Labor Economics Exam 2

Income Distribution Trends in the United States (also observed in other countries)

Wage and income inequality have increased over time • Declining income shares for the lowest 60% of households • Increasing income share of highest 20% (and highest 5%)

Quasi-Fixed Labor Outcomes

With QFLC, firms evaluate labor employment as a multiperiod decision QFLC ⟹ the wage rate (W) < MRP, (post-hiring), even in competitive labor markets. Thus, firms receive a net surplus for incurring fixed hiring/training costs Labor Market Implications of the Quasi-Fixed Labor Cost Model • All else equal, the post hiring wage (Wp) is inversely related to the following: • The discount rate, The quasi-fixed hiring/training costs, • All else equal, the post hiring wage (Wp) is directly related to the following: • The expected length of employment - number of time periods, • The post-hiring labor productivity, ceteris paribus) Since W < MRP, (post-hiring), firms may be reluctant to reduce labor employment (layoff workers) when there is a reduction in product demand due to an economic downturn (recession). Thus, the buffer created by the post-hiring net surplus may reduce employment fluctuations over the business cycle. This result is known as 'labor hoarding'. Layoff rates among the less-skilled workers may be higher than among high skilled workers, especially if firms incur greater hiring, training and other quasi- fixed labor costs for highly-skilled workers. If the net surplus (buffer) is greater for high-skilled workers, firms are reluctant to reduce high-skilled employment, then repay the significant hiring costs when economic conditions improve.

Education

Within age groups, workers with higher levels of education have higher mobility rates because they have higher earnings potential and are more likely to search for job opportunities across broader geographic areas that offer more favorable employment prospects

Worker utility function

Workers maximize their utility from employment, not just income (i.e., wages). A worker's utility function is based on a combination of monetary (i.e., pecuniary) and nonmonetary (nonwage) employment attributes (NWAT) -- amenities (or disamenities): 𝑼 = 𝒇(𝑾, 𝑵WAT)

Labor Market Polarization

"...expanding job opportunity in both high-skill, high-wage occupations and low-skill, low-wage occupations, coupled with contracting opportunities in middle wage, middleskill white-collar and blue-collar jobs" Skill-based technological change and/or high-tech investment that increases productivity of highly skilled workers, and reduces the need for low-skilled workers, may increase the relative wages of high-skilled workers. • Structural Changes in the Labor Market such as the decline in manufacturing (i.e., deindustrialization) and unionization, along with the growth of service sector employment and population growth in lower-wage regions may also contribute to a growth in labor market inequality. Labor market polarization also can contribute to growing inequality

Weff and Wpc

(Weff > Wpc⇒ involuntary unemployment)

indifference curves

- Each indifference curve illustrates the combinations of wage and job risk that provide a worker with the same overall level of utility. • Indifference curves are positively sloped -curves are convex. This implies that as a disamenity increases, a worker requires increasing amounts of additional wages. Higher I-curves indicate higher utility • I-curves do not intersect

Law of one price (wage)

: If all jobs and workers are identical, and labor markets are perfectly competitive with complete labor mobility and full information, the wage structure might exhibit zero dispersion. This extreme outcome is unlikely.

Relocation implications

A decrease in the supply of labor in the origin and an increase in the supply of labor at the destination • The wages in each region begin to converge • It is likely that the total market value of output (e.g., GDP) increases for the combined labor markets (i.e., an increase in economic efficiency).

Which one of the following outcomes is not typically offered as a possible explanation for the benefits to a firm that offers efficiency wages? A. Firms never benefit from paying a wage that exceeds the market-clearing competitive wage. An efficiency wage may reduce labor turnover and quit rates and allow firms to reduce hiring and training costs. An efficiency wage may reduce the chances workers will reduce effort (shirk) because the opportunity costs of being terminated have increase. An efficiency wage may be viewed as an employer 'gift', and workers reciprocate by increasing effort and productivity (lowering unit labor costs). An efficiency wage may act as a signal by the firm to attract workers of higher ability and motivation.

A. Firms never benefit from paying a wage that exceeds the market-clearing

Which of the following best describes the concept of 'Human Capital'? A. Skills, knowledge and other attributes embodied in workers that improve labor's contribution to the production of goods and services (productivity). The amount of capital employed by the firm, relative to the level of labor. The direct relationship between the wage rate and labor effort (efficiency). The constancy and predictability of earnings and employment.

A. Skills, knowledge and other attributes embodied in workers that improve labor's contribution to the production of goods and services (productivity).

Hedonic Wage Theory illustrates the concept of compensating wage differentials. Which of the following assumptions is (are) consistent with HWT: A. holding utility constant, workers must be compensated with higher wages to incur additional job disamenities such as injury risk. firms and workers do not have accurate information on the relevant non-wage amenities of jobs. all workers have homogeneous preferences with respect to Disamenities all of the above.

