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Chapter 1
Introduction to Labor EconomicsIntroduction to Labor Economics
Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.
McGraw-Hill/Irwin
1-2
Why study Labor Economics?
• Human resources allocate substantial time and energy to labor markets.
• Labor economics studies how labor markets work.
• Labor economics helps us understand and address many social and economic problems facing modern societies.
1-3
Basics of the Labor Market
• Participants are assigned motives:
– Workers look for the best job.
– Firms look for profits.
– Government uses regulation to achieve goals of public policy.
• Minimum wages• Occupational safety
1-4
Three “Actors”• Workers
– The most important actor; without workers, there is no “labor”.
– Desire to maximize (i.e., to optimize by selecting the best option from available choices).
– Supplies more time and effort for higher payoffs, causing an upward sloping labor supply curve.
1-5
Three “Actors”
• Firms
– Decide who to hire and fire.
– Motivated to maximize profits.
– Relationship between price of labor and the number of workers a firm is willing to hire generates the labor demand curve.
1-6
Three “Actors”
• Government
– Imposes taxes, regulations.
– Provides ground rules that guide exchanges made in labor markets.
1-7
Why Do We Need a Theory?
• Explain and understand how labor markets work.
• Focus on the essential variables while leaving out other, less crucial, factors.
• Create a model that helps explain the theory.
1-8
Positive vs. Normative Economics
• Positive economics– Addresses the facts– Focus on “what is”– Questions answered with the tools of economists
• Normative economics– Addresses values– Focus on “what should be”– Requires judgments
1-9
Labor market vs. other markets
• labor services are rented, not sold,
• labor productivity is affected by pay and working conditions, and
• the suppliers of labor care about the way in which the labor is used
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Internal labor market
A firm uses an internal labor market if:
• external hiring is used primarily for entry-level jobs, and
• higher level positions are filled by promotion from within the firm
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Internal labor market
Internal labor markets exist because the use
of such markets:
• reduces hiring and training costs,
• improves employee morale and motivation, and
• reduces the effect of uncertainty
1-12
Primary vs. Secondary labor markets
• primary labor market - high wages and stable employment relationships.
• secondary labor market - low wages and unstable employment relationships
1-13
Labor force and unemployment
• labor force = noninstitutionalized individuals aged 16 or above who are either working or actively seeking work.
• unemployed = those who are not working but are “actively looking for job”
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Unemployment rate
•Discouraged workers are workers who have given up looking for work. • An increase in the number of discouraged workers causes the unemployment rate to fall.
1-15
Labor force participation rate
• the labor force participation rate rises during an expansion and falls during a recession.
• fluctuations in the labor force participation rate over the course of the business cycle dampen cyclical fluctuations in the unemployment rate
1-16
Sectoral shifts in employment
• primary sector (agricultural) employment has declined as a share of the labor force,
• secondary sector (industrial) employment has declined slightly as a share of the labor force, but only in the past few decades, and
• tertiary sector (service sector) employment has increased as a share of the labor force.
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Reasons for the shifts in employment• the primary sector (agriculture) is
characterized by rapid growth in labor productivity and a low income elasticity of demand,
• the secondary sector is characterized by rapid growth in labor productivity and a moderately high income elasticity of demand, and
• the tertiary sector is characterized by slow growth in labor productivity and a high income elasticity of demand
1-18
Nominal and real wages
• Nominal wages are not adjusted for inflation and are said to be expressed in terms of “current dollars.”
• Real wages are wages that have been adjusted to take into account the effect of inflation. Real wages are expressed in terms of dollars from a given base year and are said to be expressed in “constant dollars.”
1-19
Wages, earnings, total compensation and income
• wage = payment per unit of time• earnings = wage x hours• total compensation = earnings + fringe
benefits• fringe benefits = payments-in-kind + deferred
compensation• income = total compensation + unearned
income (or income = earnings + unearned income)
1-20
1-21
The Markets in Which Firms Must Operate
1-22
Demand for labor
The labor demand curve is downward sloping due to:• a substitution effect, and• a scale effect.
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Substitution effect
• substitution effect - substitution of other resources for a resource that becomes relatively more expensive.
1-24
Scale effect
The scale effect associated with a wage
increase involves the following steps:• higher wages result in higher average and
marginal costs of production,• leading to an increase in the equilibrium price
of the product,• leading to a reduction in the quantity of the
product demanded,• leading to a reduction in the use of all inputs
used to produce the product.
1-25
Shifts in labor demand
Labor demand may shift due to changes in:
• the demand for the product, and
• the prices of other resources.
1-26
Industry demand for labor
• An industry's demand for labor consists of the total demand for a particular type of worker in a given industry. (An industry consists of all of the firms that produce a given type of output.)
• An industry's labor demand curve is determined by adding together the labor demand curves for all of the firms in the industry.
1-27
Market demand for labor
• The market for a given category of labor consists of all of the firms that might hire a given type of labor, regardless of the industry in which the firm operates.
• The market demand for labor is determined by adding together all of the industry demand for labor curves.
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Market labor supply
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Shifts in market labor supply curve
Shifts such as this may be due to:
• changing wages in other markets, or
•changes in worker tastes and preferences
1-30
Collective bargaining agreement
1-31
Supply restriction
1-32
Overpaid and underpaid workers
• economists argue that workers are overpaid if their wage is above the equilibrium,
• workers are underpaid if their wage is below the equilibrium wage
1-33
Supply and Demand in the Engineering Market
Equilibrium
50,000
40,000
30,000
20,00010,000 30,000
Labor Supply Curve
Labor DemandCurve
Earnings ($)
Employment
1-34
Summary
• Labor economics studies how labor markets work.
• Models in labor economics typically contain three actors: workers, firms, and governments.
• A good theory should have realistic assumptions and can be tested with real-world data.
• The tools of economics are helpful in answering positive questions.
End of Chapter 1
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