Labor Market Equilibrium

We start with the assumption that each labor market is competitive. What does this mean? How is equilibrium price set? Why is this an “equilibrium” wage?

Labor Market Equilibrium What do we mean by “economic efficiency” in the context of markets? Why would competitive labor markets lead to efficient outcomes?

Labor Market Equilibrium What are some issues in this competitive model? Unemployment? Underemployment? Employer market power? Extremely low wages?

Labor Market Equilibrium Multiple Labor Markets and Migration Suppose there were two cities, A & B For similar types of labor, wage is higher in city A than city B. What will happen over time?

Labor Market Equilibrium “The whole of the advantages and disadvantages of different employment and labour and stock must, in the same neighborhood, be either perfectly equal or continually tending toward equality. If in the same neighborhood there was any employment either evidently more or less advantageous than the rest, so many people would crowd into it in the one case, and so many would desert in the other, that its advantages would soon return to the level of the other employments.” -Adam Smith Why might this not happen though?

Labor Market Equilibrium What determines equilibrium wage in a given sector? So why can there be wage inequality across sectors in equilibrium?

Labor Market Equilibrium How about wage inequality within a sector? Is this consistent with a competitive labor market? Besides wage, what else can differ across jobs in a given sector? How will these differences play out in equilibrium?

Labor Market Equilibrium So, without mobility restrictions, it is “rents” (for the marginal worker) not wage that should be equalized across sectors. What conditions might cause aggregate rents to be higher in one labor sector than another? What might restrict mobility? In what sectors are aggregate rents likely to be low?

Labor Market Equilibrium Suppose jobs can differ in their degree of safety. Workers: Care about their wage and their probability of injury. What will indifference curves look like in wage/prob. of injury space? How will I.C.s differ for workers with different tolerances for risk? Firms: Profit per worker depends on wage paid and degree of risk. We can consider iso-profit curves in wage/prob. of injury space. How will isoprofit curves differ across different types of firms?

Labor Market Equilibrium So how will wages and risk-level at each job be determined? Suppose there are 2-types of workers---highly risk-averse, less risk- averse---and two types of firms--- type 1 (relatively expensive to mitigate risk) and type 2 (cheap to mitigate risk) In equilibrium, it must be true that each firm operates on “zero-profit” iso-profit curve. Why?

Labor Market Equilibrium $w w 1 w* w 2 High risk r 1 r* r 2 low risk Could firm type 1 ever offer a risk lower than r* in equilibrium? Could firm type 2 ever offer a wage higher than w* in equilibrium? Suppose firms of type 1 offered {w 1,r 1 } and firms of type 2 offered {w 2,r 2 }. Can this be an equilibrium?

Labor Market Equilibrium $w w 1 w* w 2 High risk r 1 r* r 2 low risk Could firm type 1 ever offer a risk lower than r* in equilibrium? Could firm type 2 ever offer a wage higher than w* in equilibrium? Suppose firms of type 1 offered {w 1,r 1 } and firms of type 2 offered {w 2,r 2 }. Can this be an equilibrium?

Labor Market Equilibrium $w w 1 w* w 2 High risk r 1 r* r 2 low risk Could firm type 1 ever offer a risk lower than r* in equilibrium? Could firm type 2 ever offer a wage higher than w* in equilibrium? Suppose firms of type 1 offered {w 1,r 1 } and firms of type 2 offered {w 2,r 2 }. Can this be an equilibrium?

Labor Market Equilibrium $w w 1 w* w 2 High risk r 1 r* r 2 low risk Could firm type 1 ever offer a risk lower than r* in equilibrium? Could firm type 2 ever offer a wage higher than w* in equilibrium? Suppose firms of type 1 offered {w 1,r 1 } and firms of type 2 offered {w 2,r 2 }. Can this be an equilibrium? Yes! No one has an incentive to deviate. Wage/risk locus

Labor Market Equilibrium $w w 1 w 2 High risk r 1 r 2 low risk

Labor Market Equilibrium What are key implications of this simple model? Is this equilibrium efficient relative to random sorting or a fixed “risk” standard? Consider the wage/risk locus that could be observed in the data: Does it tell us how much it will cost high risk firms to mitigate risk? Does it tell us how much low wage workers would need to be paid to accept higher risk? What is key assumption behind this model?

Labor Market Equilibrium So equilibrium wage depends on preferences and “other” options for appropriate workers. E.g., my reservation wage for being a warehouse worker is different now than when I was in college. My reservation wage for being an investment banker may differ from some of my peers. How does all of this relate to “Guinea pigging”?