EC 350

general elasticity

Ed = (percentage change in quantity of labor demanded)/ (percentage change in wages) Ed = (change in quantity)/(average of quantities) ÷ (change in wages)/(average of wages)

Elasticity of Labor

(%change in quantity of labor supplied)/(%change in the wage rate)

Use the Becker Household model (talking about uses of time and comparative advantages) to discuss how each of these societal changes affected the changing labor force participation rates of women in the past 60 years. (2 points each)

(a) Reduced birth rates and availability of birth control As women have fewer children, there is less demand of their time for child-rearing, and they have (or are perceived to have) less of a comparative advantage in childrearing. Therefore, they can spend less time on household production (which includes childcare) and more on working. 2(b) Increasing wages and availability of jobs for women As women have access to higher-paying jobs, and jobs that women previously held increased in wages, men no longer have as much of a competitive advantage in earning wages, so women enter the workforce at rates closer to men. Also, with increased wages, households can substitute toward good-intensive commodities, and require less time on household production. Therefore, women have more time available to work, and do so. (c) Increasing household productivity Technology has increased how productive people can be in the house, though better appliances, ready-to-eat meals, more powerful cleaning products, and more. While the substitution effect would suggest more time is spent on housework if you're more productive at it, the income effect dominates here, as doing more housework is not very useful, past a point. Therefore, women spend less time on household production and more time in the labor force.

Assume that in a household, two parents (a husband and wife) work the same amount for the same amount of money. Thinking about household production, comparative advantage, and the added-worker effect, state how each of these changes would affect the hours worked by both the husband and the wife. (2 points each)

(a) The wife receives a promotion and a large raise. The wife now has the comparative advantage in earning wages, so she will work more hours. The husband then will work fewer hours to make up for housework, and from the income effect. (b) The husband loses his job. The wife works more hours, from the added worker effect. The husband will work fewer hours, but will spend time trying to find a new job. (c) The husband takes a class in home repair and yard maintenance. The husband now has a comparative advantage in housework, so he will spend more time on housework and less time working. The wife then will work more to compensate. 1(d) They have a young child that the wife needs to breastfeed. Now the wife has a comparative advantage in child-rearing, and will work less (or find a job where she can breastfeed while working). The husband will then work more.

Wage Constraints

*Individuals face budget constraints between income and leisure based on the wage rate they face The wage rate is the rate at which individuals can exchange time for income Higher wages = steeper budget; lower wages = flatter budget

Many individual labor curves are backward-bending, but the market labor supply curve has a positive slope everywhere. Why is this?

*this can be explained by the income and substitution effects. As the wage rate rises, the labor supply curve for a typical person first is positively sloped as the substitution effect swamps the income effect; eventually the curve becomes negatively sloped (turns backward) as the income effect of further wage rate hikes exceeds the substitution effect.

Product Monopoly

A firm who has a product monopoly faces a downward-sloping demand curve, so hiring more workers causes the price of the product to fall Because the firm can't price discriminate its products, this means that its Marginal Revenue Product is less than the Value of Marginal Product The firm follows the MWC = MRP profit-maximizing rule, but because MRP ¡ VMP, it will hire less labor than a competitive firm

Labor Monopsony

A monopsony is a market with a single buyer: in this case, only one firm demands a particular type of labor In this case, in order to hire more workers, the firm must raise wages for all its workers - it cannot price-discriminate. Therefore, Marginal Wage Cost ¿ Average Wage Cost. Therefore, workers will be paid less than their marginal productivity The firm sets MRP = MWC as usual, but only pays AWC to each worker

perfectly competitive labor market

A perfectly competitive labor market assumes a large number of firms and workers, no market power over wages, and perfect information and mobility - the same setup we saw for job training A decent approximation for some industries (fast food, retail clerks, etc.), but obviously not for most other industries The interaction of labor supply and labor demand creates a market wage rate that all market participants view as a given

Business Cycle Effects

Added-worker effect: when one household member becomes unemployed, other household members increase their labor supply (and thus total labor force participation). Discouraged-worker effect: when the economy gets worse, it gets harder to find a job, and the unemployed may become discouraged and leave the labor force. Labor force participation is pro-cyclical: it is higher in good times, lower in bad - the discouraged-worker effect appears to dominate.

