LECTURE April Tuesday, April 30, 13

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1 LECTURE April

2 ANNOUNCEMENTS HW 10 due this Friday Final exam in Anderson 330 (on May 14th 6:30-8:30PM) If you need to take the makeup, notify by next Tuesday (May 7th) at 4PM Start studying! Extra OH next Thursday 11:00 AM - 1:00 PM Review Sessions also in Anderson 330 next Friday (4-5:30 PM with me) and (6-7:30 PM) 2

3 OUTLINE Labor Markets Labor Productivity Labor Income and Wage Inequality Skill Biased Technical Change Unskilled Biased Technical Change Economics of Superstars and the.01% 3

4 TOPIC 20 (21?) Labor 4

5 BIG PICTURE What makes up demand and supply in the labor market? How is wage determined in the labor market? What have been trends in income and wage inequality in the United States? What is skill-biased technical change and how has impacted trends in wage inequality? How do unions and discrimination impact labor markets? 5

6 LABOR MARKETS We have studied demand of products, like wine and cheese, and disturbances of these markets (taxes, quotas, etc.) Another fundamental market is the market for labor Who makes up demand and supply in the labor market? Firms demand labor to make products which they can then sell Consumers supply labor to make a wage Studying labor markets is a baseline to understanding another important economic concept: inequality 6

7 LABOR DEMAND 7

8 LABOR DEMAND Firms want to hire labor for their purpose in making products (or services) that can be sold What are factors that will impact how much labor firms demand? Technology of the firm (if your company only needs computers to operate and a few people...) Output price - how much does the firm sell the product or service for Input prices - Wages, price of other inputs (computers, machines, office space, etc.) Input prices, technology, output prices can determine labor demand of a firm 8

9 TECHNOLOGY Recall our technology diagram from Crusoe on the island (lecture 14) Output Input Labor Time Technology Skill 1 melon / hr 3 melon / hr Watermelon Lobster Crusoe is limited by time: Time is the limited resource How good his technology tell us his productivity: How much he can produce in a period of time 9

10 TECHNOLOGY In general the technology is embodied in the production function Production function tell us how output depends on the quantity of inputs Consider Don s lawn business Don s inputs: 2 workers that work 8 hours a day, 1 truck, 2 lawn mowers, and 1 hedger Don s outputs: using these inputs, he can mow 10 lawns in a day 10

11 MARGINAL PRODUCT OF LABOR With more inputs we expect output to increase as well Suppose Don adds one more full-time worker and can now mow 13 lawns Adding this one worker improved Don s output by 3 lawns The additional output of the last worker added is called the marginal product of labor 11

12 VALUE OF MPL How much should Don pay this worker with marginal product (MPL) of 3 lawns? It should depend on how valuable the extra work is Suppose the price per lawn mowed is $40 Then the value of the extra work (the MPL) is $40*3=$120 So the value of this third worker is $120 Whether the firm hires the worker depends on the wage If wage > $120, no way Don hires If wage < $120, he would be willing For most types of firms wage = $120 (wage = the value of the marginal product of labor) 12

13 DIMINISHING MPL Suppose, we have much better technology so the graph now looks like this Notice that the marginal product of labor for this firm is decreasing with the people we hire Recall from firm theory lecture (18), for a firm with diminishing returns it takes more and more input to produce one unit of output Lawns Mowed Marginal Product of Labor MPL Here we call the decreasing marginal product of labor, diminishing marginal product Units of Labor 13

14 DIMINISHING MARGINAL VALUE Suppose now the price of mowed lawn is $2 The value of marginal product of labor is then simply the MPL * $2 $ Labor Demand Holding constant the other factors that influence demand (price of other inputs, technology), the value of MPL graph is firm demand Demand = Value of MPL Units of Labor 14

15 LABOR DEMAND Set wage = value of MPL Notice then that demand decreases as the price of labor (wage) increases Worth restating: SHIFT IN PRICE (WAGE) IS A SHIFT ALONG DEMAND $ Labor Demand What will shift the demand curve? Changes in technology Changes in price of output 10 Demand = Value of MPL Units of Labor 15

16 SHIFT IN DEMAND Suppose the price of a mowed lawn increases to $4 per lawn The value of the marginal product of labor will shift up from MPL*2 to MPL*4 So demand will shift up as well $ Labor Demand Notice this type of shift is different than in the product market Demand for the 10th unit of labor is still 0 since he still produces no extra output Demand 1 Demand Units of Labor 16

17 LABOR MARKET EQUILIBRIUM AND THE US MARKET 17

18 LABOR SUPPLY To determine equilibrium in the market, we need both supply and demand How does supply change with wage? $ Labor Supply Supply Expect higher wage increases the supply of labor for an industry (for a country, labor is probably perfectly inelastic in the short run) Aside: remember our discussion of leisure choices before for an individual Should the income or substitution effect dominate for wage to increase hours worked? If the substitution effect dominates, then leisure will decrease (hours worked increases) Units of Labor 18

