MODERN LABOR ECONOMICS THEORY AND PUBLIC POLICY CHAPTER Modern Labor Economics: Theory and Public Policy, Eleventh Edition Ronald G. Ehrenberg Robert S. Smith 11 TH EDITION Copyright ©2012 by Pearson Education, Inc. All rights reserved. Frictions in the Labor Market 5

Copyright ©2012 by Pearson Education, Inc. All rights reserved. Modern Labor Economics: Theory and Public Policy, Eleventh Edition Ronald G. Ehrenberg Robert S. Smith Introduction: Frictions & Monopsonies in Labor Markets If there is “friction” slowing the mobility of capital and labor in labor markets, or if there is employer buying power (monopsony) in labor markets, the labor market outcomes described in the earlier chapters can change. –Wages for similar workers can differ –Employers will not pay a wage=MRP of labor –In some circumstances, an increase in the minimum wage will increase both wages and employment.

Copyright ©2012 by Pearson Education, Inc. All rights reserved. Modern Labor Economics: Theory and Public Policy, Eleventh Edition Ronald G. Ehrenberg Robert S. Smith Assumptions 1.Identical workers will be paid the marginal revenue product of the last worker hired: in other words—homogeneous labor will be paid the same wage. 2.The firm can hire as many workers it wants at the market wage: in other words—the firm is in a perfectly competitive labor market. 3.All labor costs are variable costs: in other words, the firms costs go up as more hours of labor is hired but there are no fixed up-front costs at the point of hire (no training or hiring costs). 4.The firm can immediately respond to changes in the product market by hiring or laying off workers. Picture from Test-your-Assumptions.aspx

Copyright ©2012 by Pearson Education, Inc. All rights reserved. Modern Labor Economics: Theory and Public Policy, Eleventh Edition Ronald G. Ehrenberg Robert S. Smith Friction Labor market friction is the idea that due to lack of information or due to the cost of changing a) what you are doing, b) where you are or c) who you are working with, things do not move as quickly or as smoothly as we have assumed to this point. If there is labor market friction, labor market outcomes will be different than we have argued to this point. Example: the law of the same wage: workers who have the same productivity will be paid the same wage. With labor market friction this will not be true. Looks like this bear is operating in a labor market with no friction!

Copyright ©2012 by Pearson Education, Inc. All rights reserved. Modern Labor Economics: Theory and Public Policy, Eleventh Edition Ronald G. Ehrenberg Robert S. Smith Law or Assumption of a Single Wage for Comparable Workers S D We Assumption: Arnold=Danny

Copyright ©2012 by Pearson Education, Inc. All rights reserved. Modern Labor Economics: Theory and Public Policy, Eleventh Edition Ronald G. Ehrenberg Robert S. Smith Actually They Were Both Paid the Same! Zero! (up front) The Daily Dish: Arnold Schwarzenegger and Danny DeVito forfeited pay checks for their hit comedy movie “Twins” to help studio bosses get the project off the ground. [Schwarzenegger]: “I said right off, ‘Don’t give me anything, you are taking a risk, let’s make the movie for $16.5 million, let’s keep it cheap, no one takes a salary. Let’s just get a certain percentage, the back end, and then we’ll split that.’” The gamble paid off and “Twins” went on to gross $216 million at the worldwide box office, making a lot of money for the two lead actors. [Well, we really do not know if they each got the same percentage: so maybe they weren’t paid the same.] Arnold Schwarzenegger and Danny DeVito made ‘Twins’ for free, The Daily Dish

Copyright ©2012 by Pearson Education, Inc. All rights reserved. Modern Labor Economics: Theory and Public Policy, Eleventh Edition Ronald G. Ehrenberg Robert S. Smith Wages for Some Comparable Workers Vary by Region Nonunion Laborers $16.22/$12.69=1.28 Nonunion Ironworkers $25.44/$22.46=1.13

Copyright ©2012 by Pearson Education, Inc. All rights reserved. Modern Labor Economics: Theory and Public Policy, Eleventh Edition Ronald G. Ehrenberg Robert S. Smith Possible Reasons for Regional Wage Difference for Same Workers Regional differences in cost of living? Regional differences in unionization? Regional differences in employer competition? Lack of information about higher paying jobs elsewhere? Inability of capital to move to low-cost regions? Cost to workers of moving from low-wage to high-wage regions? Cost of hiring new workers?

