Introduction to microeconomics

1. Introduction to microeconomics Chapter 12 Labour Markets

2. Discounting • (see separate presentation on web site)

3. Labour Markets Equilibrium • Selling human labour is not like selling other goods. • Workers “rent” their labour services. • Supply and demand are still the key analytic tools. • Supply and demand together determine equilibrium wage and quantity. • Shifts in the labour supply and labour demand curves are analogous to shifts in output markets. LO1: Marginal Productivity and Wage in Competitive Labour Markets

4. Wage and Salary Determination • Marginal product of labour - MPL • The additional output a firm gets by employing one additional unit of labour. • It is the benefit in output from hiring one more worker. • Value of marginal product of labour - VMP • The dollar value of the additional output a firm gets by employing one additional unit of labour. • It is the dollar value benefit from hiring one more worker. • General rule: a worker’s pay in long-run equilibrium will be equal to his or her VMP — the net contribution he or she makes to the employer’s revenue. LO1: Marginal Productivity and Wage in Competitive Labour Markets

5. Imperfect Information in Labour Market • People differ in their skills and abilities, and because those skills and abilities change over time, an individual worker’s quality cannot be graded easily. • The true output of individuals is often difficult to observe directly, particularly if they work as part of a team. • Firms and workers often have incentives of their own to not reveal true information. • Firms end up paying a wage that reflects what they expect a typical worker’s level of output to be, given those observable characteristics. LO1: Marginal Productivity and Wage in Competitive Labour Markets

6. EXAMPLE 12.2: How many workers will Abitibi hire? (Part 1) • Abitibi hires workers in a competitive labour market at a wage of $350/week • We assume here that all workers are of the same type or observationally equivalent. VMP = MP × P VMP>W Law of diminishing returns VMP<W Firm will hire 3 workers LO1: Marginal Productivity and Wage in Competitive Labour Markets

7. EXAMPLE 12.3: How many workers will Abitibi hire? (Part 2) LO1: Marginal Productivity and Wage in Competitive Labour Markets

8. Wage and Salary Determination in Competitive Labour Markets • When a firm can hire as many workers as it wants at a given market wage, it will increase hiring until VMP equals the wage. • Note: since firms know that productivity varies among individuals, they have to estimate the expected productivity of workers, recognizing that some characteristics (e.g. education) predict expected productivity. • The wages of a particular type of worker will depend on expected productivity. • Competition among firms will tend to equalize wages among observationally equivalent workers. LO1: Marginal Productivity and Wage in Competitive Labour Markets

9. EXAMPLE 12.4: How many workers will Abitibi hire? (Part 3) VMP>W VMP<W Firm will hire 4 workers LO1: Marginal Productivity and Wage in Competitive Labour Markets

10. Change of Employment • If the wage rises, employment will decline. • If price of the product rises, employment will be expanded. • because the VMP rises with product price. • If productivity rises employment will rise . • because the VMP rises with an increase in labour productivity. LO1: Marginal Productivity and Wage in Competitive Labour Markets

11. Adjusting for inflation • Assume that you were paid $34,000 per year in 2010 • You received a raise of 1% in 2011 • How much better off would you be in 2012 than in 2010 • Adjusting for inflation means taking a base year ($34,000 in 2010) and dividing the target year (34,000 x 1.01) by CPI. http://www.bankofcanada.ca/rates/related/inflation-calculator/

12. 12.2 Monopsony And Imperfect Competition in Labour Markets

13. Monopsony • A market with only a single buyer. • Workers get paid what the firm decides to pay them. • The firm needs to raise wages if it is to attract more labour. • The firm’s marginal cost of hiring one more worker is that worker’s wage plus the cost of increasing wages for existing employees. • Marginal labour cost is greater than the wage rate, firm will hire fewer workers. • Prevalence of monopsony in labour markets has declined because most people now live in large urban labour markets with many potential employers. LO2: Monopsony and Its Effects on Wages and Distribution of Economic Surplus

14. Marginal Labor Cost • The increase in a monopsonist’s total wage bill when an extra worker is hired. • Since firm has to pay a higher wage to attract a new worker, they usually have to pay the higher wage to all their current workers too. • Marginal Labor Cost = wage + (wage change)*(employment). • Monopsonist’s produce too little / hire too few. • The private cost of an additional hire is greater than the social cost of that hire, since hiring one more person means having to increase everyone’s wages. LO2: Monopsony and Its Effects on Wages and Distribution of Economic Surplus

15. EXAMPLE 12.5: How many workers will Bluenose hire? (Part 4) • Bluenose is the only employer on the market, cutting board sells for $30 each. VMP>MLC VMP<MLC Firm will hire 2 workers LO2: Monopsony and Its Effects on Wages and Distribution of Economic Surplus

