1week2 labor 2008

MGT. M259C: Analysis of Labor Markets --PP CM230 Labor Markets and Public Policy Daniel J.B. Mitchell Ho-su Wu Professor Anderson School and School of Public Affairs

Reminder

Left from Last Week Implementing the concept of the real wage CPI (Consumer Price Index) Concept Problems Phonograph example

Problem: What if the nominal expenditures involve more than one good?

Answer: You must deflate by a price index containing the relevant goods.

General Formula for a “Laspeyres” Price Index such as the CPI

It PitQib/ PibQib where: t = current time period b = base expenditure period P = price Q = quantity i = good (e.g., corn, tomatoes) I = Laspeyres price index

Example In base expenditure period, price of tomatoes = 50¢ and price of ear of corn = $1  In base period I consumed 20 tomatoes ($10) and 5 ears of corn ($5) for total cost of $15 

(PibQib = $15) Today in time t the price of tomatoes is 75¢ and the price of corn is 90¢.  To replicate my consumption today, I have to spend $19.50 

(PitQib = $19.50)

It PitQib/ PibQib = $19.50/$15.00 = 1.30 Interpretation: To maintain my base expenditure period consumption, I would need to spend 30% more today than I did in the base period  Note: If we set the index base period to be the same as the base expenditure period, we would probably express this as 130 where year b = 100 

Suppose my nominal wage in year b was $10 and in year t it is $14.30 Question: What is my “real� wage in year t expressed in year b dollars?

Answer: $14.30/1.30 = $11 Calculation: My real wage has risen by 10% since $11/$10 = 1.10 Interpretation: If I wanted to consume exactly the same basket of goods in year t that I did in year b, my new wage would allow me to buy 10% more of such baskets.

Note the break in trend starting in the early 1970s.

Cautionary Notes 





I may in fact change my consumption basket between time b and time t. So the index does not measure my “cost of living.”

There may be changes in the quality of tomatoes or corn between time b and t. Adjusting “effective” prices to take account of these quality changes may be difficult.

I may make substitutions which would cushion the impact of price increases and take advantage of price decreases (fewer tomatoes, more corn).

Phonograph Edison’s original tin foil cylinder model, 1877

Berliner disk machine, 1895

Quality Illustration

Phonograph Columbia 1908 disk model

Ultraphone 1919 with horn inside wooden cabinet Quality Illustration

Footnote on technological progress Phonautograph 17 years before phonograph

Sample graphic made in 1860 on sootblackened paper Édouard-LÊon Scott de Martinville, Parisian typesetter

MGT. M259C: Analysis of Labor Markets --PP CM230 Labor Markets and Public Policy Daniel J.B. Mitchell Ho-su Wu Professor Anderson School and School of Public Affairs

Agenda 

Labor Supply – – – – – –



Hours: Wage/Leisure Trade-Off Substitution effect Income effect Supply-side tax cut example Welfare examples Dynamic turnover issues (deferred to unit 4)

Labor Demand – Derivation – Traditional minimum wage analysis – Monopsony (deferred to unit 6-7)

Labor Supply 

   

         

Smith Barber Tanner Brewster Miller Mason Thatcher Farmer Hunter Baker Cook Carpenter Cooper Wainwright Wheelwright

Labor Supply  Tucker  Turner  Chandler  Clark  Potter  Crocker  Dyer  Glover  Ploughwright  Plowman  Weaver  Drayman

Some empirical facts Labor supply There are many people beyond the officially unemployed with some interest in having a job There are also people with jobs who are actively looking for new jobs especially (but not only) contingent workers The amount of labor supplied is a function not only of the number of employees but the number of hours they work In recent years, overtime hours worked in manufacturing were quite high

More empirical facts Wage Determination Wages can be predicted statistically by job/worker, and employer/workplace characteristics Wages tend to be higher at unionized and larger employers Full-timers earn more per hour than part-timers Jobs requiring substantial “knowledge� pay more than others Jobs with supervisory duties pay more than others Physically demanding jobs pay LESS than others

 Migration

– Domestic – International  Trade

Examples of issues often explored in supply & demand framework

and Employment

Wage

Supply

Demand 0

Labor Input

Labor Supply Does the individual supply curve for labor look like this?

Wage

0

Labor Input

Labor Supply

Or this?

Wage

0

Labor Input

Labor Supply

Or maybe this?

Wage

0

Labor Input

Standard Economic Analysis Says “Anything Goes” Substitution Effect vs.

Income Effect along Labor/Leisure/Income Trade-Off

Work is a “Bad” in the Standard Story

Assumption: Individual controls working hours Income in $

Slope = -Wage

0

Available hours <--Labor Leisure-->

Question: How do we depict a wage increase?