Which industry would likely have a steeper market labor supply curve: aerospace engineers, or administrative assistants? Why?

Aerospace engineers take much more education and training that administrative assistants, and therefore it is much more difficult to enter that particular labor market. Therefore, engineers would have a steeper market labor supply curve.

Racial Differences

African-American women started with much higher labor force participation than white women, but this gap has narrowed African-American men started about the same as white men, but now have slightly lower participation Differential discrimination, lower education and pay, and government benefits all affect these trends

allocative efficiency

An allocation is efficient when every worker is being as productive as possible with their time, through labor, leisure, or anything else. A worker's marginal contribution in production = Value of Marginal Product So, in an efficient allocation, the VMP for every firm should be equal

Individual Firm

An individual firm faces a flat labor supply curve, so the Marginal Wage Cost = Average Wage Cost Each firm hires workers until the Marginal Revenue Product = Marginal Wage Cost to maximize profits For a competitive firm, the Marginal Revenue Product = Value of Marginal Product

Many individual labor curves are backwards-bending, but the market labor supply curve has a positive slope everywhere. Why is this?

As the wage rate goes up, more individuals enter the particular labor market, from outside the labor force or from other industries. This keeps the labor supply curve bending outwards.

Which condition divides Stage IB from Stage II in a firm's production function?

Average Product = Marginal Product - Same as Average Product reaches a maximum.

Monopoly and Efficiency

Because a monopolist hires workers such that MWC = MRP instead of VMP, the labor market outcome is inefficient Additional workers could produce more output more valuable than their time, but because they would bring down the price of the product, the firm doesn't hire them. The net value to society could be increased by hiring more workers, but at the expense of the firm

What affects the elasticity of the long-run labor demand curve?

Elasticity of Product Demand - more elastic product demand means more elastic labor demand. Ratio of labor costs - a higher ratio of labor costs means higher elasticity of labor demand, as a wage increase makes a larger difference to firms. Substitutability of other inputs - more substitutability means more elasticity, as labor is more easily replaced by capital and firms can easily switch between them. Supply elasticity of other inputs - more elasticity in other inputs leads to more elasticity for labor demand, as

Female Participation

Female participation has risen at all age levels Domestic situations play a large role in this: married women are still employed at a lower rate than single women Lots of possible explanations; teasing out cause versus effect is very difficult Possible influences: Rising wages for women Changing culture and opportunities Household productivity increases Declining birthrates and birth control Higher divorce rates Maintaining living standards Studies have suggested rising wages are the largest influence

Commodities can be either:

Goods-intensive: requiring lots of purchased goods Time-intensive: requiring lots of time

Gross compliments

If labor and capital are gross complements, a decline in the price of capital will increase the demand for labor. Gross complements are inputs such that when the price of one changes, the demand for the other changes in the opposite direction.

Gross substitutes

If labor and capital are gross substitutes, the decline in the price of capital will decrease the demand for labor. Gross substitutes are inputs such that when the price of one changes, the demand for the other changes in the same direction.

Monopsony and Efficiency

In a monopsony, additional workers could increase efficiency, but reduce the total profits of the firm Additional workers could be more productive than their outside option, but because they would force wages up for other workers, the firm doesn't hire them At the artificially low wage, there appears to be a shortage of labor to the supplier

Which best describes the rationale behind the cobweb model?

Individuals must make labor supply decisions for the future about past information. - Thus, supply adjustment overshoots.

Three uses of time within a household:

Labor market participation Household production Consumption time

Cobweb Model Rationale

Labor suppliers see a particular price and adjust their supply to that price Next, labor demanders see that quantity supplied and adjust their price to that quantity This process repeats itself until labor reaches an equilibrium

Male Participation

Largest trend: reduction in hours for older men. Why? Rising wages and earnings; education Social security, pensions, and other savings Disability benefits Wives entering labor force Younger men have been mostly constant

Determinants of Labor Supply

Many external and internal factors affect labor demand Wage rates in other industries - higher outside wages means fewer workers want to enter Nonwage external income - greater outside income (welfare, disability, etc.) reduces need to work Internal preferences - changing preferences from household dynamics, demographics, etc. can affect labor supply Nonwage aspects of job - Increaseing nonwage income (benefits) and enjoyment of job can increase labor supply Number of workers - More qualified people working means more hours to be supplied

