Labour Economics

Labour Economics

A branch of economics that studies how the labour market works by focusing on participants and their dynamics

What are the stocks in the labour market?

> Children - Aged 0-15

> Employed - 16 or over and work a min 1 hour a week

> Unemployed - 16 or over who don't work but are seeking work

> Economically inactive - 16 or over who don't and aren't actively looking for a job

Why have the type of male jobs changed?

> Technological change - manufacturing becomes capital-intensive

> Demographic

> Globalisation - most primary and secondary sector jobs have been offshored to developing countries

Developments in the UK labour market

> Structural change - Mining and manufacturing jobs down 90% by 2020 (impacted male employment)

> Changes in types of jobs for men - fewer employed in manual jobs

> Changes in types of jobs for women - mostly employed in high-skilled/low-skilled social jobs

> Changes in wages - Since 1980 - 90th percentile wages have increased much more rapidly, creating wage inequality with the 50th and 10th percentile

Firm decisions during labour market recessions

> Lay off workers

> Delay or cancel hiring

> Reduce hours of work

> Reduce pay

Workers decisions in labour market recession

> Don't leave current job

> Stop searching for new jobs - become "inactive" or "discouraged"

Reservation Wage

The reservation wage is the lowest wage rate that leaves an individual indifferent between working and not working.

The Individual Labour Supply Curve

Backward bending individual labour supply curve

Derives from the points shown in the Individual labour supply curve. Shows how as the wage increases, the income effects begin to dominate.

The aggregate labour supply curve

The elasticity of labour supply

> Measures the extent to which hours worked change in response to a change in the wage rate

> Lower than 1 = labour supply inelastic, Less than 1 = labour supply elastic

> Less than zero, labour supply curve is downward sloping (income effect dominates)

> More than zero, labour supply curve is upward sloping (substitution effect dominates)

Randomised Social Experiment

> Select a representative sample

> Randomly assign study subjects to a “treatment” or a “control” group

> The advantage is that treatment and control will be identical (on average) along all other dimensions. The treatment is thus exogenous, which allows us to “identify” a true causal effect.

Before and After Comparison (Difference-in-Differences)

> Key assumption: The growth trend in participation rates between the two groups of women (with vs without children) would’ve been the same

> After the policy, the participation rate of women with single children increased at a faster rate

Hours of Work over the Life-Cycle for Two Workers with Different Wage Paths

Andy earns more than Tom.

> If the substitution effect dominates, Andy will work more hours at a higher wage

> If the income effect dominates, Andy will work fewer hours at a higher wage

Evaluation of the EITC (Earned Income Tax Credit) expansion

> Treatment group: single women with children (no income from spouse)

> Control group: single women without children (not eligible for EITC)

> Impact on labour supply for single women with children shown in the graph:

• Raises income for low earners → shifts budget line up.

• Phase-in encourages more work; plateau provides constant support; phase-out reduces credit gradually.

• Overall → increases labour supply.

Elssa and Liebman study (1996)

> They studied the effect of an expansion of the EITC on labour supply

> Labour force participation of single mothers increased after the expansion of the EITC by an additional 2.4 percentage points

Total product of labour curve

> Output increases as employment increases (at a diminishing rate)

Marginal and Average product curves

> MP curve: Shows the additional output from hiring one more unit of labour. Initially rises due to specialisation, then falls due to diminishing returns.

> AP curve: Shows output per unit of labour . Rises at first, reaches a maximum, then declines as diminishing returns set in.

> MP intersects AP at AP’s maximum point.

The Employment decision in the short run

• The firm employs labour up to the point where VMPe = w

• Profit maximisation also requires that the VMPe is declining so we are at point C and not point A

• The wage will always be less than or equal to VAP

Short-Run Labour Demand Curve

Employment decision in the Long Run

> In the long run, all inputs can be changed

> An isoquant is used that describes all combinations of K and E which produce the same level of output

Slope of the Isoquant

> How much capital is needed to replace each unit of labour without a decrease in production

> The ratio is called the marginal rate of technical substitution (diminishing between E and K)

In what two ways do firms decided how many workers to hire in the long run?

> Cost minimisation - find the least costly combination of capital and labour to produce a chosen level of output

> Profit maximisation - find the most efficient combination of capital and labour at a chosen level of costs

What is the impact of a wage decrease on the long-run demand for labour?

> Scale Effect - Firm takes advantage of cheaper labour by expanding production

> Substitution effect - Firm takes advantage of the wage change by rearranging its mix of inputs (i.e. output stays constant, employment increases, and capital decreases)

Elasticity of Labour Demand

> Measures the extent to which employment changes in response to a change in the wage

> If 0 > δ > -1, the elasticity of labour demand is inelastic

> If δ < -1, the elasticity of labour demand is elastic

Elasticity of substitution

> Measures how easy it is to replace one input (labour) with another (capital)

What are Marshall’s 4 rules of derived demand?

1. Labour demand is more elastic the greater the elasticity of substitution

2. Labour demand is more elastic the greater the elasticity of demand for the output

3. Labour demand is more elastic the greater labour’s share in total costs

4. Labour demand is more elastic the greater the supply elasticity of other factors of production

The Cross-Elasticity of Factor Demand

How do you determine if two inputs are substitutes or complements?

> Two inputs are substitutes if:

• The cross-elasticity is positive

• The elasticity of substitution between the two inputs is large

> Two inputs are complements if:

• The cross-elasticity is negative 

• The elasticity of substitution between them will be small