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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