In 2011, the United States had a total population of 311 million. 71 million were under 16 or institutionalized, and 154 million were employed or actively unemployed. What is the labor force participation rate? (3 points)

Potential Labor Force = Total population - Underaged and Institutionalized Population Labor Force Participation Rate = Actual Labor Force / Potential Labor Force Potential Labor Force = 311 million − 71 million = 240 million LFPR = 154 million 240 million = .6417 = 64.2%

Fill in the blanks: the definition of gross substitutes is that for two inputs, an increase in the for/of the first input will cause a(n) in the for/of the second input Which words change for the definition of gross compliments?

Price, increase, demand Increase becomes decrease

Review of factors that affect labor demand:

Product demand - increases the price and thus mnarginal revenue product Productivity - more product produced increases marginal revenue product Other prices of inputs - for gross complements, an increase in price will decrease demand for labor. For gross substitutes, a price increase will increase demand. Number of firms - more firms, more demand

Determinants of Labor Demand

Review of factors that affect labor demand: Product demand - increases the price and thus marginal revenue product Productivity - more product produced increases marginal revenue product Other prices of inputs - for gross complements, an increase in price will decrease demand for labor. For gross substitutes, a price increase will increase demand. Number of firms - more firms, more demand

Economic Perspective

Scarcity Opportunity Costs People make what they perceive to be optimal choices (Optimization) Choices are updated as information, opportunity, or status changes (Adaptability)

Why do we study labor economics?

Socioeconomic issues - labor economics contributes greatly to large-scale economic and social trends, and other visible economic and political issues Quantitative Importance - about 65 percent of US income is in the form of wages and salaries, rather than capital payments. Personal Importance - Most of your personal income will come from labor, and decisions related to labor economics are probably the most important economic decisions you will make.

Applications of Labor Supply

Textiles workers - most textile and apparel manufacturing has been shipped overseas, and the industry has seen increased automation. Therefore, demand for American textile workers has dramatically decreased, and it continues to shrink. Fast food workers - a higher labor force participation rate increased demand for fast food workers, so some tried to recruit homemakers and retirees when they couldn't recruit enough teenagers. Now this has reversed - teens can't get fast food jobs held by older workers. Minimum wage - acts as a price floor for the labor market; can cause unemployment for those making the least money

In the long run, both labor and capital can be varied, so firms can react in more ways to a change in wages - they can vary labor AND capital, and there are more possible effects

The [output effect] is the effect on production of wage rate changes: as the wage rate goes down, production gets cheaper, so they produce more and need to hire more labor. This is what happens in the short run. The substitution effect is the effect a change in the relative price of labor on labor and capital, at a constant production level As labor gets relatively cheaper, the firm will use less capital and more labor, and vice versa. This trade-off depends on the interactions of capital and labor, and technology. Only present in the long run (as capital can't vary in the short run).

Is the added-worker effect better explained by the income effect or the substitution effect? What about the discouraged worker effect? Explain your answer in terms of expected household income and wages. (4 points)

The added-worker effect is when one household member loses a job, other household members increase their labor supply. This is an example of the income effect - household income goes down, so household labor supply increases. The discouraged worker effect is when the economy gets worse and it gets harder to find a job, unemployed workers exit the labor force. When the economy gets worse and it gets harder to find a job, the expected wages earned from a new job and the returns to job hunting are lower, and with lower returns and expected wages, labor supply decreases. This is the substitution effect in action.

What is one way outside intervention could move the market toward labor efficiency?

The government or a labor union could implement a minimum wage of 15, so that hiring the first workers isn't cheaper, and the MWC becomes the AWC in that range.

It shows that those with less education have significantly higher unemployment rates. They also have much lower labor force participation rates. What about the labor market for uneducated workers is different that could cause these differences in outcomes?

The minimum wage mostly affects undereducated workers, which as we have seen creates an oversupply of labor in a particular market, which shows a higher unemployment rate. Although workers may want to work for less than the minimum wage, they cannot, and thus keep looking for jobs. Also, for undereducated workers, dropping out of the labor force could mean becoming homeless, so they keep looking for jobs.

singanlling model

The signalling model says that education does not actually make workers more productive; it merely proves to employers that workers are already good employees: smart, hardworking, and dedicated.