A. holding utility constant, workers must be compensated with higher wages

According to the efficiency wage hypothesis, a firm's unit labor costs will decrease (and potential profits increase) under which of the following conditions: A. labor effort (productivity) increase by a larger proportion than the wage increase. B. labor effort (productivity) increase by a smaller proportion than the wage increase.C. labor turnover increases for the firm. D. workers increase their level of shirking.

A. labor effort (productivity) increase by a larger proportion than the wage increase.

According to the 'shirking' variation of the Efficiency Wage Hypothesis, wages set above the competitive equilibrium wage (which results in a labor market that does not 'clear') may yield higher worker effort and productivity, and reduce unit labor costs, because: A. the opportunity cost to the worker of being dismissed for shirking is higher given the efficiency wage. B. more workers choose to quit their jobs and leave the labor force. C. workers accept the efficiency wage as a 'gift', and therefore increase their effort and productivity to reciprocate. D. firms are able to hire workers with superior ability and higher motivation.

A. the opportunity cost to the worker of being dismissed for shirking is higher given the efficiency wage.

The probability or improbability (i.e., uncertainty) of success (very high earnings) in an occupation.

According to Smith, it is reasonable to assume that occupations with few opportunities for high earnings, and a high chance for low (or zero) earnings will attract few workers, and therefore offer a higher average wage. However, owing to a principle of human nature ('immodesty' - a worker's tendency to overestimate his/her chances of success), these occupations entice larger numbers so that average wages tend to be lower (i.e., a few workers with high earnings and many with low earnings). Examples: the vast majority who aspire to be professional athletes, actors, singers, etc. rarely reach the highest earnings levels (what J.S. Mill called the 'great prizes') of the profession. However, many still train for and enter these occupations.

Which of the following outcomes is not predicted by the hedonic wage theory, all else equal? A. The hedonic wage function is positively sloped when wages are related to a nonwage disamenity (e.g. job risk). B. Firms that pay lower wages, but offer more amenities, always have higher than average profits. C. Firms that spend funds to reduce a disamenity (or increase an amenity), must also increase the wage rate in order to keep profits constant. D. Workers attempt to maximize utility from both wage and nonwage job attributes, subject to labor market constraints.

B. Firms that pay lower wages, but offer more amenities, always have higher than average profits. C. Firms that spend funds to reduce a disamenity (or increase an amenity), must also increase the wage rate in order to keep profits constant.

The Human Capital model of geographic labor mobility indicates that a worker/family is more likely to migrate if the net present value of relocating is positive. Ceteris paribus, which of the following will increase the likelihood of moving? A. a decrease in the wage differential between the destination and the origin locations. B. an increase in the number of periods (years) one expects to reside in the new location. C. an increase in the direct costs of moving. D. an increase in the discount rate.

B. an increase in the number of periods (years) one expects to reside in the new location.

In the Wealth of Nations, Adam Smith discussed several characteristics of labor employment which operate to "equalize the net advantages" that accrue to labor, and thus help explain wage variations across individuals and/or occupations (trades). Which of the following characteristics were NOT included in Smith's discussion?A. The difficulty, time or expense involved in successfully mastering a trade.B. The 'agreeableness' or 'disagreeableness' of a job in terms of working conditions or prestige. C. The amount of capital used in relation to the level of labor services. D. The level of trust or social responsibility embodied in the occupation. E. The uncertainty (predictability) of earnings in a trade or occupation.

C. The amount of capital used in relation to the level of labor services.

Which of the following are generally NOT be considered a quasi-fixed cost of labor? A. Initial costs for training newly hired workersB. Employer contributions for employee health insurance C. The wage rate D. Recruitment and screening costs for new employees

C. The wage rate

Which of the following statements best describes why labor economists consider human capital to be an investment? investments in human capital rarely involve any initial outlays or costs. human capital investments are subject to increasing marginal returns. C. investments in human capital typically require direct or indirect initial sacrifices in anticipation of future benefits such as increased earnings potential. D. the potential benefits of human capital cannot be determined.

C. investments in human capital typically require direct or indirect initial sacrifices in anticipation of future benefits such as increased earnings potential.

Labor Investments

Costs of increasing/decreasing additional workers: job search, advertising, recruiting, screening, interviewing, terminating - severance pay, etc. • Costs of formal or informal training - firms incur direct (explicit) and indirect (implicit)t costs of training employees. (Worker training is discussed in more detail later in the semester.)

