ECON 4009 Labor Economics I 2013 Fall Elliott Fan Economics, NTU Lecture 2 Economics of Labor, 2013...

ECON 4009 Labor Economics I 2013 Fall Elliott Fan Economics, NTU Lecture 2 Economics of Labor, 2013 Fall Elliott Fan

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 2 Firms Demand in SR Only labor input is variable while capital amount is fixed. Marginal revenue product (MRP) Additional revenue earned if employ one more unit of input When factor price is fixed, MRP is obtained by marginal product of labor times marginal revenue of the output. (you need to be careful on this)

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 3

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 4 Firms Demand in SR Wage rate and MRP Marginal product of labor is defined as the contribution to output by adding an additional unit of labor. So the amount of labor needed to produce one more unit of output is: And the cost of this amount is (this, by definition, refers to marginal cost of x):

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 5 Firms Demand in SR Wage rate and MRP Now we know that when the firm maximizes profit, they set marginal revenue equal to the marginal cost: So:

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 6 Firms Demand in SR Two major points drawn from the algebra: It confirms that a profit-maximizing firm operates where the wage rate of labor is equal to its marginal product of labor. The firms demand curve for labor coincides with the MRP L curve.

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 7 Some comparative statics Wage goes up. Output price goes up. An increase in plant size

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 13 Profit maximization

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 16 Critiques of Marginal Productivity Theory A common criticism is that the theory bears little relation to the way that employers make hiring decisions. Another criticism is that the assumptions of the theory are not very realistic. However, employers act as if they know the implications of marginal productivity theory (hence, they try to make profits and remain in business).

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 17 Recap Production and Costs in the Long Run Firm can adjust employment of capital and labor Achieve the least cost method of producing a given quantity of output

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 18 Isoquants Geometry of LR production Requires labeling vertical axis with K, stands for capital Requires labeling horizontal axis with L, which stands for labor Requires fixed period of time Least costly method Avoid technologically inefficient points which are outside the boundary General observations about isoquants Slope downward Fill the labor-capital plane Never cross Convex to origin

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 20 Marginal Rate of Technical Substitution Absolute value of slope of isoquant MPL divided by MPK Amount of capital necessary to replace one unit of labor while maintaining a constant level of output If much labor and little capital employed to produce a unit of output, MRTS LK is small Provides geometric proof that isoquant is convex

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 22 Marginal Rate of Technical Substitution The discussion above assumed a one-unit change in labor. More generally, if labor changed by some amount of L, we will have: and we would have:

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 23 Choosing a Production Process Minimizing cost necessary for maximizing profit Isocost curve Tracks set of all baskets of inputs employed Assume cost fixed Slope: -P L /P K Firm chooses point where isocost and isoquant curves tangent Means MRTS = P L /P K Tangencies lie along firms expansion path

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 25 Firms Demand in the LR All factors variable Assume fixed technology (the production function), rental rate (P K ), and market price (P X ). Note that making the assumption that P K is fixed incurs no loss of generosity, as only the relative price matters.

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 26 Construction of LR Labor Demand Factor demand vs output demand: The major difference is that a firm, unlike the case of output demand, has no budget constraint. Instead it has an infinite family of isocost lines, and it could choose to operate on any one of them. So we call factor demand derived from output demand. In short, we have to consider the optimal decision on the output market.

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 27 Construction of LR Labor Demand To be more precise, we need to determine how much to produce before we determine exactly how much factors to hire. Eg: We, again, need to resort to the principle of MR=MC.

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 30 Construction LR Labor Demand Substitution and scale effects associated with a factor price change SubE: When the price of an input changes, that part of the effect on employment that results from the firms substitution toward other inputs. ScaE: When the price of an input changes, that part of the effect on employment that results from changes in the firms output

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 31 Substitution and Scale Effects Direction of substitution effect Reduces firms employment of labor

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 34 Substitution and Scale Effects Direction of scale effect LRTC rise and shallower LRMC rises Regressive factor Combine effects Labor demand curve always slopes downward Scale effect never dominates substitution effect The proof is here.here

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 35 SR and LR Relationship In LR MRP shifts due to adjustments in capital employment Infinite number of steps

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 37 Industrys Demand Sum of individual firms demand curve for factor of production Monopsony Upward-sloping supply curve Marginal labor cost (MLC) Employment and wage rate

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 39 Industrys Demand Existence of monopsony Even a firm that is unique in its industry has no monopsony power, provided that firms in other industries compete with it for the use of the factors. Monopsony is rare, especially in the long run.

