Chapter 4. The Labor Mkt & LFPChapter 4. The Labor Mkt & LFPChapter 4. The Labor Mkt & LFPChapter 4. The Labor Mkt & LFP

• Labor market

• supply and demand

• elasticity

• LFP trends

• Using labor mkt. to explain LFP trends

• Labor market

• supply and demand

• elasticity

• LFP trends

• Using labor mkt. to explain LFP trends

I. Labor marketI. Labor marketI. Labor marketI. Labor market

• labor supply• decisions by individuals, HH

• labor demand• decisions by firms

• labor supply• decisions by individuals, HH

• labor demand• decisions by firms

Labor SupplyLabor SupplyLabor SupplyLabor Supply

• relationship between wages and hours worked

• 16 hours :• market work (H)• nonmarket work or leisure (L)

• relationship between wages and hours worked

• 16 hours :• market work (H)• nonmarket work or leisure (L)

assumeassumeassumeassume

• work is a disutility• don’t like it, BUT• do it for $ to buy stuff

• consumption & leisure are good • like to buy stuff• like to enjoy stuff

• work is a disutility• don’t like it, BUT• do it for $ to buy stuff

• consumption & leisure are good • like to buy stuff• like to enjoy stuff

tradeofftradeofftradeofftradeoff

• more hours worked,

• more $ to buy stuff,

• but less time for leisure

• more hours worked,

• more $ to buy stuff,

• but less time for leisure

C = consumption H = hours worked L = hours for leisure

H = 16 - LI = nonearned income

C = (w)(H) + I

w = wage

C = (w)(16 - L) + I

tradeoff between consumption & leisure

L

C

C = (w)(16 - L) + I

I

16

16w + I

changes in the wage (w)changes in the wage (w)changes in the wage (w)changes in the wage (w)

• how does it affect the choice between C and L?

• income effect• higher wages increase income• do more of what you like• increase C and L• decrease H

• how does it affect the choice between C and L?

• income effect• higher wages increase income• do more of what you like• increase C and L• decrease H

• substitution effect• higher wages make L more

expensive• L now relatively more expensive

than C• increase in C, decrease in L• increase in H

• substitution effect• higher wages make L more

expensive• L now relatively more expensive

than C• increase in C, decrease in L• increase in H

total effect of increase in wtotal effect of increase in wtotal effect of increase in wtotal effect of increase in w

• C increases,

• total effect on H unclear

• if substitution effect >income effect• H increases

• C increases,

• total effect on H unclear

• if substitution effect >income effect• H increases

labor supplylabor supplylabor supplylabor supply

H

w Slabor

change in labor supply ifchange in labor supply ifchange in labor supply ifchange in labor supply if

• nonearned income changes (I)

• changing preferences for C, L• nonearned income changes (I)

• changing preferences for C, L

Labor DemandLabor DemandLabor DemandLabor Demand

• derived demand• depends on the demand for the

product produced

• derived demand• depends on the demand for the

product produced

how much to hire?how much to hire?how much to hire?how much to hire?

• cost of additional labor (wage)

• vs.

• value of additional labor

• cost = or < value

• cost of additional labor (wage)

• vs.

• value of additional labor

• cost = or < value

what is value of labor?what is value of labor?what is value of labor?what is value of labor?

• increase in output from hiring additional unit of labor• marginal product of labor• MPL

• value of increase in output

= price x MPL

= MRP

• increase in output from hiring additional unit of labor• marginal product of labor• MPL

• value of increase in output

= price x MPL

= MRP

exampleexampleexampleexample

• Kinkos

• 1 copier

• copies cost 8 cents each

• Kinkos

• 1 copier

• copies cost 8 cents each

Workers/hr output MPL MRP wage

Workers/hr output MPL MRP wage0 0 $5

Workers/hr output MPL MRP wage0 0 $51 100 100 $8 $5

Workers/hr output MPL MRP wage0 0 $51 100 100 $8 $52 170 70 $5.60 $5

Workers/hr output MPL MRP wage0 0 $51 100 100 $8 $52 170 70 $5.60 $53 200 30 $2.40 $5

Workers/hr output MPL MRP wage0 0 $51 100 100 $8 $52 170 70 $5.60 $53 200 30 $2.40 $54 210 10 $0.80 $5

MPLMPLMPLMPL

• declines as worker/hr increases

• why?

