Work and the Labor Market 19 Work and the Labor Market Work banishes those three great evils: boredom, vice, and poverty. — Voltaire CHAPTER 19 Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

Work and the Labor Market 19 Chapter Goals Use the theory of rational choice to explain why an increase in the marginal tax rate is likely to reduce the quantity of labor supplied Explain how the demand for labor is a derived demand Discuss four factors that influence the elasticity of market labor supply 19-2

Work and the Labor Market 19 Chapter Goals Define monopsony and bilateral monopoly Discuss three types of discrimination Explain real-world characteristics of labor markets in terms of market, political, and social forces Discuss four factors that influence the elasticity of market labor demand 19-3

Work and the Labor Market 19 Work and the Labor Market A labor market is a factor market in which individuals supply labor services for wages to individuals and firms that demand labor services Incentive effect is how much a person will change hours worked in response to the wage rate The labor supply choice is between nonmarket activities and legal market activities Economists focus on the incentive effect when considering an individual’s choice of whether and how much to work 19-4

Work and the Labor Market 19 The Supply of Labor Applying rational choice theory to the supply of labor tells us that the higher the wage, the higher the quantity of labor supplied The labor supply curve has a positive slope because the opportunity cost of not working increases as wages get higher Wage Rate Q of Labor Supply of Labor 19-5

Work and the Labor Market 19 Real Wages and the Opportunity Cost of Work The upward sloping labor supply curve tells you that, other things equal, as wages go up, the quantity of labor supplied goes up This is explained by the income effect causing a decrease in hours worked and the increased cost of leisure activities causing an increase in hours worked Historically real wages have been increasing and people have reduced the number of hours they work, but they still work more hours than predicted 19-6

Work and the Labor Market 19 Income Tax, Work, and Leisure Taxes reduce the net wage of individuals, reducing the incentive to work For welfare recipients, the tax penalties for working create a great incentive to not work or to work in the underground economy An increase in the marginal tax rate is likely to reduce the quantity of labor supplied EU countries, which have relatively high marginal tax rates, are struggling with the problem of providing incentives for people to work 19-7

Work and the Labor Market 19 The Elasticity of Labor Supply Elasticity of labor supply depends on: Individuals’ opportunity cost of working The type of labor market being discussed The elasticities of individuals’ supply curve Individuals entering and leaving the labor market Employees prefer an inelastic labor supply, but employers prefer an elastic labor supply Estimates for labor supply elasticity are about 0.1 (inelastic) for heads of household and 1.1 (elastic) for secondary earners 19-8

Work and the Labor Market 19 Immigration and the International Supply of Labor International limitations on the flow of people play an important role in elasticities of labor supply Large differentials in wages mean that many people from low wage countries would like to move to high wage countries to earn higher wages EU countries have open borders among member countries, allowing the flow of labor between low and high wage countries 19-9

Work and the Labor Market 19 The Derived Demand for Labor The demand for labor follows the basic law of demand: the higher the wage, the lower the quantity of labor demanded The demand for labor by firms is a derived demand meaning the demand for factors of production by firms depends on consumers’ demands Wage Rate Q of Labor Demand for Labor 19-10

Work and the Labor Market 19 Factors Influencing the Elasticity of Demand for Labor Four factors that influence the elasticity of demand for labor are: The elasticity of demand for the firm’s good The relative importance of labor in the production process The possibility, and cost, of substitution in production The degree to which the marginal productivity falls with an increase in labor 19-11

Work and the Labor Market 19 Labor as a Factor of Production The labor market includes labor and entrepreneurship Entrepreneurship refers to labor services that require high degrees of organizational skills, concern, oversight responsibility, and creativity The traditional factors of production are land, labor, capital, and entrepreneurship Days of entrepreneurship can be equivalent to weeks and months of non-entrepreneurial labor 19-12

Work and the Labor Market 19 Equilibrium in the Labor Market Equilibrium is where the quantity demanded of labor is equal to the quantity supplied Wage Rate Q of Labor Demand for Labor Supply of Labor QeQe WeWe Equilibrium wage is W e Equilibrium quantity is Q e 19-13

Work and the Labor Market 19 Shift Factors of Demand International competitiveness may increase the demand for labor in the U.S. in spite of lower wages in foreign countries because: U.S. workers may be more productive Transportation costs are lower Foreign companies can avoid trade restrictions Production techniques are not compatible with foreign social institutions Focal point phenomenon is a situation where a company moves to a country because others have already moved there Technology both increases/decreases the demand for labor 19-14

Work and the Labor Market 19 The Role of Other Forces in Wage Determination Real-world labor markets are filled with examples of individuals or firms who resist these supply and demand pressures through; Labor unions Professional associations Agreements among employers Supply and demand forces strongly influence wages, but they do not fully determine wages 19-15

Work and the Labor Market 19 Labor Market in Action The effect of an above equilibrium wage is an excess supply of labor and jobs must be rationed Wage Rate Q of Labor Demand for Labor Supply of Labor QDQD W1W1 QSQS Excess supply of labor WeWe 19-16