16. Labour Supply andMarginal Labour Cost for a Monopsonist The line labelled SSL plots the number of workers willing to supply labour at a given wage, while line MLC indicates the increase in total labour cost associated with hiring each additional employee. The line labelled VMP illustrates that, as more workers are added, the increase in output from hiring each additional worker declines. The monopsonist can expand employment only by offering higher wages. For example, move from point A to B, If the company wants to hire a second worker (Bertram), it must not only pay him $200/week more than it is currently paying Alisha, but it must also raise Alisha’s pay to $300/week. The marginal labour cost of hiring Bertram is $500/week (point B’) Unlike the perfectly competitive employer, which continues hiring only until VMP equals the market wage, the monopsonist continues hiring until VMP equals marginal labour cost, which exceeds the market wage. The profit-maximizing employment level for the monopsonist is lower than the level that would maximize total economic Surplus. LO2: Monopsony and Its Effects on Wages and Distribution of Economic Surplus

17. Demand and Supply in Competitive Labour Markets • The aggregate Demand Curve for labour. • The sum, over all firms, of how many workers each firm would hire at a given wage. • The horizontal sum of each employer’s VMP curve. • The aggregate Supply Curve of labour. • The sum, over all persons, of the amount of labour each person would supply at a given wage. • Since individuals can move between labour markets, the Supply Curve for an individual labour market is upward sloping. • However, for the economy as a whole the supply curve of labour may be vertical or even backward bending. • In each labour market, demand and supply determine the equilibrium wage and level of employment. LO3: Demand and Supply in Competitive Labour Markets

18. D1 = VMP1 D2 = VMP2 12 12 12 Wage ($/hour) Wage ($/hour) Wage ($/hour) 6 6 6 100 150 50 100 + = Employment in firm 1 (person-hours/day) (a) Employment in firm 2 (person-hours/day) (a) Total employment (person-hours/day) (c) The Occupational Demand for Labour D = VMP2 + VMP2 • If firm 1 and firm 2 are two firms that employ labour in a given occupation, we generate the demand curve for labour in that occupation by adding the individual demand curves horizontally. 150 250 LO3: Demand and Supply in Competitive Labour Markets

19. 12.4 Equilibrium - Supply and Demand

20. The Effect of an Increase in the Demand for Computer Programmers S As increase in the demand for programmers from D1 to D2 results in an increase in the equilibrium level of employment (from L1 to L2) and an increase in the equilibrium wage (from W1 to W2). W2 W1 Wage ($/hour) D2 D1 L1 L2 Employment of programmers (person-hours/year) LO3: Demand and Supply in Competitive Labour Markets

21. 12.5 Equilibrium and Unemployment

22. Unemployment • Searching activity determines unemployment. • Jobless individuals who have actively looked for work are classified as unemployed. • people who have given up looking or who never did look for work are labelled not in the labour force. • Imperfect information and optimal search in the labour market. • Frictional (search) unemployment. • Other types of unemployment. • Structural unemployment , seasonal unemployment, and cyclical unemployment. LO4: Labour Market and Unemployment

23. 12.6 Explaining Differences in Earnings

24. Differences in Earnings • In competitive labour markets, differences in pay tend to reflect differences in expected productivity. • Productivity differences may result from differences in: • Talent. • Training. • Work effort. • Human capital : skills produced by education, training and experience that affect a worker’s productivity ( MPL ). • Human capital theory. • A theory of pay determination that says a worker’s wage will be proportional to his or her stock of human capital. LO5: Factors that Cause Differences in Earnings

25. EXAMPLE 12.6: Will Mary be Better-off if She Gets an MA? (Part I) • Mary is 22 and has just graduated with a BA in economics. • She now has a job as a local manager for a major corporation. • Out-of-pocket costs of the MA are $8000 per year for each year. • In addition, she would have to forego her current earnings while in school (opportunity cost). • The question is, do the future benefits repay the early costs? LO5: Factors that Cause Differences in Earnings

26. Investment in Human Capital • The decision to acquire training or education can be analyzed with the same conceptual tools as decisions to invest in other assets. • If acquiring skills is costly, when is it worth doing? • Investment requires comparing costs incurred today with the value of future benefits. • The “present value” concept is invaluable because benefits may be many years in the future, while costs are immediate. • Present Value = (Amount of Future Payment) / discount factor. LO5: Factors that Cause Differences in Earnings

27. EXAMPLE 12.6: Should you get an MA? (Part II) LO5: Factors that Cause Differences in Earnings

28. FIGURE 12.3 MA (b) Benefits of MA • The Returns of an MA in Economics • Costs are incurred during the period an MA is being acquired. Once acquired, the MA provides benefits over subsequent working life. BA (a) Costs of MA Net returns to MA Benefits of MA Costs of MA LO5: Factors that Cause Differences in Earnings

29. EXAMPLE 12.6: Should Mary get an MA? • Net present value of her investment, is $8410. • A positive net present value means that the benefits of the investment outweigh the costs. • Manon concludes that it is financially worthwhile to get an MA. • Three important things determines the present value calculation • 1. Costs = opportunity cost (foregone earnings) + out-of-pocket cost (how much she gives up by choosing to invest in education), • 2. Benefits = the additional salary Manon forecasts that she will get from her MA choice (and when she gets it), • 3. Discount rate = how impatient she is in waiting for future returns. LO5: Factors that Cause Differences in Earnings

