Labor Econ Test
Elasticity of Labor Demand
(% change in employment/% change in wage) (% change in quantity of labor demanded/% change in wage)
Elasticity of Labor Supply
(%∆ quantity of labor supplied/%∆w) or (%∆ hours worked/%∆wage) E = 0, perfectly inelastic; quantity does not change if p changes E < 1, inelastic, quantity changes less than change in p E >1, elastic, quantity changes more than change in p perfectly elastic = quantity changes WAY more than change in p E = 1, unitary quantity changes same as price changes
MRTS
(K/E) = (−MPE/MPK)
Indifference curves have four important properties:
1. Indifference curves are downward sloping • Otherwise, having more C and L would be undesirable 2. Higher indifference curves indicate higher levels of utility • Otherwise, having more C and L would be undesirable 3. Indifference curves do not intersect • Otherwise, one would be indifferent between two bundles in which one has strictly more C and/or L. 4. Indifference curves are convex to the origin • Indifference curves must be convex to the origin if we are ever to observe a person sharing time between work and leisure activities • This assumption also gives us diminishing returns to consumption and leisure.
Assumptions of a Perfectly Competitive Market
1. No Market Power (workers can't set wages, firms can't set prices) [workers choose to supply labor or not] 2. No transaction costs 3. Perfect Information 4. Free Entry and Exit 5. Markets will clear (implications = no involuntary unemployment)
Fall in wage Long Run Demand curve
1. Wages fall 2. MC fall so firms expand (scale effect) 3. Substitution effect; isocost line flattens long run labor demand increases
Three criteria firms meet when they decide to hire
1. w =VMPE • You pay the very last worker you hire (one of the least productive workers) a wage equal to the value of what he produces 2. VMPE is decreasing • If VMPE is increasing, then the next worker is more productive than the last. Therefore, it does not make sense to stop hiring when VMPE is still increasing. 3. If wage is above VAP, hire 0 workers • If wage is above VAP, then the average cost per worker is above the average revenue per worker. The firm would lose money.
SR Labor Demand from Class notes
1. when wages fall, each firms MC changes, expanding production at Po 2. They try to hire more labor along individual labor demand curve, which causes firms to expand supply which causes a fall in Po due to more output in the market 3. VAPL and VMPL will thus decrease, changing the firms short run labor demand curve, individual firm adjusts to a new short run labor demand curve which is shifted in
Substitution Effect
A substitution effect takes into account the changed wages but not the desire to produce more output. This makes the slope of the isocost shallower in the case of a wage decrease. Hence, substitute capital for labor when wage falls.
LR demand curve for Labor
A wage cut does 2 things to the isocost line: 1. It shifts the y-axis intercept downward because your wage bill has decreased 2. It makes the slope shallower firms does not incur the same costs before and after wage change; wage cut reduced the marginal cost, encouraging firm to expand
Scale Effect
A wage drop would encourage the firm to produce more output. A scale effect is this desire for expanded production, but it assumes wages have not changed. This causes outward shifts in the isocost curve
Isoquant
An isoquant describes the possible combinations of labor and capital that produce the same level of output. higher levels - more output dont intersect most isoquants have diminishing MRTS
law of diminishing returns
As more and more workers are added to fixed capital stock, the gains from specialization decline and the MPL of workers decline
Decline in Work Attachment Among Older Workers study 2-13?
Between 1960 and 2001, the labor force participation rate of men aged 55 to 64 fell from 85 to 68 percent. It is likely that this is caused by increased pension benefits. The fraction of men who were covered by pension programs in addition to Social Security rose from 26% in 1950 to 66% in 1990. The probability that men aged 58-63 work falls by 18% if they have private pension plans.
Isocosts
C = wE + rK The line connecting all the various combinations of labor and capital that the firm could hire with C dollars is the isocost line. The slope of the isocost line is −w/r
Elasticity of Substitution
Depends on sub. effect and the curvature of the isoquant more curved, smaller sub. effect (% change in K/E)/(% change in w/r) percentage change in ratio of K/L resulting from a 1% change in the price of labor)
Magnitude of Scale and Sub. Effect
Depends upon production technology, shape of isoquant, substitution of 2 inputs
Elasticity of sub of Inputs relates to elasticity of demand for labor
If E = infinity, and w >r, a firm will not employ anyone (K= K0 and L = 0) If E = infinity, and r >w, a firm will only use labor inputs If E = 0, any change in wage or rent will not change K,L ratio
How is labor demand elasticity related to elasticity of demand for output?
