Labor Market and Capital Markets Flashcards

Chapter 11: The Labor Market

Chapter Objectives

• Discuss the tradeoffs between work and leisure based on substitution and income effects.
• Explain why an individual’s labor supply curve is backward-bending.
• Describe the factors that can change labor supply and demand.
• Determine the competitive market equilibrium for labor.
• Identify ways in which economic discrimination can occur in the labor market.
• Describe the concept of segmented labor markets and their effect on wage levels.
• Identify federal laws and policies aimed at combating discrimination.
• Describe the history, costs, and benefits of trade unions.
• Discuss how the labor market has adapted to changing economic conditions.

Competitive Labor Markets

• Similar to competitive product markets with key assumptions:
  • Firms operate in competitive industries with many buyers and sellers, a homogeneous product, and easy entry and exit.
  • All workers are regarded as equally productive.
  • Information in the industry is widely available and accurate.

The Supply of Labor

• Definition: The number of hours an individual is willing to work at various wage rates.
• Reservation Wage: The lowest wage at which an individual is willing to work.

Individual Labor Supply

• Substitution Effect:
  • Workers choose more hours as wages increase because the opportunity cost of leisure increases.
• Income Effect:
  • Workers choose fewer hours as wages increase and more hours when wages decrease.
• Backward-Bending Individual Labor Supply:
  • At higher wage levels, the income effect may dominate the substitution effect, leading individuals to work fewer hours.

Market Labor Supply

• Unlike individual labor supply curves, the market labor supply curve is positively sloped.
• Higher wages attract more workers (e.g., point a to point b).
• Market labor supply can shift (e.g., point a to point c) in response to various factors.

Shifts in Labor Supply

• The following factors can shift the labor supply curve:
  • Demographic changes
  • Nonwage aspects of jobs
  • Wages in alternative jobs
  • Nonwage income

The Firm’s Demand for Labor

• Derived from the demand for its product and the productivity of labor.

Marginal Revenue Product (MRPL)

• The amount of additional revenue one worker earns for the firm.
  • MRPL = MPPL \times MR
• MPPL (Marginal Physical Product of Labor):
  • The additional output from adding one more worker.

Value of the Marginal Revenue Product (VMPL)

• In competitive labor markets, the firm is a price taker, which means MR = P. Therefore:
  • MRPL = MPPL \times P = VMPL
• For competitive firms, profit is maximized when labor is hired to the point where VMPL = \text{Wage Rate}.
• Firms hire workers based on their value relative to their cost:
  • MRPL = W

Shifts in Labor Demand

• The following factors can shift the labor demand curve:
  • Changes in product demand
  • Changes in productivity
  • Changes in the prices of other inputs

Market Demand for Labor

• Aggregation of individual firms' labor demand.

Elasticity of Demand for Labor

• Measures the responsiveness of the quantity of labor demanded to changes in wages.
• Factors include:
  • Elasticity of demand for the product.
  • Ease of input substitutability.
  • Labor’s share of total production costs.

Economic Discrimination

• Workers of equal ability and productivity are paid different wages or are otherwise discriminated against.
• Result: Members of different groups are segregated into different occupations.

Becker’s Theory of Discrimination

• Argument: Discriminatory firms must pay higher wages for “preferred” workers, resulting in higher costs and lower profit.
• Non-discriminating firms can hire from a larger supply of workers at lower wages, resulting in lower costs and greater profit.
• Conclusion: Pressures of market competition should drive discrimination to zero in the long run.

Limitations to Becker’s Theory

• Adjustment costs of firing unproductive workers and hiring new workers can be high.
• Some workers (such as single parents) may be less willing to accommodate employer’s demands (such as travel).
• Some workers choose more flexible career paths that do not penalize extended absences from the labor market.

Segmented Labor Markets

• Occur when labor markets split into separate parts, leading to wage differentials.
• Theories include:
  1. Dual Labor Market Hypothesis: Labor market is split into primary and secondary sectors.
  2. Job Crowding Hypothesis: Occupations are separated into predominantly male and female jobs.
  3. Insider-Outsider Theory: Workers are segregated into union and nonunion sectors.

Job Crowding/Dual Labor Market

• Discrimination in male-dominated jobs shifts the supply left, pushing wages higher, while wages in female-dominated jobs decrease.

Public Policy to Combat Discrimination

1. Equal Pay Act of 1963: Requires that women and men receive equal pay for equal work.
2. Civil Rights Act of 1964: Prohibits discrimination based on race, color, sex, religion, or nationality.
3. Executive Order 11246: Established affirmative action.
4. Age Discrimination in Employment Act of 1967: Protects workers over age 40 from age discrimination.
5. Americans with Disabilities Act (1990): Prohibits discrimination based on physical or mental disabilities.
6. Equality Act (Proposed): Would prohibit discrimination based on sexual orientation or gender identity.

Unions

• Associations of employees that bargain with employers over the terms and conditions of work.

Types of Unions

• Craft Union: Represents members of a specific craft or occupation (e.g., air traffic controllers—NATCA).
• Industrial Union: Represents all workers employed in a specific industry (e.g., auto workers—UAW).

Benefits vs. Costs of Union Membership

• Benefits include:
  • Higher wages and job benefits through collective bargaining.
  • Greater job security against arbitrary or vindictive decisions by management.
• Costs include:
  • Membership dues.
  • Costs of strikes (lost wages).
  • Loss of some individual flexibility.

Types of Union Structures

• Closed Shop: Only union members are hired.
• Union Shop: Nonunion workers can be hired but must join the union within a specified time.
• Agency Shop: Nonunion workers may be hired but must pay dues for the union’s services.

