topic 12: labor markets

what is the labor market

we assume markets are perfectly competitive, so workers and firms take market price = wage as given, quantity = hours worked or number of employees

whats labor demand

firms looking for workers

whats labor supply

individuals looking for jobs

from demand (=firm’s) point of view

marginal cost = wage

marginal benefit = marginal revenue product = marginal product * price of product

labor demand equals what?

= marginal revenue product

what way is labor demand sloping and why

it is downward-sloping because

• diminishing marginal product of each new worker

• declining output prices (declining demand for output this firm produces)

• labor-capital substitution (higher wages make machines relatively cheaper)

what shifts labor demand curve

• demand for firm’s output

  • labor demand is a derived demand → depends on demand for produced product, the higher the demand for workers

• Capital stock, capital prices

  • Firms choose optimal combination of labor + capital (=machines)

  • Scale effect: as either input (labor or capital) becomes cheaper, you can produce more, so demand for both inputs increases

  • Substitution effect: as capital becomes cheaper, firms use more machines and fewer workers

  • Typically, machines are complements to high-skilled workers and substitutes for low-skilled workers

• Management and technological progress

  • Techno progress may allow firms to hire fewer workers in principle

  • In practice, this usually doesn’t happen, instead leads to economic growth

from supply (=”workers”) point of view:

marginal cost = opportunity cost of your time = leisure

marginal benefit = wage received

labor supply is what?

marginal benefit of leisure

what way is labor supply sloping

upward

supply curve is derived via 3 decisions

intensive margin: how many hours do people want to work at given wages

• implies that labor supply can be upward or downward sloping both

whats substitution effect

work is more attractive than leisure at higher wages

whats income effect

you don;t have to work as much to get the same pay

whats extensive margin 1

how many people choose to work

• higher wages make work more attractive relative to alternatives (study, homemaking, retirement)

extensive margin 2

which profession does each person choose

• higher wages incentivize people to switch professions

what shifts labor supply curve

• wage changes in other jobs induce workers to switch jobs

• income and payroll taxes reduce labor supply (supply curve shifts up)

• income support programs affect the opportunity cost of work. larger income support induces less work

• changes to opportunity cost of leisure (because of social norms, technology)

what are demand factors that explain wages

human capital (knowledge and skills that make workers productive)

signaling (education works as a signal of worker properties that can’t be observed directly, what you learn is not important)

what are supply factors that explain wages

compensating differential = wage premium/penalty to compensate for unpleasant/pleasant work

seek out: jobs with premiums for dis-amenities that do not bother you as much as an average person

avoid: jobs with high penalties for amenities that you do not values as much as an average person

other factors that affect wages

minimum wages, unions, licensing, monopsony power, discrimination

minimum wages

lead to loss of jobs and increase in unemployment, works best when labor demand elasticity is low (i.e. labor demand is inelastic)

unions

lead to higher wages through restriction of labor supply and increased bargaining power

licensing

leads to higher wages by restricting labor supply by requiring credentials, ensures quality of work

monopsony power

leads to lower wages by allowing firms to use their power to reduce salaries/benefits

discrimination

leads to lower wages for discriminated individuals, segregation, and inefficient use of resources as workers are not assigned to jobs/skills at which they have biggest comparative advantage

taste discrimination/prejudice

outright dislike for members of certain groups

Statistical discrimination

use of stereotypes (or actual true averages) to infer qualities of workers based on their observable characteristics. If the stereotypes are correct, outcomes are not worse on average, but most qualified workers are hurt

implicit bias

unintentional discrimination due to associations