Which of the following are considered labor market outcomes of the quasi-fixed labor cost model? A. Firms evaluate labor employment as a multi-period decisionB. In the post-hiring periods, firms earn a net surplus where the wage rate (W) < MRP, (post-hiring).C. Ceteris paribus, the post hiring wage (Wp) is directly related to the expected length of employment - i.e., number of time periods, TD. Ceteris paribus, the post hiring wage (Wp) is inversely related to hiring/training costs. E. All of the above are implications of the QFLC model.

E. All of the above are implications of the QFLC model.

Efficiency Wage Hypothesis (EWH)

Efficiency Wage Hypothesis suggests that firms might benefit from paying a wage that exceeds the market-clearing competitive wage (Wc). The benefits from this efficiency wage (Weff > Wc ) include higher labor effort and productivity, and therefore lower labor costs and potentially higher profits. This model assumes that there is a positive link between the wage rate and labor 'effort' and productivity.

Shirking Model

Efficiency wages result in less employee 'shirking' (reducing the quality or quantity of labor effort). If employers follow a strategy of paying WEff > WC: ∞ The opportunity cost (lost earnings) of being terminated for shirking increases. Thus, workers increase effort (productivity) in response to this higher opportunity cost. ∞ Involuntary unemployment reduces the probability that a dismissed worker finds another job, and therefore lowers the incentive to shirk. Reduced employee shirking increases productivity and lowers labor costs.

Unemployment rates

Families with unemployed primary earners are more likely to move. The unemployment rate at the origin location positively affects the probability of out-migration due to lost earnings; the unemployment rate at the destination location negatively affects the probability of out-migration due to less favorable employment prospects

Quasi-Fixed Labor Cost Model Assumptions

Firms are perfectly competitive in the product & labor markets • Firm incurs (fixed) non-wage labor costs (of $H) in the first period of labor employment (i.e., quasi-fixed labor costs) • The hiring period wage is exogenous • Firms have some flexibility in setting post-hiring period wage(s) • Unlike in the standard labor demand model, the firm has a multiperiod perspective when employing labor when quasi-fixed labor costs are present. Thus, a firm must use the discounted present value of all projected labor costs and revenues • A profit-maximizing firm will employ labor to the point where the present value of the marginal factor cost equals the present value of the marginal revenue product The initial quasi-fixed labor cost model was developed by University of Rochester economist Walter Oi.

Assumptions of EWH

Firms are perfectly competitive in the product & labor markets • Firms do not have full and complete information on labor effort (and productivity), and thus incur monitoring costs for precise measurements of worker effort (e.g., expenditures on supervisors or employee monitoring technology) • The firm's short-run production function is based on worker effort (efficiency) (e), labor employment (L), and the fixed input(s). Worker effort/efficiency (e) is positively related to the wage rate (W) and supervision resources (S). Firms attempt to determine the efficiency wage (Weff) that results in the optimum increase in worker effort and the lowest wage cost per unit of labor; this assumes that the potential gains from adjusting wages exceed those of adjusting supervision resources (S).

Gift exchange (reciprocity model)

Firms that offer higher wages may attract more able job applicants. This makes it profitable to offer wages that exceed the market clearing level. In this model, efficiency wages serve as a signal that workers with greater motivation and ability (and productivity) are rewarded for those attributes.

Superior applicant (favorable self-selection model)

Firms that offer higher wages may attract more able job applicants. This makes it profitable to offer wages that exceed the market clearing level. In this model, efficiency wages serve as a signal that workers with greater motivation and ability are rewarded for those attributes. Firms benefit from the higher productivity.

The degree of 'public trust and responsibility' which is granted to workers in an occupation.

For example, given two guards - one who guards the Queen of England and one who guards an apple orchard, the Queen's guard has more responsibility and public trust, and thus receives a higher wage.

The 'agreeableness or disagreeableness' of an occupation.

For example, jobs with clean, safe work environments, or a high level of social acceptance, may offer lower wages than comparable occupations that are less desirable. T

Non-Wage Labor Cost

From a firm's perspective, non-wage labor costs are additional expenditures for labor such as legally required insurance programs (e.g., social security, unemployment, disability), fringe benefits (retirement & pensions contributions, health insurance, sick leave, paid time off, etc.) and taxes on payrolls or employment. From a worker's perspective, non-wage labor costs are most often viewed as fringe benefits that form part of their total compensation.

Hedonic Wage Theory (HWT)

Generally, utility maximizing workers with heterogenous preferences are matched with heterogenous employers with different isoprofit functions. The set of worker-firm equilibrium outcomes generates the market link between wages and nonwage amenities - refer to as the Hedonic Wage Function (HWF)

Other factors

Home ownership in origin Housing cost in destination Occupational licensing (non-transferability) Income and property taxes at origin/destination locations Language/cultural barriers at destination location Spouse's/partner's earnings or employment in origin "Non-traded" location amenities in the origin/destination: climate, pollution, congestion, school systems, cultural opportunities, etc.