Work and the Labor Market 19 Labor Market in Action The effect of an increase in the supply of labor will cause: Wage Rate Q of Labor D S0S0 Q0Q0 W1W1 Q1Q1 W0W0 Equilibrium wage to decrease Equilibrium quantity to increase S1S

Work and the Labor Market 19 Imperfect Competition and the Labor Market If a monopsonist hires another worker, the equilibrium wage will rise The marginal factor cost is above the supply curve Monopsony is a market in which a single firm is the only buyer of labor A bilateral monopoly is one in which a single seller of labor (a union) faces a single buyer of labor 19-18

Work and the Labor Market 19 Monopsony, Union Power, and the Labor Market W Q D Marginal Factor Cost QUQU WUWU S WCWC WMWM MR In a competitive labor market, equilibrium is W C and Q C Monopsony equilibrium is at point A where fewer workers are hired, Q M, and the wage, W M A union pushes for a higher wage, W U, and a lower quantity of workers, Q U In bilateral monopoly the wage will be between W U and W M and quantity between Q U and Q M QMQM QCQC A 19-19

Work and the Labor Market 19 Fairness and the Labor Market Social and political views of fairness play a role in wage determination Efficiency wages are wages paid above the going market wage to keep workers happy and productive Comparable worth laws mandate comparable pay for comparable work Living wage laws require employers to pay a worker a wage that would support a family of four at the poverty level 19-20

Work and the Labor Market 19 Job Discrimination and the Labor Market Discrimination exists in all walks of life The three types of demand-side discrimination are: Discrimination based on individual characteristics that will affect job performance Discrimination based on correctly-perceived statistical characteristics of the group Discrimination based on individual characteristics that do not affect job performance or are incorrectly perceived 19-21

Work and the Labor Market 19 Institutional Discrimination Institutional demand-side discrimination can also exist Institutional factors have an effect on things such as pay, but workplace discrimination also explains a portion Institutional discrimination is a discrimination in which the structure of the job makes it difficult for certain groups of individuals to succeed Institutions can have built-in discrimination 19-22

Work and the Labor Market 19 Evolution of Labor Markets Labor markets as we now know them developed in the 1700s and 1800s The political and social rules that operated at that time pushed wage rates down to subsistence levels, work weeks were long, and working conditions were poor Laws, such as minimum wage or child labor laws, play an important role in the structure of labor markets Labor laws and unions have evolved in response to workers’ political pressure 19-23

Work and the Labor Market 19 Unions and Collective Bargaining In the late 1800s and early 1900s, the government supported business’ opposition to workers’ right to strike In the 1930s the Wagner Act guaranteed workers the right to form unions, strike, and bargain collectively In 1947 the Taft-Hartley Act was passed limiting union activities and also provided for: States could pass right-to-work laws Closed shops were illegal Union shops were allowed Prohibited secondary boycotts 19-24

Work and the Labor Market 19 Unions and Collective Bargaining Unions were weakened in 1981 when Ronald Reagan fired striking air traffic controllers Union membership has declined in recent years partly due to the unions’ successes Today, nearly 50% of union members work for the government These unions are becoming stronger and will likely be exerting their influence 19-25

Work and the Labor Market 19 Changes in Union Membership, Percent of the Labor Force After the Depression in the 1930s, unions grew in importance, but since the mid-1970s the importance of unions has declined 19-26

Work and the Labor Market 19 Chapter Summary Incentive effects are important in labor supply decisions The higher the wage, the higher the quantity supplied The demand for labor by firms is derived from the demand by consumers for goods and services The higher the wage, the lower the quantity demanded Elasticity of labor supply depends on: Individuals’ opportunity cost of working Type of market Elasticity of individuals’ supply curves Individuals entering and leaving the labor market 19-27

Work and the Labor Market 19 Chapter Summary Elasticity of labor demand depends on: Elasticity of demand for the product Relative importance of labor in the production process Possibility and cost of substitution in production Degree to which marginal productivity falls with an increase in labor A monopsony is a market in which a single firm is the only buyer A monopsonist hires fewer workers at a lower wage compared to a competitive firm 19-28

Work and the Labor Market 19 Chapter Summary A bilateral monopoly is a market in which there is a single seller and a single buyer The wage and number of workers hired depend on the relative strength of the union and the monopsonist Views of fairness have led to laws that mandate comparable pay for comparable work Discrimination may be based on relevant individual characteristics, group characteristics, or irrelevant individual characteristics Since the 1980s, labor unions have been declining in importance 19-29

Work and the Labor Market 19 Preview of Chapter 20: Who Gets What? The Distribution of Income Explain what a Lorenz curve is Present U.S. income inequality in a global context Discuss how the poverty definition is both an absolute and a relative measure Summarize the statistical findings on income and wealth distribution Explain three problems in determining whether an equal distribution of income is fair Summarize the U.S. tax and expenditure programs to redistribute income Present three side effects of redistributing income Discuss two alternative ways to describe the distribution of income 19-30