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 40 Application Affirmative action and production costs: A firm is color blind if race does not enter the hiring decision. Discrimination shifts the hiring decision away from the cost minimization tangency point on the isoquant.

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 41 Affirmative Action q*q* P Q Black Labor White Labor The discriminatory firm chooses the input mix at point P, ignoring the cost-minimizing rule that the isoquant be tangent to the isocost. An affirmative action program can force the firm to move to point Q, resulting in more efficient production and lower costs.

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 42 q*q* Q P Black Labor White Labor A color-blind firm is at point P, hiring relatively more whites because of the shape of the isoquants. An affirmative action program will increase this firms costs if it must further increase its amount of black labor. Affirmative Action

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 43 To answer this question formally, we need to examine the optimal principle for a firm to hire workers: so This implies that a monopolys labor demand lies below the one for an otherwise identical competitive firm. Intuitively, as a monopoly firm produces less than a competitive market would do, the firm hires less labor. Do monopoly firms hire more or less?

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 44 The wage rates that monopolies pay, however, are not necessarily different from competitive levels even though employment levels are. An employer with a product-market monopoly may still be a very small part of the market for a particular kind of employee and thus be a price taker in the labor market. However, the ability to pay high wages makes a managers life more pleasant by making it possible to hire people who might be more attractive or personable or have other characteristics managers find desirable (Efficiency wage theory) Do monopoly firms pay more or less?

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 45 Suppose the government decides to levy a pay-roll tax on the employer, to what extent does the employer bears the tax burden? Comparative statics: pay-roll tax

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 46 Figure 3.4 The Market Demand Curve and Effects of an Employer- Financed Payroll Tax

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 47 Tax burden will be shared by the supplier and the demander. The tax incident is independent of the way the payroll tax is levied. What matters here is the elasticity of demand and supply. Comparative statics: pay-roll tax

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 48 Tax on PhDs income Guo Taiming argued for tax on PhDs low income (or occupations)tax on PhDs low income

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 49 Tax on PhDs income There is no way to implement it successfully. Its not students who waste resources, its the subsidy for higher education.

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 50 Mandatory tips?

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 51 AGAIN, There is no way to implement it successfully due to non-compliance. Different components of wage compensation are substitutes. Mandatory tip?

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 52 Definition of own-wage elasticity of demand The own-wage elasticity of demand is defined by the percent change in its employment (E) induced by a 1 percent increase in its wage rate (W): Using percent change, instead of level change, to avoid the effect of measurement unit. We usually pay attention only to the magnitude, as the sign is assumed to be negative.

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 53 Definition of own-wage elasticity of demand Note that it is a measure for a point, not for the entire curve. But colloquially, a flatter demand curve exhibits a higher elasticity than a sleeper one. For a straight line, the higher region is more elastic than the lower region. (why?)

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 55 HicksMarshall laws of derived demand 1.When the price elasticity of demand for the product being produced is high. 2.When other factors of production can be easily substituted for the category of labor. 3.When the supply of other factors of production is highly elastic (that is, usage of other factors of production can be increased without substantially increasing their prices). 4.When the cost of employing the category of labor is a large share of the total costs of production. To view the proof, here is an example.here

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 56 Laws 1 and 2

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 57 Estimates of LD elasticity

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 58 Applications of LD elasticity Elasticity and union: Most unions value both wage and employment opportunities for their members. So the more elastic the demand for labor, the smaller the wage gain that a union will succeed in winning for its members. Because, the more elastic the demand curve, the greater the percentage employment decline associated with any given percentage increase in wages.