Income in $

0

Available hours <--Labor Leisure-->

Answer: Trade-Off Line Rotates Clockwise Income in $ New Wage Trade-Off Line

0

Available hours <--Labor Leisure-->

Question: Will individual work more hours or fewer hours at new higher wage?

Income in $ New Wage Trade-Off Line

0

Available hours <--Labor Leisure-->

Question: Will individual work more hours or fewer hours at new higher wage?

Income in $

More hours Fewer hours

Starting point at old wage 0

Available hours <--Labor Leisure-->

Answer: More hours if â&#x20AC;&#x153;substitution effectâ&#x20AC;? dominates Income in $

More hours

Starting point at old wage 0

Available hours <--Labor Leisure-->

But could be fewer hours if â&#x20AC;&#x153;income effectâ&#x20AC;? dominates Income in $

Fewer hours

Starting point at old wage 0

Available hours <--Labor Leisure-->

How Much Choice?

How Much Choice?

Hours per time period (day, week, year)  Working time within day 

How Much Choice?

How Much Choice?

Individual perspective  Household perspective 

Analyzing the Choice  Indifference

curve

analysis  Supply-side tax cut case  Alternative welfare programs case

Indifference Curve Analysis $

0

Leisure

$

At constant level of utility, higher wage (price of leisure) leads to less leisure (more labor) This is the pure substitution effect Original point

0

Leisure

Uncle Harry dies, leaving me an annuity (income even with complete $ leisure)

$$ $$ $$ $

Income effect results in more leisure (less work)

Annuity income 0

Leisure

$

Question: Consider McGovern minimum income plan. Would it affect work hours?

Moral: Any policy that affects income potentially affects work.

Annuity income 0

Leisure

Analysis of a Supply-Side (Income) Tax Cut Income in $

Pre-tax leisure/labor trade-off

0

Available hours <--Labor Leisure-->

Analysis of a Supply-Side (Income) Tax Cut Income in $ Slope = -W Slope = -W(1-T) Pre-tax leisure/labor trade-off Impact of T% tax rate

0

Available hours <--Labor Leisure-->

Analysis of a Supply-Side (Income) Tax Cut Question: If point A is the choice with no tax, could

Income in $

imposing

A

0

tax raise work hours contrary to supply-side argument?

Available hours <--Labor Leisure-->

Analysis of a Supply-Side (Income) Tax Cut Income in $

Answer: Maybe yes...

A B

0

Available hours <--Labor Leisure-->

Analysis of a Supply-Side (Income) Tax Cut Income in $

Answer: Maybe yes; maybe no.

A

Bâ&#x20AC;&#x2122;

0

Available hours <--Labor Leisure-->

Analysis of “Traditional” Welfare Program Income in $

Will offering an income floor with 100% implicit “tax” on earnings up to floor discourage work?

A

0

Available hours <--Labor Leisure-->

Analysis of “Traditional” Welfare Program In this case, the answer is “yes” even though the individual’s dollar income is lower at B than at A.

Income in $

A

B

C

0

Available hours <--Labor Leisure-->

But what if guaranteed income had been lower at C?

Analysis of Negative Income Tax Approach In this case, although there is some work reduction, work attachment remains at C.

Income in $

C A

0

Available hours <--Labor Leisure-->

Aggregate Labor Supply is the horizontal sum of individual labor supply curves W

ÎŁ

w1

0

0

L

W

w1

0

L

Aggregate Labor Supply is the horizontal sum of individual labor supply curves W

ÎŁ

w1

0

0

L

W

w1

0

L

Aggregate Labor Supply is the horizontal sum of individual labor supply curves W

ÎŁ

w1

0

0

L

W

w1

0

L

Aggregate Labor Supply is the horizontal sum of individual labor supply curves W w2

ÎŁ

w1

0

0

L

W

w2

w1

0

L

Aggregate Labor Supply is the horizontal sum of individual labor supply curves W w2

ÎŁ

w1

0

0

L

W

w2

w1

0

L

Aggregate Labor Supply is the horizontal sum of individual labor supply curves W w2

ÎŁ

w1

0

0

L

W

w2

w1

0

L

The Demand Side Remember: Labor demand is â&#x20AC;&#x153;derivedâ&#x20AC;? from product market conditions interacting with the production function (technology).

The Demand Side

Assumption: Employees screened for basic quality.