19 LABOR MARKET EQUILIBRIUM Suppose labor supply is as given here; what is the equilibrium wage? $ Labor Market Supply As usual, the equilibrium price is the wage so demand for labor equals supply So equilibrium wage is $25 and equilibrium number of workers (quantity) is 5 Wage Eq Demand = Value of MPL Units of Labor Workers Eq 19

20 APPLICATION: UNITED STATES Of course, there is not a single wage offered to every person, but there is also not a single labor market We can study in empirical application, however, average wage in a variety of settings What has happened to the average real wage (real means adjusted for inflation) in the US over the past few decades? Has it actually grown with productivity (as our assumption that wage = productivity supposes)? 20

21 WAGE AND PRODUCTIVITY GROWTH While just a simple correlation, we can see that wage growth seems to be associated with productivity growth What drives productivity growth? In the US, primarily changes in technology Period Labor Productivity Growth Real Wage Growth % 1.9% % 2.8% % 1.2% % 2.3% 21

22 WAGE INEQUALITY 22

23 WAGE INEQUALITY Average real wage may have risen, but the story is not the same for all types of workers and wage levels are certainly different What drives the differences? Compensating Wage Differentials - wage differences driven by characteristics of the job Skill Premium - more skilled or more experienced workers tend to get higher wages in the States 23

24 COMPENSATING WAGE DIFFERENTIAL People otherwise the same might receive different wages because of characteristics of their work In particular jobs that are unpleasant and dangerous tend to pay higher wages. Why? We expect desirability of these jobs to be lower so fewer workers are willing to supply their labor Higher wage is a needed incentive to get something to supply their labor versus going to a similar, yet less messy job 24

25 HUMAN CAPITAL Human capital refers to some stock of skill (typically from experience, education) that contributes to a person s ability to produce Workers with higher human capital tend to receive higher wages We can see the difference in wages between skilled and unskilled labor through the skill premium The skill premium is the pay difference between these two types of workers 25

26 SKILL PREMIUM From chapter 19 in your book Here, skill is taken to mean formal education level (other applications might define skill differently) Wages are in $1,000s 2008 prices The premium tells us how much higher the average wage for a college grad is compared to someone with only high school education Notice the premium has grown significantly since 1980 Men High School College Premium 44% 88% Women High School College Premium 35% 71% 26

27 THE WAGE PUZZLE Explaining this trend has and continues to be a major discussion in macroeconomics College Wage Premium 27

28 FALSE MODELS Take supply in the skilled and unskilled market as inelastic (why inelastic? how quickly can you change your education...) Simple Predictions of Wage Movement with Supply Changes Skill Wage Skilled Labor Market S1980 S2008 Since 1980, the supply of skilled labor has relatively increased and unskilled labor has decreased Our model predicts that the premium should fall (college wage should fall and high school rise) What could explain reality? We need some change in demand W1980 W2008 Unskilled Wage W2008 W1980 Unskilled Labor Market S2008 Skilled Workers S1980 Demand Demand Unskilled Workers 28

29 EXPLAINING THE PREMIUM First, let s confirm shifts in demand will solve the issue Skilled Labor Market Unskilled Labor Market Skill Wage S1980 S2008 Unskilled Wage S2008 S1980 D1980 W2008 D2008 W1980 W2008 D2008 W1980 D1980 Skilled Workers Unskilled Workers If we believe that demand for skilled labor has increased and for unskilled has decreased, we can resolve the issue But what drives the change in demand? 29

30 WAGE TRENDS, WAGE AND INCOME INEQUALITY We will consider four explanations that might explain the wage and income trends in the United States 1. Skill Biased Technical Change 2. Immigration and Trade 3. Decline of Unions (not a demand-side argument) 4. Economics of Superstars 30

31 SKILL-BIASED TECHNICAL CHANGE How does skilled or unskilled labor make products or provide services? Need other technologies to complement them Firms develop these technologies (computers, machines, production processes, etc.) Skill-biased technical change claims that most of this development in recent years has been for skilled labor because of the growing population of skilled labor In the simple story these technologies complement skilled and substitute unskilled labor So these technologies make skilled labor more productive (and increase demand for them) and vice versa for unskilled labor 31

32 SKILL-BIASED TECHNICAL CHANGE For example, consider car production In the era of Henry Ford, (low skill) laborers did most of the work of assembly Now Toyota can make cars with little lowskill labor and skilled labor that design the machines and cars The machines have substituted (replaced) the low skill labor and complemented the high skill labor Henry Ford car production V. Modern Toyota production And so demand for high skill labor has increased and decreased in the automotive sector Or high V. low-tech education provision 32

33 UNSKILLED BIASED TECHNICAL CHANGE Developing technologies biased towards skilled labor is not inevitable, though In the late 1800s, skilled labor was artisans and craftsman; unskilled labor were most everyone else The big technological leap was Henry Ford s assembly line was a technology that was a complement to unskilled labor; it significantly improved the productivity of unskilled labor With the increase in demand for unskilled labor, the skill premium decreased in that period 33