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
– 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
– 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
– Tax earnings
– Training
– Payroll tax
– Affirmative action
– Illegal labor
– Immigration
 Introduction
• Methodology
– Scientific Method
• 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
• 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)

•
 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

• W is an endogenous variable
• N and are exogenous variable

– As always, we do this step by step.

– Comparative Statics
• Positive effect from wage, W
• Negative effect from alternative wages,
• 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
 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

• 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 4-
week 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 May 2012 %
(thousands) (thousands) Change
Total working 235,272 242,966 3.27%
population, TP
Labor Force 154,731 155,007 .18%
Employment 141,007 142,287 .91%
Unemployment 13,724 12,720 -7.32%
Not in Labor 80,541 87,958 9.21%
Force
Discouraged 740 830 12.16%
Workers
Marginally 2,100 2,423 15.38%
Attached
 Definitions
P o pu lation
(> = 1 6 ye a rs o ld)

L a bo r Fo rce N o t in th e L ab o r Fo rce

E m plo yed U n e m p lo yed

• 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 Total
50 Men
40 Women
30
20
10
0
1950 1960 1970 1980 1997

• Labor force participation is on the rise overall

• LFP rates for men are falling, while those
for women are rising dramatically.
• Avg hours worked per week have also fallen substantially.
 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

0
1900

1910

1920

1930

1940

1950

1960

1970

1980

1990
• 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
60

50 Agriculture
% of Employment
40 Manufacturing

30 Services (non-
govt)
20 Govt services
10

• 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:
Dollar Figures from Different Times
• Do the following to convert (inflate) Babe
Ruth’s wages in 1931 to dollars in 2005:
Price level in 2005
Salary2005 = Salary1931
Price level in 1931

195
= $80,000
15.2

= $ 1,026,316