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 59 Applications of LD elasticity So we can infer the following: 1.Unions would win larger wage gains for their members in markets with inelastic labor demand curves. 2.Unions would strive to take actions that reduce the wage elasticity of demand for their members services. 3.Unions might first seek to organize workers in markets in which labor demand curves are inelastic (because the potential gains to unionization are higher in these markets).

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 60 Applications of LD elasticity The truck industry is split into two distinct segments: 1.One type of general freight carrier exclusively handles full truckloads (TLs), taking them directly from a shipper to a destination LD is more elastic (why?) 2.The other type of carrier handles less than-truckload (LTL) shipments, which involve multiple shipments on each truck and an intricate coordination of pickups and deliveries LD is less elastic.

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 61 Complements or substitutes? When there are more than one input, we need to consider whether the two inputs are complements or substitutes. If two inputs are substitutes in production, then increases in the price of the other input may shift the entire demand curve for a given category of labor either to the right or to the left, depending on the relative strength of the substitution and scale effects. That is, the cross-elasticity is positive. Are skilled and unskilled workers complements or substitutes?

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 62 Figure 3.3 Effect of Increase in the Price of One Input (k) on Demand for Another Input (j), Where Inputs Are Substitutes in Production

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 63 Complements or substitutes?

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 64 Definition of cross-wage elasticity of demand

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 65 Definition of cross-wage elasticity of demand whether two inputs are gross substitutes or gross complements depends on the relative sizes of the scale and substitution effects. Assume that adults and teenagers are substitutes in production, a decrease in the teenage wage: 1.There is a substitution effect: for a given level of output, employers will now have an incentive to substitute teens for adults in the production process and reduce adult employment. 2.There is a scale effect: a lower teenage wage reduces costs and provides employers with an incentive to increase employment of all inputs, including adults.

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 66 Important findings about the cross elasticity 1.Skilled labor and unskilled labor are substitutes in production. 2.We are not certain whether either skilled or unskilled labor is a substitute for or a complement with capital in the production process. What does appear to be true is that skilled (or well-educated) labor is more likely to be complementary with capital than is unskilled labor and that if they are both substitutes for capital, the degree of substitutability is smaller for skilled labor.

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 67 Important findings about the cross elasticity Thus, we have 2 important implications: 1.The finding that skilled labor is more likely than unskilled labor to be a gross complement with capital is important to our understanding of recent trends in the earnings of skilled and unskilled workers (see chapter 15), because the prices of computers and other high- tech capital goods have fallen dramatically in the past decade or so. 2.Other things equal, own-wage labor demand elasticity will be larger in magnitude for unskilled than for skilled workers. (why?)

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 68 Example: minimum wage To estimate the effects of MW, we need to consider at least the following concerns: 1. Real vs nominal wage

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 69 Example: minimum wage To estimate the effects of MW, we need to consider at least the following concerns: 2. Uncovered sector an issue about partial vs general equilibrium SUSU Dollars SCSC Employment EUEU EUEU EUEU ECEC (b) Uncovered Sector EE SUSU SUSU ww w*w* w*w* DUDU DCDC (If workers migrate to covered sector) (If workers migrate to uncovered sector)

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 70 Example: minimum wage To estimate the effects of MW, we need to consider at least the following concerns: 3. Noncompliance It is possible that some firms do not comply with the regulation This is especially possible for countries such as Taiwan, where wage compensation structure is complex and overtime work is often unpaid.

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 71 Facts about minimum wage Card and Kreugers 1992 paper is one of few outliers. Neumark has reviewed more than 100 academic studies on the impact of government wage-setting and concluded that the vast majority find a negative employment effect on low-skilled workers. The effect of MW on confronting poverty is also limited. Alternative policies, such as EITC, should be considered.

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 72 Evidence of the effects of raising the minimum wage David Card and Alan Krueger, American Economic Review, 2000 In 1992, New Jersey raised the min. wage from $4.25 to $5.05 largest min. wage in the United States at that time. Card and Krueger telephoned managers at fast-food restaurants in New Jersey and Pennsylvania a few months before and after the change.