Equalization of net advantages to labor

If all jobs and workers are identical, and labor markets are perfectly competitive with complete labor mobility and full information, the wage structure might exhibit zero dispersion. This extreme outcome is unlikely.

Turnover Model

If employers follow a strategy of paying WEff > WC, firms can reduce quit rates and therefore reduce the costs of labor turnover (i.e., the quasi-fixed labor costs of recruitment, hiring, and training). The higher wage also allows firms to achieve another objective, i.e., the development of a more experienced, and, therefore, more productive and lower cost, work force. With higher wages and involuntary unemployment, workers are less likely to leave a firm.

HK as an investment

In a similar fashion to tangible assets (e.g., real capital), investments in human capital (an intangible asset) typically require initial sacrifices such as financial outlays (direct payments and expenditures) and indirect outlays (such as lost income and other opportunity costs) in anticipation of future benefits (increased productivity and/or earnings potential).

The constancy or inconstancy of employment.

Jobs with more stable and predictable earnings tend to pay lower hourly wages than occupations with erratic, less predictable compensation. For example, Smith found that brick layers and masons earn more than factory workers because the latter are employed indoors and work year-round. Brick layers and masons, however, have no source of income during Page | 7 periods of cold weather, and thus must have higher wages to compensate for interrupted earnings.

Employee Benefits

Legally required payments such as social security, workers' compensation, and unemployment insurance. Other benefits such as pensions (defined benefit and defined contribution plans) health Insurance, paid time off: vacations, holidays, and sick leave, etc.

Comparisons of the United States and other countries

Mexico, South Africa, and Brazil are higher, but China, Russia, UK, Japan, India, Canada, Germany, Sweden are lower

The ease, difficulty, or expense of mastering the skills of an occupation.

Occupations that have high training and education, or long apprenticeship requirements, must offer higher wages in order to attract potential workers and compensate them for acquiring the appropriate skills. For example, Smith claimed that because education and training in the arts and professions requires significant time and expense, workers in these occupations will earn more, ceteris paribus

Quasi-Fixed Labor Costs

Quasi-fixed labor costs are not strictly proportional to hours of work and are often allocated on a per-worker basis. Quasi-fixed labor costs generally fall into two categories: investments in labor and certain employee benefits.

Gini Coefficient

The Gini coefficient ranges between 0 (perfect equality) and 1 (perfect inequality). Thus, the greater the curvature of the Lorenz Curve (area A), the higher the Gini Coefficient, and the more unequal income is distributed.

Distance

The probability of moving tends to decease with the distance of the move . Direct costs will be higher Psychic costs may be higher

Unit Labor Cost (ULC)

The ratio of total labor compensation over labor productivity. ULC illustrates that increases in hourly compensation, ceteris paribus, will increase unit labor costs, and increases in labor productivity will reduce them. Thus, labor productivity increases can offset the effect of wage & compensation increases on unit labor cost.

Iso Profit functions

The tradeoff between W and NWAT, holding economic profit constant , are depicted graphically by concave isoprofit curves that show various combinations of W and NWAT which result in the equal profit for a firm. For non-wage amenities, isoprofit curves are negatively sloped; for non-wage disamenities (such as job risk), isoprofit curves are positively sloped. Wage-NWAT combinations on higher isoprofit curve yield lower profit

Age

Younger workers are more likely to move • As workers age, they are less likely to migrate because: o they expect to work fewer years to recoup migration costs o they may have greater monetary and psychic costs of moving (e.g., stronger ties to origin). In most countries in Europe or North America, rates of internal migration tend to peak for workers between the ages of 20 and 35.

Wage structure

refers to the dispersion in labor market earnings across workers, industries, occupations, or regions. Wage differentials can arise from many sources: for example, variations in labor market characteristics, worker attributes, job conditions, etc. will result in a distribution (variance) of wages and earnings.

Human capital (HK)

refers to the skills, talents, capacities, elements of knowledge and other attributes embodied in workers that can improve labor's contribution to the production of goods and services (productivity). • labor market migration/mobility/job search [Discussed this week] • on-the-job training (OJT) and labor market experience [introduced next week and continued in Week 12] • schooling and the level of educational attainment [Discussed in Week 13] • continuing education/certification • health/nutrition/fitness

Lorenz curve

shows the cumulative income share received by all individuals (or households), from 0 to 100% along the y-axis, against the cumulative distribution of individuals (households) along the x-axis. Along the x-axis, observations are ranked from lowest (i.e., poorest) to highest (i.e., richest).

Solow Condition

unit labor costs fall as long as effort increased proportionately more than the wage, ceteris paribus.