LABOUR DEMAND AND PRODUCTIVITY

- Text: Benjamin, Gunderson, Lemieux and Riddell, Ch. 5, some of Ch. 6 (Quasi-fixed costs), parts of Ch. 13 (incentive pay)

Marginal Productivity Theory of Short-run Labour Demand:

- In short-run the following are given:

- technology, business organization and incentives- quantity of non-labour inputs

- Competitive labour market: many small employers, many workers.

- Simple idea:

- Employers seek to maximize profits.

- So, hire more labour if:

benefit > cost

Employer’s Benefit from hiring an extra unit of labour?

- The value of what that labour produces:

(Extra output from an extra unit of L) x (Extra money per unit of extra output)

= (marginal physical product of labour) x (marginal revenue)

= MPP x MR

= Marginal revenue product (MRP)

- The marginal revenue product curve plots MRP against the quantity of labour.

1

Shape of the MRP curve:

- Key question: How does MPP vary with L other things equal?

- other things? quantity of other inputs technology firm organization and incentives .

- MPP curve: - may be upward sloping at low levels of L

- downward sloping at high L.

- Why?

- Low L: specialization, division of labour possibilities.(Adam Smith: pin factory)

MPP may rise initially as L rises.

(More L: less changeover time between tasks, better task assignment, specialist becomes better at task, etc.)

2

- Higher L:

Diminishing returns: MPP eventually declines holding other inputs constant.

Why?

- As L increases, each unit of L has less of the other inputs to work with.

- Or: initial L to high return uses, later L to lower return uses.

- Diminishing returns can give a downward sloping MRP curve.

- An additional consideration: How does MR vary with L?

- Key: the competitiveness of the output market.

- Competitive output market:

- Firms are too small to affect the price of their product.

- So: Marginal Revenue (MR) = Price of output (P).

- More L, more output, same price so MR is the same.

- Then shape of MRP driven by shape of MPP only.

3

- Non-competitive product market:

- The amount the firm produces affects the price it is paid.

- More output, must cut the price to sell it.

- Result: MR declines with output and L.

- MRP steeper downward slope than MPP.

Cost of an Extra Unit of Labour:

- Competitive labour market: employer must pay the “going rate” (W).

- Must pay as well as other, competing employers.

- small employers are wage takers: wage is independent of quantity hired. (labour supply to an individual employer is flat at W)

- Later: will consider a wage-setting employer ("monopsony").

- Other labour costs?

- if they vary directly with time-worked can be treated as part of W;

- if don’t vary directly with time-worked: quasi-fixed cost (see below).

4

Employer Hiring Decision:

- MRP curve: shows employer gain from hiring extra L.

- W is the cost of extra L.

- Hire more labour as long as: W<MRP

- Do not hire if: W>MRP

Result? - Firm hires up to the point where: MRP=W

- At this point each unit of L is paid W.

- The wage the worker earns is tied to productivity.

i.e., labour is paid its marginal product.

- Role of competition and worker mobility?

- say a worker is underpaid (W<MRP)

- competing employer: profitable to pay a wage closer to MRP

- worker is bid away unless they are paid W=MRP.

5

Short-run Labour demand curve for the firm:

- Hire where W=MRP: this gives the quantity of labour demanded.

- Labour demand curve: downward sloping part of the MRP curve.

(More precisely downward sloping part where Average Revenue Product > MRP -- text Fig. 5.1)

- If at point where W=MRP on upward sloping part of MRP: profits minimized! economically irrelevant.

- Short-run demand curve: holds technology, plant, machines, etc. fixed.

- Income distribution and this outcome? area under MRP is total value of output; WL is total wages paid; rest goes to other inputs or is profit.

6

Labour demand curve shifts:

- Can shift due to changes in MPP:

- Change in amount or quality of other factors of production

- Change in technology (process innovation)- can raise productivity of existing jobs - could lead to new ones too (MP=0 rises to >0)

- Change in organization or incentives.

- Can shift due to changes in MR

- Change in output price, position of the firm's product demand curve.

[ technology (product innovations) can work through MR ]

(see website: Varian's article on productivity, computers and organization in the U.S.)

