1. In this chapter, we learn: how a basic supply-and-demand model helps us understand the labor market. how labor market distortions like taxes and firing costs affect employment in the long run. how to compute present discounted values, and how to value your human capital.  the return to a college education has risen enormously over the last half-century.  the wages of a person starting to work this year and continuing to work for the next 45 years are worth approximately $1 million in today’s dollars. Wages account for two-thirds of per capita GDP…and have for a long time Average wages adjusted for the cost of living have grown 2 percent per year for the last century, reflecting increases in productivity.  Since 1990, however, average hourly earnings adjusted for inflation have grown only 0.61% and average weekly earnings have grown only 0.43%

2. 2010 Labor Market Facts: Employment – to – Population Ratio

3. Composition of the Laborforce: 2005 and January 2010 237 million 153 138 14.8 84 2005 Jan 2010

4. The unemployment rate is the fraction of the labor force that is unemployed A person is unemployed if she does not have a job that pays a wage or salary, she actively looked for a job during the four weeks before measuring the unemployment rate, and she is available to work. The unemployment rate in 2005 was 7.6/149 = 5.1% The unemployment rate in 2010 was 14.8/153 = 9.7%

5. Labor Market Facts: The Unemployment Rate 2010

6. Dynamics of the Labor Market Job creation and job destruction are the gross flows of jobs that are being created and destroyed every month as part of normal changes in the U.S. economy. Most spells of unemployment were relatively short. People who are unemployed for long periods account for most of the total weeks of lost work.  Hysteresis: long-term unemployed become unemployable and stay unemployed The duration of unemployment has increased sharply in the current Great Recession.

7. 7 Employment 127 million Job Change 3.5 million Unemployment 7.0 million Out of labor force 66.7 million 1.1 1.3 1.7 1.5 1.8 Labor Force Data, 1994 – 1999 (monthly flows) Separation rate = (2.8+1.8+2.8)/122 = 6% per month Labor Market Monthly Flows, 1996 – 2003 Population leaving labor force/month = (2.8 + 1.4)/(122 +59.3) = 2.3 % Unemployed finding work = 1.4/6.2 = 23% /mo. Unemployed leaving unemployment each month = (1.4+1.4)/6.2 = 45% Avg duraation of unemployment = 1/.45 = 2.2 months

8. Labor Supply and Demand The labor demand curve is derived from the firm’s profit maximization problem. Firms hire workers until the marginal value product of labor (MP L ) equals the wage rate.  If MP L > Wage, firms wants to hire additional workers  If MP L < Wage, firms wants to hire fewer workers The demand curve for slopes downward because of the diminishing marginal product of labor.  As we add more workers and hold all else equal, each additional worker produces less. The labor supply curve slopes upward because the price of leisure is higher when wages are higher.  It takes a higher wage to get workers to give up more and more “leisure” The intersection of labor supply and demand determines the level of employment and the wage rate.

9. Reflects diminishing marginal product of labor.

10. Change in Labor Supply: An income tax or payroll tax  A Wedge Between What Firm Pays and Worker Gets If the government collects a tax on a worker’s wage, labor supply shifts left. For any given wage, a worker receives less money and supplies less labor. In order to be in equilibrium, firms must raise wages. As firms raise wages, they will need to fire some workers and the unemployment rate will rise. However, over time, workers will become discouraged and may drop out of the labor force. If all laid-off workers become discouraged, the unemployment rate is unchanged in the long run.

11. A Change in Labor Demand: Regulations making it harder to fire workers. Firms will demand fewer workers because they will not be able to fire them later. Labor demand shifts left causing wages and employment fall. The unemployment rate rises initially and recovers as discouraged workers drop out of the labor force. Rigid (“sticky”) wages: If wages are sticky, the failure of wages to fall to clear the labor market will result in a larger fall in employment.

12. Efficiency Wages: Keep wages high! Paying a wage greater than the wage needed to retain a worker may actually increase a firm’s profits. Paying higher wages allows workers to eat healthier and become more productive. Paying higher wages ensures a higher level of effort and less shirking. Higher wages will attract more able workers to a firm.  Reduced hiring costs Higher wages will reduce turnover  Reduced training costs

13. Supply and Demand Shocks in the U.S. Labor Market Increases in the employment-population ratio are due in large part to increases in the number of women working. Supply shocks include changes in social norms and changes in technology for managing fertility. Demand shocks include reduced discrimination against women. Rising unemployment in the 1960s and 1970s and the subsequent decline in the 1980s is possibly explained by the baby boom. Young people have higher unemployment rates traditionally – and the baby boom increased the proportion of young people in those decades.

14. Flavors of Unemployment The “natural rate” of unemployment is the rate that would prevail if the economy were in neither a boom nor a bust. The natural rate of unemployment includes two components:  Frictional unemployment is due to workers being between jobs in the dynamic economy  Search unemployment  Wait unemployment  Structural unemployment results from the labor market failing to match up workers and firms in the market. –In a healthy, dynamic economy, some industries are growing while others are declining Cyclical unemployment is the difference between the actual rate and the natural rate and is associated with short-run fluctuations in output.

15. Labor Markets around the World Unemployment in Europe had been substantially above America’s rate since 1980, while Japan’s rate was historically below the United States. Euro-sclerosis???: European unemployment has increased dramatically because of: Adverse shocks (productivity showdown and high oil prices) hit Europe and other countries. Inefficient labor market institutions exist in Europe, as unemployment and welfare benefits are substantially higher. Many programs are designed such that there is a high implicit tax rate for returning to work. GDP per capita is lower in Europe because workers work less hours. If the choice is voluntary, then Europeans enjoy leisure more and welfare is likely improved. If the decrease in hours worked is a result of distortions in the labor market, it is likely not welfare enhancing.

16. How Much is Your Human Capital Worth? The present discounted value of your lifetime income is likely greater than 1 million dollars. The premium to having a college degree relative to a high school degree has been rising rapidly over the last forty years. The wage premium of a college degree over a person’s years worked far outweighs the forgone wages and tuition costs of going to college.

17. As wages have grown, so has the supply of college graduates – such a supply shock implies wages should decline. Because the supply of works has increased, it must also be the case that the demand for college- educated workers has increased by an amount large enough to offset supply. Furthermore, the demand shift for college- educated workers must be large enough to also counteract any shifts occurring in the market for high school graduates. Explanations for a large shift in demand for highly educated workers include: Skill-biased technical change is the idea that new technologies are more effective at improving productivity of college-educated workers than of high school educated workers. Globalization is the increased opening of trade. Because highly educated workers are a scarce resource in the world as a whole, trade will raise wages of college-educated workers.