ECON 1 Chapters 11-13

The Demand for Superstars

"Winner take all" labor market -- get really large salaries for a small percentage of people; all those who did not make it do not make money

How many workers?

*or how many hours of worker labor should you hire? [Replace "worker" with "hours.] - Marginal principle: Should we hire one more worker? - Cost‐benefit principle: Yes, if the marginal benefit exceeds the marginal cost. - Marginal cost of hiring one more worker: their wage - Marginal benefit of hiring one more worker is marginal revenue product

Why Your Labor Demand Curve Is Downward‐Sloping

- Higher wages decrease the quantity demanded 1. Diminishing marginal product 2. Declining output prices 3. Labor‐capital substitution (Higher wages make machines cheaper, relative to labor.)

Inequality and Poverty in US

- Income Inequality Has Been Rising Since the Late 1970s - The Very Rich Are Getting Richer - The U.S. Has Greater Income Inequality Than Other Advanced Democracies - The Poor in the U.S. Are Among the Global Rich - The pie chart understates how heavily concentrated wealth is within the population - Measured Poverty Isn't Declining Actual Poverty Is Declining

Labor Supply

- Labor supply is all about the marginal benefit of leisure. - If you follow the rational rule: Your labor supply curve is also your marginal benefit of the leisure curve. - Labor supply is very inelastic almost perfectly inelastic

Demand for workers

- Law of demand applying to buying worker time - Lower wages lead to an increase in the quantity demanded. -- use workers instead of machines -- increase production

Supply of workers

- Law of supply applied to selling worker time - Higher wages lead to an increase in the quantity supplied. -- More people want to work.

What determines wage?

- Like all markets, the labor market is driven by supply and demand. - Prices in the labor market are hourly wages - Prices provided by potential workers - Quantities in the labor market are hours of work. - Quantities of hours that can be purchased by firms - Buyers are employers. - Sellers are employees - The forces of supply and demand determine the wage and total employment.

"Insurance death spiral"

- people who are relatively less likely to lose their jobs become less likely to buy insurance --> higher payouts per policy --> higher prices --> repeat

Costs of Redistribution

1. Administrative costs 2. Taxes reduce the incentive to work 3. Means‐tested programs raise effective marginal tax rates 4. Moral hazard leads people to make riskier choices 5. Tax avoidance, tax evasion and welfare fraud 6. Wasteful lobbying by interest groups

Career Adivce

1. Choose a profession where the good is likely to be highly demanded. 2. Falling machinery prices will cause: Rising wages for high‐skill labor

Three factors that explain wage differences

1. Demand: Worker characteristics 2. Supply: Job characteristics 3. Institutions

Where does labor supply come from?

1. Existing baristas have to decide how hard to work. Individual level 2. Work versus alternatives 3. Existing workers become baristas.

Why Does Education Raise Your Earnings?

1. Human capital: increases your productivity. -- You learn useful skills and soft skills. -- The longer you stay in training, the more skills you accumulate and you sell those skills in the labor market and you earn a higher wage 2. Signaling -- Tenacious workers are more likely to complete college. -- If it was less costly to more motivated people. And it is more costly for unmotivated people but it is cheap enough or not sufficiently costly to stop the motivated people from doing it to prove they are motivated.

How Many Hours to Work

1. Marginal principle: Should I work one more hour? 2. Cost‐benefit principle: Yes, if the marginal benefit exceeds the marginal cost. - Marginal benefit of an hour of work = Hourly wage 3. Opportunity cost principle 4. Implies: Work another hour if Wage > Marginal benefit of leisure

How can you get more from your workforce?

1. Training: General v. specific skills 2. Incentives: Pay‐for‐performance 3. Corporate culture: Activate intrinsic motivation. 4. Offering the right benefits 5. Attracting the right workers

What Shifts Labor Supply

1. Wages in other occupations --If wages in other jobs rises, Decrease supply of baristas 2. Income and payroll taxes -- Labor supply decisions depend on after‐tax wage. -- Taxes shift before‐tax labor supply curve. Shifting of labor supply curve and it is going to steepen or rotate 3. Income support programs --Increasing the generosity of these programs will decrease labor supply 4. Value of leisure

Three Labor Supply Decisions

1. When you work, how many hours should you work per week? 2. When should you work in the labor market, versus pursuing other alternatives like education, working at home, or retiring? 3. How should you choose which occupation to work in?

