higher level of unemp
Distribution of Employment
% of Employment
60
50
Agriculture
40
Manufacturing
30
Services (nongovt)
Govt services
20
10
•
•
•
•
•
0
19
8
0
19
6
0
19
4
0
19
2
19
0
0
0
Major patterns?
Agricultural employment has declined dramatically,
while services has expanded
Size of government has nearly quadrupled
Workers and firms adapted, and must continue to adapt (demographic)
These are “snapshots” and miss job transitions that occur between time
points. 1972-86, 11% of manuf jobs destroyed annually, 9% created 2% net
loss
Industries and Occupations
• Agricultural employment has decreased drastically while
employment in services has gone up
• Goods producing jobs kept pace with with increased
employment till 1970 and started declining after that
• Largest increase in the service sector
• Large increase in government sector
• Movement from “primary” via “secondary” to “tertiary”
sectors
• Arrival of the Post-industrial state
Unemployment and Long-Term Unemployment,
Selected European and North American Countries,
2003
Relationship between Wages, Earnings,
Compensation, and Income
Earnings and Compensation
• Total Compensation—Sum of all types of
employee compensation: wages and salaries,
non wage cash payments, and fringe benefits
– Benefits—health insurance, paid vacation,
overtime pay, and paid sick leave
• Gross Total Earnings—Earnings for a period of
time (like a year) before any deductions (like
taxes).
• Straight-time gross earnings—Earnings net of
payroll deductions, but exclude overtime and
other monetary payment
Earnings and Income
• Straight-time Wage rate = price of labor per hour
– Money you’d lose per hour if you had an unauthorized absence. So a
sick day becomes an “employee benefit”.
– e.g., if paid $100 total comp. for 25 hours: 20 spent working, 5 vacation
– then we’ll call the wage $4/hour. Not $5/hour. $80 wages, $20 benefit.
• Structure of Compensation
– Wage rate * hours worked = Earnings
– Earnings + Employee benefits = Total Compensation
– 70% of Total Compensation is from earnings, on average
– Total Compensation + Unearned income = Income
• Nominal vs. Real wages
– Nominal wage = wage in current dollars
– Real wage = nominal wage / some measure of prices
• it is used to indicate a level of purchasing power, so we can
compare across time
• earn $100/day and book costs $50, real wage = 2 books per day
Real wages of U.S. workers
(non-supervisory workers in private sector)
• What happened to real wages from 1980 to 2003?
• Nominal & Real wages
1980
1990
2003
2012
– Avg hourly earnings
$6.80 $10.19 $15.38 $20.12
– CPI (base = 1982-84 = 100)
82.4 130.7 184.0 224.6
– Avg hourly earnings
$8.30
$7.80 $8.36 $10.24
in 1982-84 dollars
– Avg hourly earnings
$15.27 $14.35 $15.38 $16.48
in 2003 dollars
• Nominal wages rising, but prices of good/services also rising,
 need to deflate by CPI (fixed bundle of food, housing, clothing, etc.)
• Set cost of our “bundle” in the base period (1982-1984) = 100.
$1 in 2003 appears to buy less than *one-third* what a 1980 $1 did.
• Conclusion: Real wages were stagnant from 1980 to 2003.
• Problems with using a fixed bundle?
The Earnings of Labor
• Nominal and Real Wages
• Nominal wage is what workers get paid in
current dollars
• Real wages are a better measure since they
indicate the purchasing power of those
nominal wages
• Real Wage = (Nominal Wage/Price Index)*100
Consumer Price Index
• Tracks the cost of a fixed basket of goods
• Problems with CPI
– Substitution bias
– Introduction of new goods
– Unmeasured quality changes
Dollar Figures from Different Years
• Do the following to convert dollar values from
year T into today’s dollars:
𝐴𝑚𝑜𝑢𝑛𝑡 𝑖𝑛 𝑇𝑜𝑑𝑎𝑦 ′ 𝑠 𝐷𝑜𝑙𝑙𝑎𝑟𝑠 =
′
𝐴𝑚𝑜𝑢𝑛𝑡 𝑖𝑛 𝑇 𝑠 𝐷𝑜𝑙𝑙𝑎𝑟𝑠 ∗
𝑃𝑟𝑖𝑐𝑒 𝐿𝑒𝑣𝑒𝑙 𝑇𝑜𝑑𝑎𝑦
𝑃𝑟𝑖𝑐𝑒 𝐿𝑖𝑣𝑒 𝑖𝑛 𝑌𝑒𝑎𝑡 𝑇
Dollar Figures from Different Times
• Do the following to convert (inflate) Babe
Ruth’s wages in 1931 to dollars in 2005:
Salary2005
= Salary1931
Price level in 2005
Price level in 1931
195
= $80,000
15.2
= $ 1,026,316