7

Market Level Labour Demand Curve:

- Market demand curve: shows the quantity of labour demanded by all firms that hire that type of labour.

- horizontal sum of labour demand curves over all employers (see text Fig.7.1)

- Possible complication? (pecuniary externality)

- As all employers change L, the price of their output could change.

(say ↑L → ↑Supply of output → ↓Price so ↓MR)

- This shifts firm labour demand curves and gives a steeper market labour demand curve (output price effect dampens change in L).

- In equilibrium W=MRP across all employers via competition and worker mobility

- Shifts in market demand occur for the same reasons as shifts in firm labour demand.

- note: feedback through output price changes is possible if the shift affects many employers.

- at the industry level feedbacks through the output price can be important.

- rising physical productivity may translate into low prices, not higher labour demand.

i.e. MP rises, MR falls so MRP is almost unchanged.

8

Applications and Implications of MP Theory: Productivity and Wages

- Marginal productivity theory links wages and productivity (MRP).

- Wage and productivity trends over time.

- Long term: they tend to move together (consistent with MP theory)

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 201680859095

100105110115120125130

Real Hourly Compensation and Real GDP per Hour (1997=100), Canada 1997-2016

Real hourly compensation Real GDP/Hour

Source: Derived from Statistics Canada Table 383-0033 Labour Productivity and Related Measures.

- Stansbury and Summers (2018) Productivity and Pay is the Link Broken? PIIE Paper 18-5.

(https://piie.com/publications/working-papers/productivity-and-pay-link-broken)

- look at US data using a simple regression (growth in real pay vs. growth in real productivity).

- 1973-2016 a 1% rise in productivity raised compensation by 0.7 to 1% (couldn’t reject that it was 1-for-1).

9

- Increasing real wages and living standards since 1800: is this a productivity story?

Source: G. Clark (2007) Farewell to Alms. Princeton University Press.

- Trends over time seem to provide some support for the wage-productivity link.

- Contrast this to many Marxist-Radical economics predictions.

i.e. exploitation, power imbalance means that employers (capitalists) reap the gains.

10

- MP theory provides a partial explanation of differences in wages between jobs, workers, countries, etc.

- Look to determinants of productivity to explain wage differences.

- Skill level: - determines what kinds of tasks the worker can do.

Can they produce high MRP goods and services?

(education and training affect skills and a person's MRP)

- Quantity and quality of non-labour inputs.- Business investment, government investments in

infrastructure can affect MRP.

(Krueger article: computers, pay and productivity)

- Technology- affects productivity and via competition pay.

- Industrial Revolution: low-skill winners (higher MRP).

- Organization- Henry Ford’s assembly line

- Schmitz paper (website): “What determines productivity?” - role of work-rules in contracts of Minnesota / N. Ont. iron

industries in 1980s.

- Health and nutrition: can affect MRP in a given job type (this and low wages in less developed countries)

- Think about average wage in India vs. Canada in terms of the above factors.

- MP theory is a partial explanation of wages and wage differences.- Supply matters too. - Degree of competition is also a factor: model assumes many

competing employers.

11

Sky-high wages: Can the model explain them?

- See text: Chapter 13 “Economics of superstars” pp. 375-376, “Tournaments” pp.376-378, “Executive Compensation” pp. 386-387.

- Sports star "Joe Hero" paid $8 million per year.

- Star actress "Jill Fame" paid $5 million for a movie.

- CEOs, finance whizzes, corporate lawyers paid millions.

- Can such high wages be explained by marginal productivity theory?

- MP theory: Joe’s high wage reflects his value to the team owners:

- extra attendance revenues, sale of team products, TV rights, etc.

- competition between teams ensures that Joe is paid his worth

- similar stories for the others: high pay reflects a combination of high value and competition.

- Economics of Superstars and Winner-Take-All Markets:

- Concern with cases where the best are paid massively more than the next best.

- This can occur even if the “best” is only slightly better than the next best.

i.e. small differences in skill are magnified into large differences in value and pay.

- Why? Rooted in the nature of the service being provided. - actor, author, athlete: large audience with a taste for the best.- manager of a large organization: can improve the productivity of

a large number of people serving a large market.- tasks where the ‘winner’ gets all the gains (e.g. top lawyers)

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- Incentive models of compensation: an alternative explanation?