• only 1 copier• so adding workers only works for

awhile

• law of diminishing returns

• declines as worker/hr increases

• why?

• only 1 copier• so adding workers only works for

awhile

• law of diminishing returns

Kinkos & hiringKinkos & hiringKinkos & hiringKinkos & hiring

• hire 1st worker?• $8 > $5 YES

• hire 2nd worker?• $5.60 > $5 YES

• hire 3rd worker?• $2.40 < $5 NO

• hire 1st worker?• $8 > $5 YES

• hire 2nd worker?• $5.60 > $5 YES

• hire 3rd worker?• $2.40 < $5 NO

• if wage = $7• hire only 1 worker

• if wage = $2• hire 3 workers

• if wage = $7• hire only 1 worker

• if wage = $2• hire 3 workers

labor demandlabor demandlabor demandlabor demand

H

w

3

$2

2

$5

1

$7

Dlabor

labor demand will increase iflabor demand will increase iflabor demand will increase iflabor demand will increase if

• kinkos gets more copiers• (more capital)

• workers become more skilled• increase MPL & MRP

• price of copies rise• increase MRP

• kinkos gets more copiers• (more capital)

• workers become more skilled• increase MPL & MRP

• price of copies rise• increase MRP

Elasticity of Labor SupplyElasticity of Labor SupplyElasticity of Labor SupplyElasticity of Labor Supply

• how sensitive is H to changes in w?

10% change in w

• if H changes by > 10%• labor supply is elastic wrt wages

• if H changes by < 10%• labor supply is inelastic wrt wages

• how sensitive is H to changes in w?

10% change in w

• if H changes by > 10%• labor supply is elastic wrt wages

• if H changes by < 10%• labor supply is inelastic wrt wages

H

w

S elastic

w1

H1

w2

H2

H

w S inelastic

w1

H1

w2

H2

• how sensitive is H to changes in I ?• increases in nonearned income

will decrease H• (only an income effect)

• how sensitive is H to changes in I ?• increases in nonearned income

will decrease H• (only an income effect)

II. Trends in LFP (revisited)II. Trends in LFP (revisited)II. Trends in LFP (revisited)II. Trends in LFP (revisited)

• recall that• male LFP is declining• female LFP is rising

• recall that• male LFP is declining• female LFP is rising

LFP Rates 1950-2002

0

20

40

60

80

100

1950 1960 1970 1980 1990 2000

LF

P r

ate

Men 16+ Women 16+

Men

Women

Male LFP by Age 1950-2002

0

20

40

60

80

100

1950 1960 1970 1980 1990 2000

20-24 25-34 35-44 45-54 54+

Male LFP by Marital Status 1970-2000

0

20

40

60

80

100

1970 1975 1980 1985 1990 1995 2000

single married other

Female LFP by Marital Status 1970-2000

0

20

40

60

80

100

1970 1975 1980 1985 1990 1995 2000

single married other

Married Female LFP

0

20

40

60

80

100

1970 1980 1985 1990 1995 2000

married w/children married w/ children <6

So we must explainSo we must explainSo we must explainSo we must explain

• rising female LFP, falling male LFP

• biggest increases for • married women• women w/ children

• biggest decreases for• older men• less educated men

• rising female LFP, falling male LFP

• biggest increases for • married women• women w/ children

• biggest decreases for• older men• less educated men

III. Using the Labor Mkt.III. Using the Labor Mkt.III. Using the Labor Mkt.III. Using the Labor Mkt.

• use labor supply & labor demand• explain changes in LFP

• market for male labor

• market for female labor

• use labor supply & labor demand• explain changes in LFP

• market for male labor

• market for female labor

male labor marketmale labor marketmale labor marketmale labor market

• if male LFP has fallen then:• either labor demand has fallen• OR• labor supply has fallen• OR• both