Fundamental aspects of labor supply:

Time is Scarce People prefer leisure over working

Describe the process of creating a market labor supply curve from individual supply curves. (4 points)

To create a market labor supply curve from individual labor supply curves, we simply add together all the hours worked by workers at a particular wage level to find total hours worked. Many of these workers have backwards-bending supply curves. However, workers will enter or exit the labor market depending on wages - higher wages mean more workers will enter the market, which makes the supply curve shift outward

Labor Force Participation Rates

Total labor force participation has risen; male participation went down, but female participation went way up Rising wages through the 1970s, then stagnating wages for the middle class through now affect this Within each sex, age groups reveal more detailed info

Many external and internal factors affect labor demand

Wage rates in other industries - higher outside wages means fewer workers want to enter Nonwage external income - greater outside income (welfare, disability, etc.) reduces need to work Internal preferences - changing preferences from household dynamics, demographics, etc. can affect labor supply Nonwage aspects of job - Increaseing nonwage income (benefits) and enjoyment of job can increase labor supply Number of workers - More qualified people working means more hours to be supplied

MRP VMP MWC calculations

We can then calculate the marginal revenue product (MRP) by calculating total revenue at each unit of labor, and calculating the differences here We can also calculate the value of marginal product (VMP) by multiplying marginal product by price - these will give the same results at this point Firms maximize profits by setting MRP equal to marginal wage cost (MWC): MRP = MW C The labor demand curve is thus a graph of MRP versus units of labor

State whether the following changes would make a person more or less likely to go to college: (1 point each)

i. Decreasing the wage premium for college. Less likely - lower benefits to college mean attendance is less valuable. ii. Increasing the discount rate. Less likely - caring less about future benefits makes them seem less valuable. iii. Increasing the difficulty of passing classes. Less likely - a higher likelihood of failing makes future benefit less valuable, and higher effort costs effectively make it more expensive. (Note: it might be possible to tell a story about more difficulty = higher wages later) iv. Reducing discrimination in the labor market against that person's type. More likely - less discrimination likely means higher wage benefits.

Give an example of a type of capital used by the following occupations. List whether you expect it to be a gross substitute or compliment, and why.

i. Garbage Collector: Garbage truck; probably a gross compliment, as there needs to be a collector for every truck. However, a particular device on the truck might be a gross substitute if it makes workers much more productive. ii. Movie Crew worker (camera operator, lighting director, etc.) Movie camera; gross compliment, as each camera needs an operator iii. Restaurant Chef Possible example: automatic vegetable slicer; gross substitute, as it reduces the need for chef prep work

State whether the market supply curve for school custodians would shift inward, outward, or not change from the following situations, and why: (2 points each)

i. The school offers a large wage increase to custodians. The supply curve would not change. This is a shift of the demand curve along the supply curve. ii. Students start vandalizing bathrooms, making the custodian's job much more annoying. The supply curve would shift inward (to the left), as custodians would demand more money for the same amount of work, because they enjoy it even less. iii. An outside custodial staffing company decreases its wages. It would shift outward (to the right) - outside options for workers decrease, so more are willing to work for less iv. The school purchases new cleaning equipment, making custodians more productive. This affects the demand curve - the supply curve would not shift

substitution effect

indicates the change in the desired hours of work resulting from a change in the wage rate, keeping income constant. the substitution effect merely tells us that when wage rates rise and leisure becomes more expensive, it is sensible to substitute work for leisure. For a wage increase, the substitution effect makes the person want to work more hours.

The zone of production

occurs in stage II, when the marginal product of labor is positive but declining. Producing in any other zone is inefficient.

Income effect

refers to changes in the desired hours of work resulting from a change in income, holding the wage rate constant. if we make a reasonable assumption that leisure is a normal good-a good of which more is consumed as income rises-then we can expect that a part of one's expanded income might be used to "purchase" leisure. when wage rates rise, and leisure is a normal good, the income effect reduces the desired number of hours of work.

The law of diminishing marginal returns

when a variable resource is added to a fixed resource, at some point the marginal product of the variable resource will decline.