Labor Markets and Professional Training © Allen C. Goodman, November 1999

Demand for Labor We start with production functions. They say: Q = f (X 1, X 2, … ). Typically, Q = f (K, L) Labor Capital Q = Q* What does it mean? How much capital and labor do we use?

Demand for Labor What does labor cost, what does capital cost? Labor Capital Q = Q* Start at point A. Is this an equilibrium? How much do we spend? E 1 = wL + rK E 2 = wL + rK K* L* A

Demand for Labor What happens if the price of labor increases? E 2 buys less labor. We produce less Q for E 2. Cost of Q will rise. Labor Capital Q = Q* If we want to continue to produce Q*, we must spend more How much do we spend? E 2 = w 1 L + rK K* L*L** K** E 3 = w 2 L + rK > E 2

What does this say about factor demand? As the wage level goes up, the quantity of labor decreases. Labor Capital Q = Q* K* L*L** K** L*** wage Labor L* w1w1 w2w2 w3w3 L**L***

What if the isoquant looked like this? As the wage level goes up, the quantity of labor decreases ??? Labor Capital Q = Q* K* L* L**L*** wage Labor L* w1w1 w2w2 w3w3 L**L*** How much substitution is there?

Supply of Labor In order to earn $ we must trade leisure for work. This gives us wages. Higher the wage rate, the more work we offer. Provides supply of labor curve. Labor wage Demand curve  an equilibrium wage. w* L*

Labor Markets Suppose we have a regime in which the labor supply is very inelastic. Labor wage Now, suppose that demand increases  an  in equilibrium wage. w* L* w** L**

Professional Training as an Investment Professional training is a long-term investment. When we “invest” what are we doing? Answer> We’re foregoing current consumption, in order to build a capital good that will give us increased future consumption. Here, it is “human capital.” What are we giving up? –Tuition –Foregone Earnings

How do we evaluate the investment? Remember discounting? Let’s do a 2 period model. Suppose we have to make a current investment of $30. It will give us a return of $17 at the end of Year 1, and another $17 at the end of Period 2. Is it worth it. Cost today = $30 Return a year from now is $17/(1 + interest rate). Why? Return two years from now is $17/(1 + interest rate) 2. Why? Net Present Value (NPV) = /(1+r) + 17/(1+r) 2 Is it worth doing? A> Depends on the interest rate. Let’s do a spreadsheet.

Spreadsheet: Ch_15.xls Early costs, returns have BIG weights. Later costs, returns have small weights.