- MP theory: given productivity, competition ensures wages equal MRP.

- Incentive schemes: causality runs the other way (pay → productivity).

- Examples: piece rates (pay per unit of output produced), bonuses, performance based raises, stock options or profit-sharing plans.

- Efficiency wage models: high pay policies (above “going rate”) may boost productivity in some circumstances.

- why? - psychology and gift exchange (Akerlof). - anti-shirking device: work harder to keep the high wage job. - high wage policy allows employer to pick the best (selection).

- Incentive stories and “very high pay”:

- Bonuses and stock options can be a large part of very high pay.- idea is to provide incentives for good performance.

- Tournament model: an incentive model of high pay- High salaries attached to top positions are like a prize.

- High-performance lower level managers can eventually be promoted to a top position.

- High salary justified by top manager’s productivity plus increased productivity of lower level managers who hope to win the prize.

13

Trends in income inequality since the early 1980s:

- high growth in incomes of the very highest earners.

- Green, Riddell and St-Hilaire (2017) Income Inequality in Canada(http://irpp.org/wp-content/uploads/2017/02/aots5-intro.pdf )

- More generally: World Wealth and Income Database (http://wid.world/country/canada/ )

- Why? What has changed? Maybe:

- Winner-take-all markets and superstars: are more goods like this than before?

- Incentive pay: more important than in the past?

- Anything else?

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- Some views on growth in very high pay:

H. Varian (Chief Economist at Google):

"THE rise in individual inequality that we have seen is due in part to the rise in globalisation. When most businesses were local, the creation of wealth by a business was limited by the geographic range in which the business could operate. But nowadays even a relatively small business can go from local to national and then global operation in a short amount of time. Fortunes can be made by providing goods and services at a low price to a global market of 6 billion people.

Communication costs and computation costs will continue to drop for the foreseeable future, and we will continue to see new billionaires being created as an inevitable side effect of this technological trend. Ocean voyages, railroads and the telegraph, along with the businesses they enabled, created vast amounts of wealth, so we should expect the same from modern communications technologies."

(this fits with a MP theory story)

S. Sumner (Bentley U. writes the blog "Money Illusion"):

"Today the most productive members of society are not those who produce things, they are those who discover the things that need to be produced.  Once you have the blueprint, it is easy to produce many types of software and pharmaceuticals.  The big money goes to those who figure out the blueprint, but also to those who allocate capital to the guy who has the idea for a Google, or Facebook, or Twitter. In contrast, the technicians who actually implement the vision often earn modest salaries.  Thus companies are “discovered” in much the same way as an iron deposit is discovered by a skilled geologist. 

And then there’s globalization, which means decisions about allocating capital can vastly improve productivity even in the old-line industries that were dominant in the 1960s, when the rest of the world hardly mattered.  Finance is not that important in an agricultural economy or even in an economy where the mass production of goods can be done with almost military precision.  It becomes extremely important in an economy where it is not at all clear what should be produced, or on what continent that production should take place."

- Alternative stories?

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D. Acemoglu MIT: many at the very top are in finance. Was deregulation key? "politics may have been the key factor in setting in motion the forces that have led to the massive rise in top inequality and also shaped the path of development of the financial industry..."

J. Stiglitz: politics and economics together? Great wealth→ political influence→ favorable policies → Wealthier!

- Could it partly be incentive problems in top-earner pay setting? (Board member incentives and CEOs)

- Changes in attitudes toward high pay (A. Atkinson LSE)?- Is very high pay socially more acceptable than 30-40 years ago?

- Is it mainly an English-speaking thing? (US, UK, Canada, Australia) If so why haven't the MP stories had the same effect elsewhere?