Marginal revenue product

= Marginal product × Price of output

Prejudice

A dislike for one group that results in lower employment or lower wages for this group.

Compensating differential

A wage premium that compensates workers for adverse attributes of a job.

Human capital

Accumulated knowledge and skills that make a worker more productive. Empirical evidence: Each year of college raises your long‐term earnings by about 8% per year.

Wealth

All available financial resources

Poverty line

An income level, below which a family is defined to be in poverty.

What Shifts Labor Demand?

Applying the interdependence principle: 1. Shifts in demand for your output --Labor is a derived demand. --you should find something where you provide a scarce, complementary service to something that is getting ubiquitous and cheap 2. Changes in the capital stock --Which effect dominates depends on the size of the scale effect, and how easily capital and labor can be substituted. 3. Management techniques and technological progress --New technologies and better management lead firms to do more with less.

Why Are Top Executives Paid So Much?

As firms have gotten larger, the value of a top CEO has risen

Backward‐bending Labor Supply Curve

At low wages the substitution effect dominates. But at higher wages the income effect becomes more important. Initially you are working more and then eventually you work less. Hit a point where you will not increase your hours at all. At very low wages it's not worth working. As the wage rises the incentive to work rises, and the substitution effect dominates. Income and substitution effects offset exactly. At high wages time is more scarce than money, so the income effect dominates.

Permanent income

Average lifetime income. There is less inequality in permanent income than income at a given point in time.

Rawlsian perspective

Behind the veil of ignorance

Choosing occupations

Benefits: Non‐wage benefits, gaining valuable skills, wage trajectory, enjoyment, working conditions Costs: career risk, physical risk, wage volatility, actual hours worked

Pay for Performance

Commissions: Pay depends on how much the worker earns for the firm. Piece rates: Pay workers for each piece produced. Bonuses: For high‐performing workers Stock options for senior managers Promotions for top performers - Problems arise when "what you pay for" ≠ "what you want."

Diminishing marginal benefit

Each additional dollar is less beneficial (yields a smaller marginal benefit) than the previous

Offering Beneficial Benefits

Employers get tax breaks. Employers have purchasing power. Complements to hard work increase productivity. Minimize substitutes for hard work.

Statistical discrimination

Employers use stereotypes of observable traits (race, gender, age) to infer qualities they can't observe (worker quality, likely tenure with the firm).

Corporate Culture

Extrinsic vs. intrinsic rewards

Substitution effect

Higher wages make work more attractive relative to leisure. Work longer hours. Substitute towards work and away from leisure A high wage provides a stronger incentive to work, leading you to work longer hours.

Rational Rule for Employers

Hire more workers* if their marginal revenue product is greater than (or equal to) the wage (marginal cost). *or more hours of work - similar to Rational Rule for Buyers - Keep hiring until Marginal revenue product = Wage - Following the Rational Rule for Employers leads to the maximum profit.

What Wages Should You Pay Your Workers?

In a competitive labor market, pay market wages

How Economists Collect Facts

Incidence Cross‐sectional comparisons Time series comparisons Cross‐national comparisons Alternative measures

Key Takeaways 3

Inequality is high, rising, and linked to immobility. (linked to parents) Concentration of wealth exceeds concentration of income exceeds concentration of permanent income or consumption. Poverty can be measured in absolute or relative terms. In the U.S., about 14% of the population lives below the official poverty line.

Social insurance

Insurance: A payoff that occurs when bad things happen to protect against economic hardship. Social: Provided by the government.

Should You Work in the Labor Market?

Intensive margin: How many hours should you work? Extensive margin: Should you work in the formal labor market? Opportunity cost principle: What are the alternatives to work? Cost‐benefit principle: Compare benefits with cost of forgoing a wage.

Will a Higher Wage Lead You to Work More or Less?

Is your individual labor supply curve upward‐sloping? (at the intensive margin) Which effect will dominate depends on how you value more time versus more money and what your individual labor supply curve looks like/bends.

Labor Demand

Labor demand is all about the marginal revenue product of labor. If you follow the rational rule: Your labor demand curve is also your marginal revenue product curve.

Occupational Licensing

Licensing: A credential that is required to work in an occupation.

