CH 5: Frictions in the Labor Market

• Monopsony– Source of monopsony power– Effects on wages & employment

• Quasi-fixed labor costs – Types of QF costs– Effects of QF costs on hours/workers– Training as a QF cost & consequences of

training investments for structure of pay.

Monopsony• The firm’s labor supply curve is upward sloping• Sources of monopsony:

– Mobility costs– Job search costs– Information costs – Small # of competing employers

Quasi-fixed labor costs

• Examples– Hiring costs– Maintenance of payroll records, issuing

checks– Training costs

• Explicit monetary costs• Implicit opportunity costs of trainer’s time and

capital used• Implicit opportunity cost of trainee’s time

Quasi-fixed labor costs

Avg. hours of formal instruction by training personnel

19

hours spent by management in orientation, informal training, extra supervision

59

hours spent by co-workers in informal training

34

hours spent by new worker watching others do work

41

Total 153

Source: textbook

Employee Benefits

Employee Benefits

Based on table above, the percentage of compensation devoted to benefits is– 27% for all benefits– 8.8% for all legally required benefits– 6.3% for paid leave – 5.9% for insurance – 3.0% for retirement and savings

Quasi-fixed labor costs• Hiring and training costs are quasi-fixed • Some benefits are quasi-fixed, others are not.

– pensions: • Are contributions a fixed dollar amount per

employee, % of pay, or % of pay up to a maximum value?

– legally required benefits: • many are % of pay up to a maximum.

– health insurance: • typically, a worker is either covered or not and the employer

contribution is independent of incremental hours worked.

Optimal Mix of Workers and Hours

• MEm = marginal expense of an additional worker= W*H + Q

where W =wage rate, H=hours per week, Q=QFC per worker• MEH = marginal expense of an additional hour of work for all its

existing workforce.= W*N

where W=wage rate and N=number of workers

• MPm = MP of an additional worker for H hours.

• MPh = MP of an additional hour of work for N workers.

Optimal Mix of Workers and Hours

Optimal mix of M and H requires

MEm /MPm = MEh /MPh

What should firm do if

• QFC rises?

• Wage rate rises?

Optimal Mix of Workers and Hours

• APPLICATIONS

– raising the salary cap for payroll taxes– increasing the payroll tax rate on capped payroll

taxes.– effect of training costs on likelihood of part-time work.– the over-time premium.– mandatory health insurance coverage– worker preferences for part-time as opposed to full-

time work?– why do firms sometimes institute mandatory over-time

rules?• would firms ever pay an over-time premium even

in the absence of federal legislation?

Training Investments

The firm's decision to invest in training a worker in a two-period model:

Period 0:• pay Z to train the worker• pay W0 in wages to the worker• worker produces MP0

Period 1:• pay W1 in wages to the worker• worker produces MP1

• If worker is not trained, MP is fixed at MP* in both periods and the worker can receive a wage of W*=MP* at a competing firm.

Training Investments

Optimal employment will be at E*

Training Investments• How are W0 & W1 determined?

• Must offer a competitive PV of compensation

• W0 + W1/(1+r) >= W* + W*/(1+r)

Training Investments

• Examples: Suppose that W*=100 and r=6%.Alternative W0 W1 Present value (r=6%)• A 128 70 194• B 100 100 194• C 81 120 194• D 62 140 194• E 43 160 194Why would the firm be reluctant to offer A or B?Why is worker reluctant to accept C, D, or E?

Training Investments

• Firms that invest in training will want to– Defer pay– Find ways to restrict mobility of workers

Training Investments

GENERAL VERSUS SPECIFIC TRAINING.

• General training increases productivity at all firms.

• Specific training increases productivity only at a specific firm (presumably the firm providing the training).

• If training is general, a firm will have difficulty recouping its investment in training.

Training Investments• With general training, firm must pay W1>MP1 in

2ndperiod unless there is able retain worker after training.

• Since W1>MP1, firm cannot recoup training investments by underpaying in second period

• In equilibrium, – PVP=PVC W0 + W1/(1+r) +Z = MP0 + MP1/(1+r)

W0=MP0-Z +(MP1-W1)/(1+r)– If general training requires, W1>MP1

• W0<MP0-Z

• With specific training, firm can pay MP1*<W1<MP1 and recoup some of its training investments. Firms can recoup investment in specific training with restricting mobility.

Training Investments

• How should training investments affect firm layoff behavior if product demand falls?

• How does the above affect the cyclical nature of productivity?

• If there are large training costs, firms should be concerned about screening out quitters. – Statistical discrimination – Fringe benefit packages– Discount rates

Investments in Training

• Employer investments in general training– Armed forces

– Sports contracts

– Employer pays for night-time education