- G. Mankiw: is speaking English increasingly valuable? (entertainment, language of business and global markets)

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Applications of MP Theory: Changes in employment composition over time

- Major shifts have occurred in the composition of employment by industry and occupation (see tables below):

- move from agriculture to industry- shift from manufacturing to services

Industry Employment Shares 1911-2016 (%) Health/ Other

Agriculture Primary Manuf. Utilities Construction Transport Trade FIRE Education welfare Services Government1911 34.2 5.0 17.4 0.4 7.3 6.7 9.5 1.4 1.7 1.3 9.1 2.91921 32.8 4.0 16.7 0.3 5.7 7.9 10.3 1.9 2.5 2.2 8.3 3.11931 28.7 4.3 16.9 0.6 6.4 7.1 10.8 2.4 2.6 2.0 11.0 3.01941 25.8 5.7 21.9 0.6 5.2 6.4 11.8 2.1 2.6 2.2 11.3 3.31951 15.6 5.4 24.8 0.9 6.6 7.6 14.1 2.7 2.9 3.3 8.7 6.01961 9.9 4.1 21.8 1.0 7.2 7.0 15.3 3.5 4.1 4.8 10.6 8.21971 5.6 2.8 19.8 0.9 6.6 5.8 14.7 4.2 6.6 5.9 11.1 8.21981 3.7 3.1 18.3 1.1 6.5 5.4 15.2 5.7 5.9 8.0 19.2 6.21991 3.3 2.4 14.7 1.0 6.4 4.7 15.6 6.2 6.2 9.5 21.4 6.32001 2.1 1.9 14.7 0.8 5.6 5.0 15.4 5.6 6.3 9.8 25.4 5.02016 1.9 1.8 8.8 0.8 7.1 4.8 15.2 6.3 7.5 12.1 27.4 6.3

Sources: Historical Statistics of Canada, Statistics Canada Census data. FIRE = Finance, Insurance, Real Estate Manuf.=Manufacturing Primary = Forestry and Logging; Fishing, Hunting; Mining, oil & gas.

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Top Occupations for Men and Women, from 1891 and 2016 Censuses

Women, 1891 Men, 1891Share (%) Share (%)

All AllFarmers 5.9 Farmers 28.2Servants 39.6 Farmer's son! 17.1Seamstresses 5.2 Agr. labourer 5.6Dressmakers 11.6 Carpenter 3.2Teachers 7.6 Labourer 7.4Saleswomen 4.0 Blacksmiths 1.3"Tailoresses" 4.0 Salesmen 6.6Housekeepers 2.1 Fishermen 1.9Laundresses 1.9 Railway 1.4Milliners 1.7 Servants 1.3

Top 10 share 83.5 74.0

Women, 2016 Men, 2016 Share

Retail salespersons 4.6 Motor vehicle and transit drivers 5.3Administrative,regulatory occupations 4.2 Retail salespersons 3.1General office workers 4.2 Cleaners 3.1Paraprofessional in legal, social, community education4.2 Computer & info systems professionals 2.8Teachers (Secondary and elementary) 3.9 Retail/wholesale trade managers 2.3Office administrative assistants 3.8 Trades helpers and labourers 2.1Cashiers 3.4 Auditors, accountants, investment prof'ls1.9Home care providers and support 3.4 Chefs and cooks 1.9Assisting occupations in health 3.2 Machining, metal shaping and erecting trades1.9Nursing 3.1 Carpenters and cabinetmakers 1.9Food counter attendants, kitchen helpers3.0 Automotive service technicians 1.8Cleaners 2.9 Electrical trades and electrical workers 1.8Food and beverage service 2.7 Longshore and material handlers 1.8Customer services reps 2.2 Logistics, tracking, scheduling occupations1.7Auditors, accountants, investment professionals2.1 Managers in construction, operations 1.7Financial, insurance support workers 2.0 Food counter attendants, kitchen helpers1.7Retail and wholesale managers 1.8 Other sales & support 1.7Finance, insurance administration 1.7 Senior management 1.7Human resource, business serv, professionals1.7 Mechanics (except motor vehicles) 1.7Policy researchers, consultants 1.6 Labourers in processing, manufacturing & utilities1.6

Share in Top occupations 59.8 43.7

Source: 1891 Census and 2016 Census.

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- MRP theory suggests explanations in terms of changes in: technology, changes in the pattern of product demand.

i.e. factors that shift MRP curves

- MRP rising (shifting up) in growing sectors:

- they can offer higher wages

- workers shift to these booming sectors

- spillover to declining sectors: competition ensures wages rise in declining sectors (or that declining sectors disappear).