• if male LFP has fallen then:• either labor demand has fallen• OR• labor supply has fallen• OR• both

H

w S

D

H*

D’

H

w S

D

H*

S’

female labor marketfemale labor marketfemale labor marketfemale labor market

• if female LFP has risen then:• labor demand has risen• OR• labor supply has risen• OR• both

• if female LFP has risen then:• labor demand has risen• OR• labor supply has risen• OR• both

H

w S

D

H*

D’

H

w S

D

H*

S’

male LFPmale LFPmale LFPmale LFP

what caused demand to fall? decline in demand for labor in

manufacturing, mining, timber sectors most workers in these sectors are men most workers in these sectors do not

have college education (high school or less)

what caused demand to fall? decline in demand for labor in

manufacturing, mining, timber sectors most workers in these sectors are men most workers in these sectors do not

have college education (high school or less)

substitution of female labor for male labor not likely: occupation segregation suggest that

female labor will not substitute for male labor very well

labor demand for men is much less elastic than female labor demand

substitution of female labor for male labor not likely: occupation segregation suggest that

female labor will not substitute for male labor very well

labor demand for men is much less elastic than female labor demand

what caused labor supply to fall?what caused labor supply to fall?what caused labor supply to fall?what caused labor supply to fall?

• rising real wages

• rising pension, disability benefits

• both mean early departure from labor force

• rising real wages

• rising pension, disability benefits

• both mean early departure from labor force

Female LFPFemale LFPFemale LFPFemale LFP

what caused labor demand to rise?

• a general rise in labor demand• economic growth• increases in MPL

• a rise in labor demand in clerical, service sector

what caused labor demand to rise?

• a general rise in labor demand• economic growth• increases in MPL

• a rise in labor demand in clerical, service sector

• rise in female education level• increase MPL

• why?• skilled labor more in demand• socially acceptable• families have resources to educate

sons and daughters

• rise in female education level• increase MPL

• why?• skilled labor more in demand• socially acceptable• families have resources to educate

sons and daughters

why did labor supply rise?why did labor supply rise?why did labor supply rise?why did labor supply rise?

• nonmarket production:• increase in availability of

substitutes & in efficiency• ex: childcare, convenience food,

microwaves• less time IS spent on nonmarket

work

• nonmarket production:• increase in availability of

substitutes & in efficiency• ex: childcare, convenience food,

microwaves• less time IS spent on nonmarket

work

• family/demographic changes• fewer children• later age of marriage• higher divorce rate

• family/demographic changes• fewer children• later age of marriage• higher divorce rate

• falling male wages• slow real wage growth for men in

1970s, 80s• increase labor supply of married

women

• falling male wages• slow real wage growth for men in

1970s, 80s• increase labor supply of married

women

Which are most important?Which are most important?Which are most important?Which are most important?

• female LFP• pre 1970: demand-side reasons• since: divorce, male wages

• male LFP• early retirement (supply)

• female LFP• pre 1970: demand-side reasons• since: divorce, male wages

• male LFP• early retirement (supply)

Does our model tell the whole Does our model tell the whole story?story?Does our model tell the whole Does our model tell the whole story?story?

• economic model may leave some things out• social attitudes• dividing time between just market

and nonmarket work

• economic model may leave some things out• social attitudes• dividing time between just market

and nonmarket work

ElasticityElasticityElasticityElasticity

• labor demand is inelastic w.r.t. wages• firms do not have large hiring

response to changing wages• true for men and women

• labor demand is inelastic w.r.t. wages• firms do not have large hiring

response to changing wages• true for men and women

labor supply elasticitylabor supply elasticitylabor supply elasticitylabor supply elasticity

• women’s labor supply MORE elastic than men’s (wages)• women more likely to leave labor

force if wages too low• women more likely to enter labor

force if wages attractive

• women’s labor supply MORE elastic than men’s (wages)• women more likely to leave labor

force if wages too low• women more likely to enter labor

force if wages attractive

• women’s labor supply inelastic with respect to childcare costs• cost is not as important as quality?

• women’s labor supply inelastic with respect to childcare costs• cost is not as important as quality?