30. Aggregate Effects of Increase in Schooling • When some students continue longer in school this simultaneously: • Increases the supply of highly skilled workers. • Decreases the supply of low skilled workers. • So the wage gap between highly educated and poorly educated workers tends to shrink. LO5: Factors that Cause Differences in Earnings

31. FIGURE 12.6:Wage Effects of an Increase in Postsecondary Enrollment • An increase in the supply of postsecondary graduates reduces the wage gap between high-school and postsecondary graduates. LO5: Factors that Cause Differences in Earnings

32. Labour Unions • A group of workers who bargain collectively with employers for better wages and working conditions. • Union wage premium for workers with the same human capital is about 10%. • Higher wages for unionized workers imply: • Unionized employers can be more selective in hiring. • Less turnover, better workplace morale. • Unionized employers may invest more in capital equipment. • Implication: higher productivity in unionized firms could offset higher wages. LO5: Factors that Cause Differences in Earnings

33. Winner-Take-All Markets • Winner-take-all labour market. • One in which small differences in human capital translate into large differences in pay. • Economic naturalist 12.2: Why does Lady Gaga earn millions more than singers of only slightly lesser ability? LO5: Factors that Cause Differences in Earnings

34. Compensating Wage Differentials • Compensating Wage Differential. • Difference in the wage rate due to the attractiveness of a job’s working conditions, compared to other jobs that require the same level and type of skill. • But tastes differ (e.g. for outside/inside work) so it’s often hard to predict the impact of compensating differentials. LO5: Factors that Cause Differences in Earnings

35. 12.7 Discrimination in the Labour Market

36. Discrimination by Employers • Occurs when employers have an arbitrary preference for one group of workers, even though all groups are equally productive. • Competitive forces may take time to erode discrimination. • Consumer attitudes (especially in the service sector) may enforce stereotyping. • An employer who stereotypes and does not hire disadvantaged workers will never be proved wrong. • Employers who go against industry norms may be perceived as more risky to deal with. LO6: Effects of Stereotypes and discrimination in the Labour Market

37. Discrimination: Both Unfair and Economically Inefficient • Inequity to the individuals who are denied equal opportunity. • Inefficient for economy because peoples’ skills are not fully used. • Canadian Public Policy on Discrimination. • Legislation against discrimination • Employment Equity Programs. • Objective: to help women and minorities get into non-traditional jobs and so prove, by experience, that traditional misconceptions are incorrect LO6: Effects of Stereotypes and discrimination in the Labour Market

38. Are women discriminated in labour markets ..\..\..\..\..\..\Users\gmason.PRAINC\Documents\Pavtube\youtube_converter\Do Women Earn Less than Men - YouTube.mp4

39. Statistical discrimination • Based on lack of information - employers don't know workers ability and used average ability as the standard • Differing level of information about the sub-groups • Group A is compared to group B. • Assume two groups, A and B, have average test scores well above the average for the entire population, • But group A's estimate is considered more reliable, • If two people, one from A and one from B interview for a job, using statistical discrimination, A is hired, because it is perceived that his group score is a good estimate, but group B's group score more likely to be "luck". • Conversely, if the two groups are below average, B is hired, because group A's negative score is believed to be a better estimate.

40. Statistical discrimination may be tolerated • Older people are charged more for life insurance, • college diploma is required for a job (because it is believed that college graduates perform, on average, better). Some well-documented instances of statistical discrimination for involuntary group membership also do exist and are tolerated. • Many countries allow auto insurance companies to charge men and women with identical driving records different rates (or factor in gender when deciding whether to deny coverage). • Statistical discrimination less tolerated when it is applied to protected groups. For example, it has been suggested that home mortgage lending discrimination against immigrants may be partly caused by statistical discrimination • Red-lining occurs when residents in certain areas are required to pay higher interest for their mortgages.

41. Chapter Summary • The long-run equilibrium pay in a competitive labour market will be equal to the value of the marginal product (VMP). • Firms that purchase labour in competitive labour markets face a constant wage, and they will hire labour up to the point at which VMP equals the market wage. • Unlike the perfectly competitive employer, the monopsonist can expand employment only by offering higher wages. • The monopsonist continues hiring until VMP equals marginal labour cost, which exceeds the market wage. • The profit-maximizing employment level for the monopsonist is lower than the level that would maximize total economic surplus. Chapter Summary

42. Chapter Summary • Human capital theory says that an individual’s VMP is proportional to his stock of human capital. • Earnings typically increase with education, age & experience (but to different degrees in some contexts). • Other earning differentials can rise due to different working hours per year, union membership, differences in working conditions (compensation wage differentials). • The theory of employer discrimination holds that part of the observed wage gaps are the result of continued stereotypes of employee productivity on the part of employers. Chapter Summary