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- Can declines in employment in Ontario’s forestry sector, pulp and paper be explained via changes in MRP?

e.g. falling output prices? Natural resource depletion? Ageing capital?

- Many changes work through effects of output market changes on MRP:

- Oil prices and Oil industry employment in Alberta: rising prices and rising employment 1999-08; both falling 2014-16.

- Trade agreements and protection often work through output market effects.

- Technology can create new productive uses for labour.

- These are demand explanations but supply side considerations may matter too.e.g. growth in “pink collar” occupations and women’s participation.

- Role of technology in the MRP labour demand model is limited.

- it can change productivity of a given type of job.

- can have feedback effects on MRP via the effects on output supply and price.

- But: model does not allow for substitution.- it doesn’t allow for labour being replaced by other inputs

(the long-run version of the model can allow for this).

20

An extension: MP theory and Long-term Employment Contracts

- See discussion of deferred compensation (Ch. 13, pp. 388-395)

- Simple model: w=MRP each period.

- What if employer and worker expect the job to be long-term?

- contract need not tie w=MRP in each period.

- over the term of contract:

- Employer: Present value of MRP must cover Present value of wage costs.

- Worker: Present value of wages under the contract must equal present value of wages in best alternatives.

(Present value? Value of future payments now)

- Logic of hiring and labour demand decision much the same as in the simple case!

- Enforcement issues with long-term contracts:

- if w >MRP near the end of contract: employer has incentive to fire.

- if w<MRP near the end of the contract: worker has incentive to quit.

- long-term contracts must deal with these issues.

(see Figures 13.1, 13.2)

21

Labour Demand in the Long-run: Substitution

- In the short-run model L was chosen given a fixed quantity of other factors of production.

- Goods can be produced using different mixes of labour and other factors of production. Long-run model allows choice of L and other inputs.

- Example below: two inputs – ideas generalize to many types of inputs.

- This is suggested by the production function where Q is output:

Q = Q(K, L)

- Isoquant: shows combinations of K and L which can be used to produce a given level of output.

- slope? - MPL /MP K

(MP = marginal product, subscript L - labour, K-capital)

(Mathematically using calculus, MPs are derivatives:

¶Q¶ L

dL+ ¶ Q¶ K

dK=dQ=0

dK /dL=−¶ Q¶ L

/ ¶ Q¶ K

¶Q¶ L

=MP L, ¶ Q¶ K

=MPK )

- with diminishing returns to K and L isoquants will be convex (see Fig. 5.2)

- Also a higher isoquant, means higher output.

22

- Hiring decision for K and L:

- Use the least cost method to produce the desired output level.

- Cost: determined by technology and factor input prices.

- Can represent costs graphically using isocost lines.

- Let w be the wage and r the rental price of a unit K.- assume competitive input markets (w, r fixed for the firm).

- Isocost: combinations of K and L which give the same level of total cost.

Total cost = w L + r K

C0 = wL + rK isocost for some cost level C0

solve for K:

K = (C0/r) - (w/r) L

Slope = -w/r Intercept depends on level of cost: higher cost, higher

intercept.

23

- Profit maximizing / cost minimizing choice:

- cost minimization implies producing any given output at the lowest possible cost.

- implies using the combination of K and L that puts the firm on the lowest isocost for that isoquant.

- isocost and isoquant will typically be tangent:

24

- Tangency gives: MPL = wMPK r

(usually? corner solution possible but not so interesting)

- If: MPL > wMPK r

hire more L, less K : can hold output constant and reduce cost.

- If: MPL < wMPK r

hire less L, more K : can hold output constant and reduce cost.

- Note that when cost is minimized the usually MP theory condition still holds:

For L MRP of L = w

For K MRP of K = r

25

- Consider the effect of a rise in the wage rate in the long-run:

- rise in w gives a new, steeper set of isocost lines

- holding output constant, the firm chooses a less labour intensive way of producing output.

- this fall in L is the substitution effect

26

- At the new combination of K and L cost is higher than before (output still at its old level).