Copyright ©2012 by Pearson Education, Inc. All rights reserved. Modern Labor Economics: Theory and Public Policy, Eleventh Edition Ronald G. Ehrenberg Robert S. Smith Examples of Demand and Supply Frictions Labor Demand Frictions Fixed Cost of hiring workers –Selection costs –Training costs –Fixed benefit costs Cost of moving to where the cheaper workers are Overtime vs. new worker Labor Supply frictions Cost of searching for new job opportunities Cost of retooling to get qualifying skills Cost of moving to a new area Risks of switching from a known to an unknown job situation

Copyright ©2012 by Pearson Education, Inc. All rights reserved. Modern Labor Economics: Theory and Public Policy, Eleventh Edition Ronald G. Ehrenberg Robert S. Smith If Worker Mobility Costs Workers Supply Curve=Less Wage Elastic Figure 5.1 The Supply of Labor to Firm A: Worker-Mobility Costs Increase the Slope of the Labor Supply Curve Facing Individual Employers

Copyright ©2012 by Pearson Education, Inc. All rights reserved. Modern Labor Economics: Theory and Public Policy, Eleventh Edition Ronald G. Ehrenberg Robert S. Smith Assumptions to This Point: 1.Wage to the firm is given (fixed) 1.i.e. supply curve is horizontal to the firm 2.All labor costs are variable costs 1.That is: labor costs vary with output 3.Not fixed costs 1.Hiring costs can be fixed costs 1.Selection of worker 2.Training 4.Have assumed firm can immediately adjust labor costs responding to product market changes

Copyright ©2012 by Pearson Education, Inc. All rights reserved. Modern Labor Economics: Theory and Public Policy, Eleventh Edition Ronald G. Ehrenberg Robert S. Smith New Assumptions/Questions How is demand for labor different if we assume that fixed costs (e.g. hiring and training costs) make change costly? Basic answer: if change is costly, these costs will create frictions which slow change.

Copyright ©2012 by Pearson Education, Inc. All rights reserved. Modern Labor Economics: Theory and Public Policy, Eleventh Edition Ronald G. Ehrenberg Robert S. Smith Employee Mobility Costs Employee friction: –Costs associated with moving from employer to employer –Effects on wages? Labor market experience? Firm tenure? Unemployment?

Copyright ©2012 by Pearson Education, Inc. All rights reserved. Modern Labor Economics: Theory and Public Policy, Eleventh Edition Ronald G. Ehrenberg Robert S. Smith Employer Hiring Costs Variable costs –Hourly wages vary with hours worked Fixed costs –Hiring selection, training, benefits (that do not very with hours worked) –Overtime? Who to train? Who to lay off in the downturn? Connection between productivity and pay? Effect of employee job-protection laws (e.g. layoff notification)

Copyright ©2012 by Pearson Education, Inc. All rights reserved. Modern Labor Economics: Theory and Public Policy, Eleventh Edition Ronald G. Ehrenberg Robert S. Smith Imperfect Mobility of Labor & Capital If labor and capital were perfectly mobile, there would be only one wage for each type of worker (each occupation) across all firms, all regions and all industries.