If demand for output is elastic and MC increases, quantity demanded for output will fall by more. As a result, quantity of labor demanded falls by more than it would if demand four output were inelastic. increase in MC causes supply to shift upward (firms supply less due to higher costs)
Long Run Employment Decision
In the long run, firms can chose combinations of how to produce by choosing the optimal amount of labor and capital); maximize profits by choosing L and K capital stock not fixed;
Skill Level and Labor Demand Elasticity
Lower skilled workers are substitutable amongst themselves, labor demand is more elastic substitutes within capital (linear isoquants, change in wage affects unskilled labor disproportionally) higher skilled workers are harder to replace labor demand less elastic complements with capital (angled isoquants) Policy Implication: As technology improves, the gap between employment rates of skilled and unskilled labor will grow, growth in inequality
The Slope of an Indifference Curve
Marginal utility is change in utility resulting from an additional unit of consumption or leisure. We denote this MUC and MUL. It can be shown that the slope of an indifference curve is ∆C/∆L = MUL/MUC MRS = slope; depends on how willingness to pay changes
Short Run Market labor demand vs. Short Run Individual labor demand
Market labor demand not as responsive as that of individual firms Market labor demand is less elastic than individual firms in the SR
Marshalls Rules of Derived Demand
Marshall's rules of derived demand describe situations that are likely to generate elastic labor demand curves in a particular industry 1. Labor demand is more elastic the greater the elasticity of substitution between capital and labor • If it is easy to substitute between capital and labor, workers need to make sure not to ask for too high of a wage or else they will be replace by a machine 2. Labor demand is more elastic the greater the elasticity of demand for the output consumer demand for output affects labor demand curve in terms of employment 3. Labor demand is more elastic the greater labor's share in total cost • If your firm only hires one person to watch a bunch of expensive machines, his wage is not of huge concern to you as it is only a tiny fraction of your cost. 4. The demand for labor is more elastic the greater the supply elasticity of other factors of production, such as capital • A large supply elasticity of other factors of production means that you can buy a bunch of them and not expect the price to go up if you buy a bunch. Therefore, if the factors do not go up in price you can replace a bunch of workers with them
Positive Economics
Positive economics, therefore, addresses questions that can be answered with the tools of economics, without interjecting any value judgment as to whether the particular outcome is desirable or harmful.
At W*
Qd = Qs & VMPL = MRS
Perfect Complements
Suppose there is a horrendous burger-shaping catastrophy and there is a law that is passed that says no human can shape burgers and every machine must be watched over by 2 workers to ensure proper shaping. Therefore, for every 1 machine you have you need exactly 2 workers. If you added a 3rd worker he would not benefit output at all. Therefore, humans and machines are perfect complements in certain proportions production function not influenced by w & r; no substitution at all; K + L are complements ( elasticity = 0)
relationship between MPL and APL
The marginal product curve intersects the average product curve at the average product curve's maximum. That is, the marginal product is above the average product until the average product's maximum, and then it lies below the average product after its maximum.
The Hours-of-Work Decision
The optimal consumption of goods and leisure for the worker is given by the point where the budget line is tangent to the indifference curve. This is the level of goods and services that maximizes her utility. At the optimal points, the slopes are equal. This implies that MUL/MUC = w. This means that in equilibrium, a person is willing to give up an hour of leisure for w units of consumption. w = amount of consumption market will pay you for a unit of time amount of L person is willing to give up to gain more C and stay at same IC = market rate that allows worker to substitute one hour of L for C
The Budget Constraint
The person's consumption of goods and leisure are constrained by her time and by her income. The person's budget constraint can be written as C =wh+V
value of marginal product
The value of marginal product is the marginal product of the worker times the price of the output; that is, VMPE = p ×MPE. This can be interpreted as the dollar value of what each addional worker produces. This is important because it determines how many workers firms decide to hire. Set employment level to the VMPL = W (predetermined)
The Slope of a Budget Constraint
This equation is in the form of a line with the slope of −w . Everything below the line is called the worker's opportunity set.
marginal benefit of a unit of labor
VMPL Stop when P * MPL = VMPL = w MB = MC VMPL > wage, hire more!!
Labor supply curve
Wage Rate vs. Hours of Work initially, positively sloped (Sub effect), then backward bending at higher wages (income effect)
Short Run Labor Demand Curve wage vs. employment
We cannot get the industry's demand curve simply by horizontally adding up firms' demands.This is because each firm's demand curve does not take into consideration its ability to shift price because the firm is too small. If the whole industry, however, decided to hire more workers, this would produce more output which would cause price to fall. This, in turn, would cause VMP to fall which would decrease demand for employees. Therefore, the industry demand curve will have a different slope than the individual firm's demand curve, even if all firms are identical.
Normative Economics
What should be?" questions. By their nature, the answers to these normative questions require value judgments. Because each of us probably has different values, our answers to these normative questions may differ regardless of what the theory or the or the facts tell us.