- firm is likely to reduce its output level.

- this produces an additional fall in L (scale or output effect)

- So:

- High wage relative to the price of machines (or some other substitute):

- expect more automation; less L used.

- Low wage relative to the price of machines (or some other substitute):

- use more labour intensive processes.

- By changing techniques the employer is substituting labour for capital (or vice versa).

27

Consequences of Substitution for the Labour Demand curve?

- Determinants of Labour Demand in the Long-run:

- Best choice of L for a given output level depends on:

- input prices: w and r- technology: shape of the isoquants

- Output market conditions are still important: help determine which output level to produce.

- Labour demand curves will likely be flatter in the long-run than short-run.

- It is often not possible (or economic) to change production techniques in the short-run.

- wait for current plant and machines to run down.

- substitution effects may have to wait until the long run.

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- The position of the long-run labour demand curve will depend upon the prices of other inputs.

- Higher price of capital (machines) will shift the labour demand curve right if machine are substitutes for labour.

- Examples of substitution:

- Robotics in the auto industry.

- Pulp and Paper, mining

- Production processes in Less developed countries vs. more developed countries

(construction in Shanghai vs. Vancouver)

- Robert Allen: high wages, low energy prices and why UK had the 1st industrial revolution (K intensive production profitable).

- Technology and labour demand:- short-run: technology affects MP and/or MR. - long-run: can create new or better substitutes for existing workers.

- It was assumed above that the two inputs were substitutes.

- Two inputs could instead be complements:

e.g., so that raising output requires more of both inputs

- With complements: a rise in the wage would reduce both the quantity of labour and the quantity of the complementary input used.

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Wage Differences between Skill Groups and Labour Demand

- Tinbergen: skill premium paid to high skill workers is determined by a

“race between education and technology”.

- education changes skill composition of workforce (supply)

- technology affects positions of the demand curves for high and

low skill workers.

- Starting in the later 1970s into 1980s, 1990s wages of high-skill

workers rose- technology winning the race (skilled: labour demand

outpaces supply)

- Katz and Murphy’s approach:

- production function with high & low skill workers as substitutes.

- derives the following result with b<0 :

ln(wH/wL) = ln(AH/AL) + b ∙ln(SH/SL)

(w – wage, A – technology effect, S – supply, subscripts H, L for

high and low-skill)

- this has been fit to US data, assuming tech. effects follow a

simple time trend.

Acemoglu and Autor (2011) for US 1963-2008 get:

30

ln(wH/wL) = -.25 + .028∙ t63 - .010∙ t92 - .644 ∙ln(SH/SL)

(.002) (.002) (.088)

where: ln(AH/AL) = -.25 + .028∙ t63 - .010∙ t92 , t63, t92 = time trends starting 1963, 1992. std. errors in brackets.

- fits the data quite well (see graph).

- note two time trends in technology term:- 1963-92 tech. change was more favorable

to high skill than it was 1992-08.

- note: Tinbergen story – technology favors high skill.

- probably true for period he studied but not always true.

- Industrial revolution: favors low skill vs skilled artisans.

- Autor: current tech. change hurts those in “routine”

jobs whether those are high or low skill.

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What do labour demand curves look like? Elasticity of Demand for Labour

Own-Wage Labour demand elasticity (eD)

eD = % change in L <0% change in W

- More elastic? higher is the absolute value of eD - see Figure 5.7

- Importance of the size of this elasticity:- Predicting effects of policies that affect labour costs.- Predicting the effects of shifts in labour supply.- Determinant of a union’s wage-employment tradeoff.

- Hamermesh (1993) classic book Labour Demand

- Surveyed elasticity estimates: -.30 as a best guess elasticity.

- Mainly from regression studies looking at industry employment variation over time with input price (including wage) and either output price indicators or output itself as explanatory variables.

- Based mainly on U.S. studies.

- Rules of thumb for elasticity value (Hicks-Marshall Laws of Derived Demand, text p.149-150):

- More elastic the more elastic is output demand.

- More elastic the greater the availability of substitutes.

- More elastic the greater the supply elasticity of substitutes.

- More elastic the higher is labour’s share of production costs.