Copyright ©2012 by Pearson Education, Inc. All rights reserved. Modern Labor Economics: Theory and Public Policy, Eleventh Edition Ronald G. Ehrenberg Robert S. Smith Hourly Wages by Region Nonunion Bricklayers $26.59/$21.17=1.26 Nonunion Electricians $25.83/$22.22=1.16

Copyright ©2012 by Pearson Education, Inc. All rights reserved. Modern Labor Economics: Theory and Public Policy, Eleventh Edition Ronald G. Ehrenberg Robert S. Smith Construction Unionization % Union

Copyright ©2012 by Pearson Education, Inc. All rights reserved. Modern Labor Economics: Theory and Public Policy, Eleventh Edition Ronald G. Ehrenberg Robert S. Smith Cost of Living and underlying data from:

Copyright ©2012 by Pearson Education, Inc. All rights reserved. Modern Labor Economics: Theory and Public Policy, Eleventh Edition Ronald G. Ehrenberg Robert S. Smith Milwaukee wages are lower Milwaukee wages are higher

Copyright ©2012 by Pearson Education, Inc. All rights reserved. Modern Labor Economics: Theory and Public Policy, Eleventh Edition Ronald G. Ehrenberg Robert S. Smith Table 5.2 Hours Devoted by Firms to Training a New Worker during First Three Months on Job, 1992

Copyright ©2012 by Pearson Education, Inc. All rights reserved. Modern Labor Economics: Theory and Public Policy, Eleventh Edition Ronald G. Ehrenberg Robert S. Smith Table 5.3 Employee Benefits as a Percentage of Total Compensation, 2010 (Average Hourly Cost in Parentheses)

Copyright ©2012 by Pearson Education, Inc. All rights reserved. Modern Labor Economics: Theory and Public Policy, Eleventh Edition Ronald G. Ehrenberg Robert S. Smith Monopsony In the first four chapters we have assumed competitive labor markets. In competitive labor markets, both employers and workers are “price takers.” They take the market price as given and they cannot affect the market price by their own choices. But in some markets, employers are “price makers”: they affect the wage in those markets by the hiring choices they make. Because in labor markets employers are buyers and not sellers of labor, we call these “price makers” monopsonists. A monopolist is a price maker who is a seller not a buyer. Picture from

Copyright ©2012 by Pearson Education, Inc. All rights reserved. Modern Labor Economics: Theory and Public Policy, Eleventh Edition Ronald G. Ehrenberg Robert S. Smith Good News and Bad News Monopsonist Can Influence Wage But Usually Has to Raise Wages of Past Hires When Raising Wage to Get New Hires and problem-explained-in-one.htmlhttp://cynicusprime.blogspot.com/2013/03/the-gop-image- problem-explained-in-one.html

Copyright ©2012 by Pearson Education, Inc. All rights reserved. Modern Labor Economics: Theory and Public Policy, Eleventh Edition Ronald G. Ehrenberg Robert S. Smith Table 5.1 Labor Supply Schedule for a Hypothetical Firm Operating in a Monopsonistic Market

Copyright ©2012 by Pearson Education, Inc. All rights reserved. Modern Labor Economics: Theory and Public Policy, Eleventh Edition Ronald G. Ehrenberg Robert S. Smith If Firm is Monopsony then the Supply Curve is NOT the Key Curve Figure 5.2 A Graph of the Firm-Level Data in Table 5.1 The monopsony firm has to raise the wages of all its previously hired workers when it raises its market wage to hire new workers. So the supply curve is not the monopsonist’s marginal expense curve. That curve is higher and less elastic.

Copyright ©2012 by Pearson Education, Inc. All rights reserved. Modern Labor Economics: Theory and Public Policy, Eleventh Edition Ronald G. Ehrenberg Robert S. Smith Monopsonist Will Hire Fewer Workers at Wage W* Figure 5.3 Profit-Maximizing Employment and Wage Levels in a Firm Facing a Monopsonistic Labor Market

Copyright ©2012 by Pearson Education, Inc. All rights reserved. Modern Labor Economics: Theory and Public Policy, Eleventh Edition Ronald G. Ehrenberg Robert S. Smith Figure 5.4 The Monopsonistic Firm’s Short-Run Response to a Leftward Shift in Labor Supply: Employment Falls and Wage Increases

Copyright ©2012 by Pearson Education, Inc. All rights reserved. Modern Labor Economics: Theory and Public Policy, Eleventh Edition Ronald G. Ehrenberg Robert S. Smith Minimum Wage Under Monopsony A minimum wage can change the monopsonist’s Marginal Expense of Labor By making the monopsonist pay the minimum wage, the marginal expense becomes the minimum wage (up to a point)

