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Introduction to Labor Economics. Chapter 2 - The Labor Market. National and local labor markets. national labor market. National and local labor markets. national labor market local labor market. Internal labor market. A firm uses an internal labor market if:

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Introduction to labor economics

Introduction to Labor Economics

Chapter 2 - The Labor Market


National and local labor markets
National and local labor markets

  • national labor market


National and local labor markets1
National and local labor markets

  • national labor market

  • local labor market


Internal labor market
Internal labor market

A firm uses an internal labor market if:

  • external hiring is used primarily for entry-level jobs, and

  • higher level positions are filled by promotion from within the firm.


Internal labor market1
Internal labor market

  • reduces hiring and training costs,

  • improves employee morale and motivation, and

  • reduces the effect of uncertainty.

Internal labor markets exist because the use of such markets:


Primary vs secondary labor markets
Primary vs. Secondary labor markets

  • primary labor market - high wages and stable employment relationships.

  • secondary labor market - low wages and unstable employment relationships.


Labor force and unemployment
Labor force and unemployment

  • labor force = noninstitutionalized individuals aged 16 or above who are either working or actively seeking work.

  • unemployed = those who are not working but are “actively seeking work”


Unemployment rate
Unemployment rate

  • Discouraged workers are workers who have given up looking

  • for work.

  • An increase in the number of discouraged workers causes the

  • unemployment rate to fall.


Labor force participation rate
Labor force participation rate

  • the labor force participation rate rises during an expansion and

  • falls during a recession.

  • fluctuations in the labor force participation rate over the course of

  • the business cycle dampen cyclical fluctuations in the

  • unemployment rate.


Trend in unemployment rates
Trend in unemployment rates

  • unemployment rates in the latter half of the 20th century were higher than in the first half


Trends in labor force participation rates
Trends in labor force participation rates

  • the labor force participation rate has declined for males (primarily for males in their early 20s and over 62).

  • the labor force participation rate has increased for females (particularly for married females).


Sectoral shifts in employment
Sectoral shifts in employment

  • primary sector (agricultural) employment has declined as a share of the labor force,

  • secondary sector (industrial) employment has declined slightly as a share of the labor force, but only in the past few decades, and

  • tertiary sector (service sector) employment has increased as a share of the labor force.


Reasons for the shifts in employment
Reasons for the shifts in employment

  • the primary sector (agriculture) is characterized by rapid growth in labor productivity and a low income elasticity of demand,

  • the secondary sector is characterized by rapid growth in labor productivity and a moderately high income elasticity of demand, and

  • the tertiary sector is characterized by slow growth in labor productivity and a high income elasticity of demand.


Nominal and real wages
Nominal and real wages

  • Nominal wages are not adjusted for inflation and are said to be expressed in terms of “current dollars.”

  • Real wages are wages that have been adjusted to take into account the effect of inflation. Real wages are expressed in terms of dollars from a given base year and are said to be expressed in “constant dollars.”



Problems with the cpi
Problems with the CPI

  • inflationary bias (substitution bias)

  • difficulty in adjusting for quality change


Wages earnings total compensation and income
Wages, earnings, total compensation, and income

  • wage = payment per unit of time

  • earnings = wage x hours

  • total compensation = earnings + fringe benefits

  • fringe benefits = payments-in-kind + deferred compensation

  • income = total compensation + unearned income (or income = earnings + unearned income)


Demand for labor
Demand for labor

The labor demand curve is downward sloping due to:

  • a substitution effect, and

  • a scale effect.


Substitution effect
Substitution effect

  • substitution effect - substitution of other resources for a resource that becomes relatively more expensive.


Scale effect
Scale effect

The scale effect associated with a wage increase involves the following steps:

  • higher wages result in higher average and marginal costs of production,

  • leading to an increase in the equilibrium price of the product,

  • leading to a reduction in the quantity of the product demanded,

  • leading to a reduction in the use of all inputs used to produce the product.


Slope of labor demand curve
Slope of labor demand curve

  • Both the substitution and scale effects result in a reduction in the quantity of labor demanded when the wage rate rises.

  • A change in the wage changes the quantity of labor demanded, but does not affect labor demand. Labor demand changes only if the labor demand curve shifts in some manner (as discussed below).


Shifts in labor demand
Shifts in labor demand

Labor demand may shift due to changes in:

  • the demand for the product, and

  • the prices of other resources.


Industry demand for labor
Industry demand for labor

  • An industry's demand for labor consists of the total demand for a particular type of worker in a given industry. (An industry consists of all of the firms that produce a given type of output.)

  • An industry's labor demand curve is determined by adding together the labor demand curves for all of the firms in the industry.


Market demand for labor
Market demand for labor

  • The market for a given category of labor consists of all of the firms that might hire a given type of labor, regardless of the industry in which the firm operates.

  • The market demand for labor is determined by adding together all of the industry demand for labor curves.



Market labor supply
Market labor supply

  • cause some workers in this market to work additional hours,

  • induce some workers to shift from other labor markets to this relatively more remunerative alternative employment, and

  • will cause some individuals who are not currently in the labor force to enter this market.

The market labor supply curve is expected to be upward sloping because an increase in the wage in a particular labor market will:



Shifts in market labor supply curve
Shifts in market labor supply curve

  • Shifts such as this may be due to:

  • changing wages in other markets, or

  • changes in worker tastes and preferences




Shifts in labor market equilibrium
Shifts in labor market equilibrium

  • an increase in labor demand results in an increase in both the equilibrium wage and the equilibrium level of employment,

  • a reduction in labor demand results in a decrease in both the equilibrium wage and the equilibrium level of employment,

  • an increase in labor supply results in a lower equilibrium wage, but a higher equilibrium level of employment, and

  • a reduction in labor supply results in a higher equilibrium wage, but a lower equilibrium level of employment.


Two types of unions
Two types of unions

  • industrial union

  • trade union (also known as a craft union)




Overpaid and underpaid workers
Overpaid and underpaid workers

  • economists argue that workers are overpaid if their wage is above the equilibrium,

  • workers are underpaid if their wage is below the equilibrium wage.


Economic rent
Economic rent

  • Workers receive economic rent when they receive a payment that exceeds the opportunity cost of supplying their labor.

  • The opportunity cost of supplying labor is the value of this time in its next-best alternative use.

  • Another name for this opportunity cost is the "reservation wage," the lowest wage offer an individual will accept.


International comparisons of unemployment rates
International comparisons of unemployment rates

  • As your text notes, unemployment rates have, in recent decades, generally been higher in Europe than in the United States.

  • It is argued that this is because nonmarket forces are more important in wage setting in Europe.


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