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(Quasi) Fixed Costs and Labour Demand:

- See Chapter 6.

- Quasi-fixed costs:

- Labour costs which do not vary directly with hours of work.

e.g., hiring and training costs

some fringe benefits (where expense is the same per employee regardless of time worked)

payroll tax contributions (if there is a contribution ceiling)

termination costs (e.g. severance)

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Some Implications of quasi-fixed costs for labour demand?

(1) Adds a dynamic (time) aspect to labour demand:

Hiring decision:

- hire if benefits > costs

- benefit: MRP cost: wage, fixed costs.

- MRP and W : exist for each period the person works

Fixed cost: incurred once or intermittently

- Proper comparison:

(Present) value of output over the length of the job vs.

(Present) value of wages over the length of the job plusquasi-fixed cost.

- Implications?

(a) MRP > W on last worker hired.

i.e. necessary to cover fixed costs

(b) Expectations regarding future W and MRP important.

- Nature of worker-employer contract with large fixed costs?- long-term contracts vs. spot contracts. - W and MRP: comparable present value

over length of contract; no need for W=MRP in each period.

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(2) Creates incentives to adjust hours per employee rather than the number of employees (other things equal)

Why? Raise average work hours: no additional fixed cost

- Fixed costs will encourage use of overtime.

- Generally: Hours per week vs. employees per week?

- Three considerations:

Fixed costs: expand hours per employee per week.

Overtime premium: expand employees per week not hours.

Marginal productivity of an extra hour per week vs. marginal productivity of an extra worker.

- higher for extra hour or extra worker?

(3) Labour hoarding during downturns:

- With fixed costs:

MRP >W (to cover fixed costs)

- if MRP should fall or W rise workers are only laid off it MRP<W (if fixed costs already paid).

i.e. so for smaller rise in W or fall in MRP no layoffs (hoarding)

- Also:

- layoffs raise the risk of losing the worker permanently

- if may want to raise employment again later this means incurring the fixed cost again.

- this can encourage hoarding

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(4) Firing costs: severance pay , justification of layoff processes

- Severance pay: payment to worker on termination (often linked to past years of service).

- Justification of layoff: quasi-legal process before termination allowed (some European countries)

- potential cost of new employee is higher than wage costs alone suggest: like a fixed cost: hire fewer

- creates a disincentive to layoffs if wages rise.

- Europe: - this type of cost may have limited job creation.

- Job creation vs. layoff effects: do firing penalties raise or lower unemployment?

- Insider-outsider distinction and fixed costs:- employers view possible new employees (outsiders) as imperfect

substitutes for current employees (insiders).

- Why? - could be because quasi-fixed costs have already been incurred

for insiders.

- Could this explain why insider wages don’t fall even when unemployment is high?

- see unemployment section.

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Appendix: Technology and Labour Markets

- Labour demand models:

- Short-run labour demand: technological change can change MRP

- alters amount of output a worker can produce (more!).

- alters output prices:

- pecuniary externality from the first effect: raises output supply and drives down output price (works against 1st effect).

- creates new products and new jobs producing these products but can also lower prices of competing products.

- Long-run labour demand:

- Substitutes and complements change. New ways of producing goods may eliminate some jobs and create new jobs.

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- H. Varian: interesting comment that jobs typically involve many tasks. Automation may eliminate some tasks so that the job changes or becomes a new type of job with different tasks.

e.g. elevator operatorSee his presentation ‘Bots vs Tots’

https://www.youtube.com/watch?v=VLcnN3kLUKI ‘People has been underestimated’

- General equilibrium effects via output prices and real incomes:

- technological improvement often allows needs to be met more cheaply.

- this increases ‘real income’ and generates more demand for other goods and services and more demand for the workers producing these goods.

- Labour supply:

- technological change can affect the value of time across uses

- Rise in women’s participation: did appliances lower the marginal value of time in home production?

- Does technology alter the value of leisure time? (Games; internet; social media)

- Technology can also influence labour supply through effects on wages (via labour demand)

- Technology and the market mechanism:

- Matching employers and workers a function of labour markets.

- Search for a good match may be affected by information technologies.

- lower costs of search - does this give better matches?

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