Copyright ©2012 by Pearson Education, Inc. All rights reserved. Modern Labor Economics: Theory and Public Policy, Eleventh Edition Ronald G. Ehrenberg Robert S. Smith Figure 5.5 Minimum-Wage Effects under Monopsonistic Conditions: Both Wages and Employment Can Increase in the Short Run

Copyright ©2012 by Pearson Education, Inc. All rights reserved. Modern Labor Economics: Theory and Public Policy, Eleventh Edition Ronald G. Ehrenberg Robert S. Smith Overtime vs. New Hire (Marginal expense of hiring a new worker) (Marginal productivity of a new worker) (Marginal expense of hiring a current worker) (Marginal productivity of a current worker) ? dilemma-balancing-tactical-and-strategic- projects/875412_ /#sthash.Rq2PioGv.dpbs What you have to pay relative to what you get from the old worker What you have to pay relative to what you get from the new worker

Copyright ©2012 by Pearson Education, Inc. All rights reserved. Modern Labor Economics: Theory and Public Policy, Eleventh Edition Ronald G. Ehrenberg Robert S. Smith What Affects ME & MP of Current vs. New Workers? Current workers ME –Have to pay higher overtime wages at some point MP –Workers get exhausted at some point New Workers ME –May have to raise wages to get more workers MP –May have hiring and training costs

Copyright ©2012 by Pearson Education, Inc. All rights reserved. Modern Labor Economics: Theory and Public Policy, Eleventh Edition Ronald G. Ehrenberg Robert S. Smith Training General training –Skills for which there are many potential interested employers –Prediction: worker will pay for these skills  Going to school  Trainee wage below beginning marginal productivity Specific training –Skills specific to one employer –Prediction: firm will pay for these skills (Peter not text): Industry training –Skills specific to one industry –Prediction: collective bargaining will pay for these skills  Example: construction Picture:

Copyright ©2012 by Pearson Education, Inc. All rights reserved. Modern Labor Economics: Theory and Public Policy, Eleventh Edition Ronald G. Ehrenberg Robert S. Smith Apprentices Receive $4.5k to $8.3k in Scholarships per Year Union-Contractor Joint Apprenticeship Programs Iowa 2008

Copyright ©2012 by Pearson Education, Inc. All rights reserved. Modern Labor Economics: Theory and Public Policy, Eleventh Edition Ronald G. Ehrenberg Robert S. Smith 34

Copyright ©2012 by Pearson Education, Inc. All rights reserved. Modern Labor Economics: Theory and Public Policy, Eleventh Edition Ronald G. Ehrenberg Robert S. Smith Training, Retention & Future Wages If workers cannot afford to train themselves, they could take a trainee discounted wage and expect to recoup their losses with higher wages later. But empirical studies suggest employers pay and employers recoup costs making-the-decision-to-find-a-new-gig/i-quit/

Copyright ©2012 by Pearson Education, Inc. All rights reserved. Modern Labor Economics: Theory and Public Policy, Eleventh Edition Ronald G. Ehrenberg Robert S. Smith Figure 5.7 Productivity and Wage Growth, First Two Years on Job, by Occupation and Initial Hours of Employer Training

Copyright ©2012 by Pearson Education, Inc. All rights reserved. Modern Labor Economics: Theory and Public Policy, Eleventh Edition Ronald G. Ehrenberg Robert S. Smith Criticism: Disconnect between Productivity & Wages Since 1970s Source:

Copyright ©2012 by Pearson Education, Inc. All rights reserved. Modern Labor Economics: Theory and Public Policy, Eleventh Edition Ronald G. Ehrenberg Robert S. Smith Summary Labor market frictions alter results from competitive labor market analysis Costly mobility of labor and capital including hiring costs, training costs, relocation costs, etc. may create different wages for identical/comparable workers Monopsony changes the calculations of what an employer will pay and how many workers the monopsonist will hire