Labor Demand Short Run at firm level (with capital fixed) Units of Output Q

0

L

Labor Demand Short Run at firm level (with capital fixed) Units of Output Q

0

Diminishing Marginal Product of Labor

L

Labor Demand Short Run at firm level (with capital fixed) Units of Output Q

Diminishing Marginal Product of Labor

MPL 0

L

Labor Demand Short Run at firm level (with capital fixed) Units of Output Q

To value the marginal product of labor, multiply units of output by P for competitive firms or MR for non-competitive firms.

MPL 0

L

Labor Demand Short Run at firm level (with capital fixed)

$

This gives us the marginal revenue product of labor measured in dollars rather than units of output.

MRPL 0

L

Labor Demand Short Run at firm level (with capital fixed)

$

What is profit maximizing decision on L if â&#x20AC;&#x153;marketâ&#x20AC;? wage is W?

W

MRPL 0

L

Mitchell’s Iron Law of Economics The correct answer to any question is “Where the lines cross” or “Where the lines are tangent.”

Labor Demand Short Run at firm level (with capital fixed) What is profit maximizing decision on L if â&#x20AC;&#x153;marketâ&#x20AC;? wage is W?

$

W

MRPL 0

L1

L

Labor Demand Short Run at firm level (with capital fixed) Moral: In short run, marginal revenue product = W gives us a firm demand curve.

$

W

MRPL 0

L1

L

Labor Demand

ÎŁ

Short Run at firm level (with capital fixed)

Wage

Add up firm level demand curves horizontally as we did with individual supply curves and we get aggregate demand curve.

D

0

L

Concept of Elasticity Percent change in labor quantity/percent change in wage: (dL/L)/(dW/W) or (dL/dW) x (W/L) or dlnL/dlnW  Will be negative for demand curve but conventionally expressed in absolute value  Terminology: If e>1, curve is elastic. If e =  curve is totally elastic. If e<1, curve is inelastic. If e=0, curve is totally inelastic. 

Note: Elasticity varies along a linear demand curve... which is another way of saying that the elasticity is not the same as the slope.

W

e = ď&#x201A;Ľ at highest point

e = 1 at half-way point

0

e = 0 at lowest point L

Alfred Marshall 1842-1924

Sir John Hicks 1904-1989

Four Marshall-Hicks conditions for a low elasticity (at a point on a labor demand curve) Demand for final product is relatively inelastic  Other factors cannot be easily substituted for type of labor  Supply of other factors is inelastic (so buying more of them significantly raises their prices)  (Generally) when the cost of this type of labor is a small percent of total costs Reminder from Prof. Mitchell: Elasticity involves shape of curve.

Level of demand involves position. 

Deregulation and Pay Compensation/FTE: Total Workforce = 100 200

Total

Airline

180

Trucking

Telephone

160 140 120 100 80 60 40 20 0 1970

1980

1990

1999

Why should we care if elasticity is low?

Example: Raising the minimum wage. Which demand curve is â&#x20AC;&#x153;betterâ&#x20AC;??

W new minimum

old minimum

0

L

Why should we care if elasticity is low?

Example: Raising the minimum wage. Which demand curve is â&#x20AC;&#x153;betterâ&#x20AC;??

W new minimum

old minimum D1 0

L

Why should we care if elasticity is low?

Example: Raising the minimum wage. Which demand curve is â&#x20AC;&#x153;betterâ&#x20AC;??

W new minimum

old minimum D1 D2 0

L

Why should we care if elasticity is low?

Example: Raising the minimum wage. Which demand curve is â&#x20AC;&#x153;betterâ&#x20AC;??

W new minimum

old minimum D1 D3 D2 0

L

Standard Demand and Supply Analysis Does Market “Clear” at Wage and Employment Combination W1, L1?

W S W1 D

0

L1

L

“Clear” means demand = supply

Standard Demand and Supply Analysis Excess Supply Pushes Wage Down W S W1 D

0

L1

L

Standard Demand and Supply Analysis

W S W1 D

0

L

Excess Demand Pushes Wage Up

Standard Demand and Supply Analysis Market â&#x20AC;&#x153;Clearsâ&#x20AC;? at Wage and Employment Combination W1, L1, given auction-like assumptions

W S W1 D

0

L1

L

Migration Domestic or International

Supply/demand framework suggests moves from low wage to high(er) wage areas.

More general framework would suggest moves from low opportunity to high(er) opportunity

Before Migration Low Wage Area

High Wage Area

W

SH

SL w2 w1 DL 0

DH 0

Markets assumed to be isolated so wage differential can prevail.

L

After Migration Former Low Wage Area

Former High Wage Area

S’L

W

w2

S’H

w3 w1 DL 0

DH 0

L

In theory, “law of one price” would prevail after free migration is allowed as supply shifts to high-wage area.