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 73 Evidence of the effects of raising the minimum wage They asked about wages paid to employees, how many employed in each restaurant (part time and full time) Chose fast-food industry because most workers in the industry paid min. wage Question: Did the min. wage increase in N.J. lead to a decrease in employment in the fast-food industry?

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 74 Empirical Strategy to answer this question

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 75 Comparing Mean Labour Supply Before and After

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 76 Comparing Relative Difference in NJ and PN Labour Supply Before and After change

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 77 What Card and Krueger find:

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 78 What Card and Krueger conclude No noticeable effect from raising the minimum wage 19% in New Jersey, compared to no change in Pennsylvania Evidence that labour demand for minimum wage workers in perfectly competitive model very inelastic, Or Evidence that firms have some monopsony power (price discriminating monopsonist might behave this way)

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 79 What others conclude Controversial result David Neumark and others have viciously attacked this finding Baker, Benjamin, and Stanger find some evidence that min. wage increases reduced long- term employment in Canada Find out more on my web page

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 80 Labour Demand Example Hamermesh and Trejo (2000) The Demand for Hours of Labor: Direct Evidence from California, Review of Economics and Statistics

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 81 Background At least since the 1970s, California required most women to be paid 1.5*wage for working beyond 8 hours a day In 1980, California extended this overtime rule to men Note, in 1998, California got rid of this policy

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 82 Why this policy is cool to look at To measure the elasticity of labour demand, we need to observe changes in wages that a firm must pay to workers, all else constant Very hard to find changes in wages that are not driven by changes in labour supply (e.g. preferences for work), in contrast to demand shifts (e.g. technology shocks, recessions)

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 83 What does our theory predict will happen by introducing overtime laws? Overtime raises the marginal cost to employers of assigning overtime. Firms should respond by lowering the incidence of long workdays and shortening the workdays of workers who continue to put in more than 8 hours a day Some firms may impose 8-hour workdays Our simple model suggests substituting away from hours of overtime for hours of regular day work (by hiring more workers)

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 84 A twist to trying to analyze this: Even without California 8-hour overtime policies, federal government imposes must pay 1.5 * wage if working for than 40 hours a week, both for men and women So for workers already working more than 40 hours a week, wont see change from policy We might observe substantial reduction in overtime work, or little effect.

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 85 % workers with workdays longer than 8 hours Men, California 19731985 Empirical Methodology: Difference Any factors that leads to change in overtime changes will be attributed to reform change.

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 86 % workers with workdays longer than 8 hours Men, New Mexico 19731985 Empirical Methodology: Diff. Before Change Estimate Effect from Difference in Differences Diff. After Change Men, California

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 87 % workers with workdays longer than 8 hours Women, New Mexico 19731985 Empirical Methodology: Diff. Before Change Should not observe same comparison for women: Diff. After Change Women, California

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 89 Their conclusions As theory predicted, percentage of workers working more than 8 hours a day declined after overtime policy introduced Implied price elasticity of demand for daily overtime hours is about -.5

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 90 Asymmetric Variable Adjustment Costs Changing employment quickly is costly, and these costs increase at an increasing rate. If government policies prevent firms from firing workers, the costs of trimming the workforce will rise even faster than the costs of expanding the firm.

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 91 Estimating Labor Demand One can identify the slope of the labor demand curve, which can be used to calculate the elasticity of labor demand, when the supply curve shifts. Problem: Must make sure the labor demand curve is not also changing.

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 92 Problems with Estimating Labor Demand Dollars S0S0 w0w0 E1E1 E0E0 D0D0 Employment w1w1 S1S1 D1D1 w2w2 E2E2 Z Z P Q R

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 93 The Impact of Wartime Mobilization of Men on Female Labor Supply

Economics of Labor, 2013 Fall Elliott Fan Lecture 3 slide 94 The Impact of Wartime Mobilization of Men on Female Wages

ECON 4009 Labor Economics I 2013 Fall Elliott Fan Economics, NTU Lecture 2 Economics of Labor, 2013...

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