Aggregate Elasticity of Men and Women
Women's labor supply tends to be inelastic (more elastic for single, childless women than moms, need to pay her more to give up time with kids) = 0.2 different parts of the curve more elastic for woman Men = 0.1, more full time already working long hours, substitution effect not as great for them
Perfect Substitutes
You can substitute a certain number of burger machines for a certain number of workers. For example, you can substitute 3 burger machines for 2 workers and get the same exact output. Therefore, machines and workers are perfectly substitutable. This is represented by the left graph below elasticity = infinity
discouraged worker effect
a worker may find it impossible to find a job during the recession and simply give up. As a result, these workers drop out of the labor force. Thus, we may see lower labor supply during recession.
life cycle path
devote more hours to the labor market when the wage is high and fewer hours when the wage is low contradicts income effect of earlier model does NOT change total lifetime income available to particular worker
Tax assessed on employers
downward parallel shift in labor demand curve wedge between total amount employer must pay to hire worker vs. total amount workers actually receive from employer
added worker effect
during a recession, the mako breadwinner of a household may lose his job and so the secondary workers in the household look for jobs. Thus, labor supply may rise during recession. unemployment insurance system could crowd out wife's labor supply
Labor participation trends
falling since 1950s for men age 25+ Participation Rate = LF/Population Unemployment Rate = Unemployed/Labor Force falling for men 65+
MRS (English terms)
how much you are willing you to give up consumption to gain a unit of leisure and still be as happy if you are going up the curve, how much you are willing to give up a unit of L in return for taking in C (how many additional dollars worth of goods it takes to bribe the person to give up some leisure time)
Labor demand elasticity and Labors Share of Product Costs
increase in wage, when labors share of costs is greater, marginal costs increase more with a wage increase % of output falls more labor demanded dalls more
Short run vs. Long run Elasticity of Demand
long run demand curve is more elastic than short run demand curve
reservation wage
minimum increase in income that would make a person indifferent between remaining at the endowment point E and working that first hour. slope of IC when he is NOT working
Cash Grants (Welfare)
no substiution effect income effect (increase consumption of all goods including leisure, hours worked goes down for these workers) worker's reservation wage goes up ) economic opportunities provided by welfare system better than those available in labor market
Female Labor Supply
opportunities and career options expansion; anti discrimination attitudes change preferences wages Family Size women with children under 6 years old have 20% lower labor participation rates women with 3+ children by and large drop out all together (oral contraceptives may explain 15% of change in female labor force participation)
total surplus (social welfare) is maximized by
perfectly competitive market Market clearing wages suggest that wages coverage across perfectly competitive markets Taking into considerate differences that are explained by different regions (cost of living) Is wage the same market clearing wage?
Profit Maximization
profit=pq−wE−rK firm can't affect w or r
Cash Grants and Hours Worked Clinton Reform of Welfare
see drawing income and substitution effect work incentives reduced; hours reduced still give a cash grant (V), but phase out benefits as you work
Effect of a Change in Non Labor Income
see page 36 V = real non labor income wage (slope) doesn't change with V, H falls signaling pure income effect
Short Run Production
short run holds level of K constant with specialization, output grows at an increasing rate with labor. as you hire more workers, the incremental gains are not as high since capital is fixed; labor can become inefficient.
Convexity implies...
slope of IC is steeper when worker is consuming a lot of goods and little leisure curve is flatter when worker is consuming few goods and a lot of leisure diminishing marginal rate of substitution
Earned Income Tax Credit
tax breaks to people who earn less than a certain threshold who are working; claim a tax credit of 40% of earnings; subsequently, zero tax credit, and negative tax reduction as EITC begins to be phased out EITC will draw workers into the market and increase the hours of work of those who work little EITC will reduce the number of hours worked for those above a certain threshold
average product of labor
the amount of output produced by workers on average
marginal product of labor
the change in total output resulting from hiring an additional worker, holding everything else constant. We assume that the marginal product of labor eventually begins to decline due to diminishing returns to labor.
the neoclassical model of labor-leisure choice
the representative person derives utility from both consumption and leisure where consumption is measured in dollars and leisure is measured in hours.
participant decision
to enter or not to enter the labor market Not working; if Wo < reservation wage (lower indifference curve; Wo < MRS
Assumptions of labor demand model
wage & price determined by the market one skill level and productivity; one kind of job workers = substitutes two inputs: L and K firms sets MB, so that MB = MC of labor workers can have different preferences perfectly competitive price takers access to same technology
Inter temporal Effects Life Cycle Path
wage increases with age taxes increase with income wage (high school) < wage (college); those with college degrees will work work more than those without because of substitution effect people allocate time over their life cycle so as to take advantage of changes
quantity demanded of labor of E
where VMPL = W as long as wage is less than the wage peak of VAPL
cost minimization
where isoquant is tangent to isocost line MB = MC MRTS = w/r 1. last dollar spent on labor yield as much output as the last dollar spent on capital ratio of marginal products to ratio of input prices 2. labor and capital also need to be hired to the point where w = VMPL; r = MPK
Implications of migration
workers and firms search selfishly for better opportunities accomplish a goal that no one in the economy had in mind: an efficient allocation of resources