Labor Market Institutions

Minimum wages Unions and bargaining power Occupational licensing Monopsony power Discrimination

Monopsony Power: A Buyer's Monopoly

Monopsony Power: Firm using its power as a major buyer of labor to pay lower wages. Monopsony is like a monopoly, but instead of one seller, there is one buyer. Increases bargaining power of employers.

Utilitarian

Promote the greatest happiness for the greatest number

Implicit bias

Relying on associations instead of complete analysis.

Job‐specific skills

Skills that are unique to a particular employer. Profitable for firms to offer: Unlikely job candidates outside the firm have these skills.

General skills

Skills that many employers find useful. Once the employee has the skills, they can get a better job at another firm.

The Luddite fear

Technological progress will lead to less hiring. --Empirically false --Reduces prices, increasing output which may increase employment.

Absolute Poverty

The adequacy of resources relative to an unchanging standard.

Relative Poverty

The adequacy of your resources relative to others in your society. A measure of social inclusion

effective marginal tax rates

The amount of each extra dollar of earnings that you lose to higher taxes or lower benefits

Extrinsic motivation

The desire to do something for its external rewards.

Intrinsic motivation

The desire to do something for the enjoyment of the activity itself.

Intergenerational immobility

The extent to which the economic status of parents determine outcomes for their children. Higher Income Inequality Associated with Lower Intergenerational Mobility If you look at countries with unequal income, they tend to have lack of intergenerational mobility

Poverty rate

The fraction of people whose family income is less than the official poverty line.

Adverse selection

The greater the likelihood of something happening, the more likely someone is to buy insurance. Adverse selection problem is a private information problem. If you could charge people different prices depending on their risk of a bad outcome, then there would be no death spiral.

Minimum wage

The lowest hourly wage that employers are allowed to pay. How much unemployment do minimum wages create? depends on elasticity of labor demand curve People who keep their jobs are clearly better off At a higher wage rate, more people enter the workforce

The Opportunity Cost of Working

The opportunity cost of work is leisure.

Labor supply

The time you spend working in the market.

How does income redistribution affect well‐being?

Total well-being rises

Unions

Unions represent workers who decide to negotiate jointly with employers. Unions facilitate "worker voice." Increasing their bargaining power and productivity.

Benefit of Redistribution

Utilitarian Diminishing marginal benefit Implication: Maximizing total well‐being involves redistribution since the poor value an additional $1 more than the rich (aggregating)

Discrimination

Wage differences don't necessarily show discrimination exists. To isolate discrimination, we need to compare: remove these features and see if there are any other wage gaps. Discrimination doesn't always yield lower wages. Discrimination is costly: If your staff discriminates Implication: Institute formal hiring procedures which minimize discrimination.

Key Takeaways

Wages and employment are determined in the labor market. Labor demand is the marginal revenue product curve. Labor supply is all about opportunity costs.

What Do Employees Want?

We all want higher wages Compensating differentials encourages people to take unpleasant jobs. Most people do not want to do these jobs. You have to pay people more to do them. Implication: You don't always want a high‐paying job. In reality, people care about wages AND amenities. So people sort into different jobs when they have different preferences.

Substitution effect:

When machinery becomes cheaper, Firms substitute machinery for labor. Substitute toward capital and away from labor. -- decreases labor demand --Machinery is a substitute for low‐skill labor.

Scale effect

When machinery becomes cheaper, Your inputs become cheaper, so you can produce more at each price. -- increases labor demand --Machinery is a complement for high‐skill labor (making you more productive).

Private information

When one party in a transaction knows something the other doesn't. Solution: Social insurance programs work because everyone has to participate.

When Income and Substitution Effects Offset

While the substitution effect leads you to work more hours at a high wage, the income effect leads you to work fewer hours. vertical curve

Rational Rule for Workers

Work more hours as long as the wage is at least as large as the marginal benefit of another hour of leisure. - similar to the rational rule for sellers - Keep working until Wage = Marginal benefit of leisure

Income effect

You don't have to work as long to buy the same amount of stuff. Potentially richer and can buy normal goods. Work fewer hours. A high wage raises your income, and you "spend" this extra income buying more leisure, thereby reducing your hours. You are choosing more hours of leisure and consuming more leisure.

When the Income Effect Dominates

downward sloping curve

Efficiency

is about maximizing total economic surplus. Measured in dollars, not wellbeing

Equity

is how these resources are distributed and who gets what. May enhance average well‐being

When the Substitution Effect Dominates

upward sloping curve