Brief History of American Unions

• Wagner Act (1935):
  • Prohibited a variety of unfair labor practices, including firing workers for engaging in union activities.
  • Required employers to “bargain in good faith.”
• Taft-Hartley Act (1947):
  • Prohibits unfair labor practices by unions.
  • Helped balance the Wagner Act by outlawing closed shops and permitting states to pass right-to-work laws.

Unions and Wages

• Union membership as a percent of U.S. workers fell steadily since the 1970s, but has stabilized since 2018.
• The average union wage is 10% to 20% higher than the average nonunion wage within the same industry.
• Unions reduce labor supply to push wages higher; this causes an increase in supply in the nonunion sector, reducing wages.

Jobs of the Future

• Focus more on services, such as health care, transportation, and information technology.
• Increased technology and the growth of high-skilled jobs have led to greater importance of education.

Key Concepts

• Supply of labor
• Reservation wage
• Substitution effect
• Income effect
• Demand for labor
• Marginal physical product of labor
• Marginal revenue product
• Value of the marginal product
• Elasticity of demand for labor
• Economic discrimination
• Segmented labor markets
• Closed shop
• Union shop
• Agency shop
• Right-to-work laws

Chapter 12: Land, Capital Markets, and Innovation

Chapter Objectives

• Explain the impact that the supply of land has on product markets.
• Determine the present value of an investment.
• Compute the rate of return of an investment.
• Describe how businesses acquire financial capital.
• Describe the relationship between education and earnings.
• Demonstrate how market equilibrium levels for human capital are determined.
• Describe the impact of economic profit on entrepreneurs and markets.
• Explain the role of innovation in improving the standard of living.

Factors of Production

• Land
• Labor
• Capital
• Entrepreneurial Ability

Land

• The supply of land is perfectly inelastic; therefore, the payment for its use (rent) is determined entirely by demand.
• With the supply of land fixed, rent is determined entirely by demand. When demand increases, rent increases, and vice versa.
• The supply of land is fixed, but can be improved or artificially expanded (e.g., Hong Kong Disneyland built on land reclaimed from the ocean).

Industrial Agglomeration

• Occurs when firms in one industry choose to locate in close proximity to each other.
• This increases the demand for land.

Physical Capital

• Includes all manufactured products that are used in the production of goods and services.
• A firm invests by purchasing physical capital, which entails comparing marginal benefit and marginal cost.

Marginal Revenue Product of Capital (MRPK)

• MRPK is the amount of additional revenue earned when a firm uses one more unit of capital.
• Firms continue to invest until the cost of capital is equal to MRPK.
• The cost-of-capital measure can be simplified by using the interest rate (i), which is determined by the loanable funds market.

Loanable Funds Market

• Determines the interest rate (i), which is used by firms in their investment decisions.

Present Value Approach

• Used to evaluate investments with different returns and different costs.
• It involves discounting, which takes into account that money received today is worth more than money received in the future.

Present Value (PV)

• Present value is the value of an investment (future stream of income) today.
• The higher the interest rate, the lower the present value.
• PV = \frac{X}{(1 + i)^n}
  • Where:
    • X = future payment
    • i = interest (discount) rate
    • n = years before payment is made

Rate of Return Approach

• Rate of return uses the present value formula but subtracts costs. Then solve the equation for the discount rate (i) at which an investment would just break even.
• The more profitable an investment, the higher the rate of return.

Comparing Two Approaches

• Present Value Approach: Calculates the present value of future income from an investment.
• Rate of Return Approach: Calculates the interest rate needed for an investment to break even.

Financial Capital

• Debt versus equity capital
  • Bond: A debt instrument that promises to pay back a certain amount over time.
  • Stocks: Shares of ownership in a company that provide voting rights and profit sharing.

Other Sources of Financial Capital

• Venture Capital: Investment in startup companies with potentially profitable ideas.
• Private Equity: Investment in struggling firms to make them more profitable.

Investment in Human Capital

• Human capital investments, such as education and training, lead to more job opportunities and greater potential earnings.
• Benefits and costs of college.
  • College students incur direct costs and forgo earnings while in school but earn significantly more money over their lifetime.
• Most studies find that college graduates earn significantly more than high school graduates over their working life.

Equilibrium Levels of Human Capital

• The demand for investment in human capital slopes down because:
  • There are diminishing returns to more education.
  • More time in school leaves less time to earn money.
• The supply of investable funds is positively sloped because students use the lowest-cost funds first.

Implications of Human Capital Theory

• Younger people have longer earning horizons and are more likely to invest in human capital.
• The greater the market earnings differential between high school and college graduates, the more people will attend college.
• The more one discounts the future (values the present more than the future), the less one will invest in human capital.
• Education serves as an important signal to potential employers that a worker is intelligent and trainable.
• On-the-job training is typically offered to increase the productivity of a firm’s workers. It can consist of supervisory training or formal coursework.

Entrepreneurship and Innovation

• The ability to take inputs and convert them into valuable products and services.
• Profit: The payment entrepreneurs receive for producing goods and services and assuming the risks of doing so.

Intellectual Property Rights

• A set of exclusive rights granted to an inventor or a producer of creative work, allowing the originator to earn profit over a fixed period.
• These rights provide an important incentive to innovate.

Types of Intellectual Property Rights

1. Patent: Protects inventions.
2. Copyright: Protects writings, music, and other creative works.
3. Trademark: Protects company names and logos.
4. Industrial Design: Protects design of products (such as a car).

Key Concepts

• Rent
• Industrial agglomeration
• Physical capital
• Present value
• Discounting
• Rate of return
• Financial capital
• Collateral
• Face value
• Coupon rate
• Maturity date
• Yield
• Share of stock
• Market cap
• Investment in human capital
• Screening
• Signaling
• On-the-job training
• Intellectual property rights