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LABOR MARKETS
d
" ati Time
ë Assume that an individual¶s utility
depends on consumption (Ô) and hours
of leisure ( )
utility = (Ô, )
ë n seeking to maximize utility, the
individual is bound by two constraints
½D = 24
Ô = ½
Ñ
" ati Time
ë Combining the two constraints, we get
Ô(24 ± )
Ô 24
ë An individual has a ³full income´ of 24
± may spend the full income either by
working (for real income and consumption)
or by not working (enjoying leisure)
ë The opportunity cost of leisure is
[
ÿti ity Maximizati
ë The individual¶s problem is to maximize
utility subject to the full income constraint
ë Setting up the Lagrangian
= (Ô, ) D §(24 ± Ô )
ë The first-order conditions are
0Õ0Ô = 0Õ0Ô - § = 0
0Õ0 = 0Õ0 - § = 0
ÿti ity Maximizati
ë ividing the two, we get
/ Ô
o Ô
/
ë To maximize utility, the individual should
choose to work that number of hours for
which the ~ (of for Ô) is equal to
± to be a true maximum, the ~ (of for Ô)
must be diminishing
m
me a
titti Eet
ë Both a substitution effect and an income
effect occur when changes
± when rises, the price of leisure becomes
higher and the individual will choose less
leisure
± because leisure is a normal good, an
increase in leads to an increase in leisure
ë The income and substitution effects move
in opposite directions
me a
Consumption titti Eet
The substitution effect is the movement
from point " to point
The income effect is the movement
from point to point
" ÿ2 The individual chooses
less leisure as a result
ÿ
of the increase in
Leisure
cÑ
Úa tatemet the Pr em
ë This means that a labor supply
function can be calculated by partially
differentiating the expenditure function
± because utility is held constant, this
function should be interpreted as a
³compensated´ (constant utility) labor
supply function
½Ô(,)
c[
t
y Eqati
ar pp y
ë The expenditures being minimized in the
dual expenditure-minimization problem
play the role of nonlabor income in the
primary utility-maximization problem
½Ô(,) = ½*,(,)] = ½(,)
ë artial differentiation of both sides with
respect to gives us
0½ 0½ 0½ 0
0 0 0 0 c
t
y Eqati
ar pp y
ë Substituting for 0Õ0, we get
0½ 0½ 0½ 0½ 0½
½ ½
0 0 0 0 0
ë ntroducing a different notation for ½Ô ,
and rearranging terms gives us the
Slutsky equation for labor supply:
0½ 0½ 0½
½
0 0 {
0 cm
CÚ a ar pp y
ë Suppose that utility is of the form
Ë
Ê
ë The budget constraint is
½
and the time constraint is
½ =
± note that we have set maximum work time
to hour for convenience c
CÚ a ar pp y
ë The Lagrangian expression for utility
maximization is
Ô¬ D §( Ô)
ë irst-order conditions are
0Õ0Ô = ¬Ô -§=0
0Õ0 = Ô¬ ¬ - § = 0
0Õ0§ = Ô = 0
cô
CÚ a ar pp y
ë ividing the first by the second yields
x x 1
! !
F 1 E
c E
! Ô
E
cå
CÚ a ar pp y
ë Substitution into the full income
constraint yields
Ô¬()
()Õ
± the person spends ¬ of his income on
consumption and = -¬ on leisure
± the labor supply function is
Ë
½ º ˺
d
CÚ a ar pp y
ë ote that if = 0, the person will work
( - ) of each hour no matter what the
wage is
± the substitution and income effects of a
change in offset each other and leave ½
unaffected
dc
CÚ a ar pp y
dd
CÚ a ar pp y
dÑ
CE ar pp y
ë Suppose that the utility function is
Ê
Ê º
ë Budget share equations are given by
Pº
Ê
Ê
Pº
± where P = Õ( - ) d[
CE ar pp y
ë Solving for leisure gives
P
and
c P
½ c
c P
d
Mar
et pp y Crve r ar
To derive the market supply curve for labor, we sum
the quantities of labor offered at every wage
ndividual "¶s
supply curve ndividual ¶s
" supply curve Total labor
supply curve
½" ½ ½ ½ ½ ½
½A* D ½B* = ½*
dm
Mar
et pp y Crve r ar
ote that at 0, individual B would choose to remain
out of the labor force
ndividual "¶s
supply curve ndividual ¶s
" supply curve Total labor
supply curve
{
½ ½ ½
dô
ar Mar
et Eqi irim
At *, the quantity of labor demanded is
equal to the quantity of labor supplied
real wage
At any wage above *, the quantity
of labor demanded will be less
than the quantity of labor supplied
½· quantity of labor
då
Maate eeit
ë A number of new laws have mandated
that employers provide special benefits
to their workers
± health insurance
± paid time off
± minimum severance packages
ë The effects of these mandates depend
on how much the employee values the
benefit Ñ
Maate eeit
ë Suppose that, prior to the mandate, the
supply and demand for labor are
½ =
½ Ô
ë Setting ½ ½ yields an equilibrium wage
of
(Ô )Õ()
Ñc
Maate eeit
ë Suppose that the government mandates
that all firms provide a benefit to their
workers that costs Y per unit of labor
hired
± unit labor costs become Y
ë Suppose also that the benefit has a
value of per unit supplied
± the net return from employment rises to
Ñd
Maate eeit
ë Equilibrium in the labor market then
requires that
( ) = Ô (Y)
ë This means that the net wage is
Ô Y Y
·· ·
ÑÑ
Maate eeit
ë f workers derive no value from the
mandated benefits ( = 0), the mandate
is just like a tax on employment
± similar results will occur as long as üY
ë f Y, the new wage falls precisely by
the amount of the cost and the
equilibrium level of employment does not
change
Ñ[
Maate eeit
ë f Y, the new wage falls by more than
the cost of the benefit and the
equilibrium level of employment rises
Ñ
îae Variati
ë t is impossible to explain the variation
in wages across workers with the tools
developed so far
± we must consider the heterogeneity that
exists across workers and the types of jobs
they take
Ñm
îae Variati
ë uman Capital
± differences in human capital translate into
differences in worker productivities
± workers with greater productivities would be
expected to earn higher wages
± while the investment in human capital is
similar to that in physical capital, there are
two differences
ë investments are sunk costs
ë opportunity costs are related to past investments
Ñ
îae Variati
ë Compensating ifferentials
± individuals prefer some jobs to others
± desirable job characteristics may make a
person willing to take a job that pays less
than others
± jobs that are unpleasant or dangerous will
require higher wages to attract workers
± these differences in wages are termed
compensating differentials
Ñô
Mp y i the
ar Mar
et
ë n many situations, the supply curve for
an input (½) is not perfectly elastic
ë We will examine the polar case of
monopsony, where the firm is the single
buyer of the input in question
± the firm faces the entire market supply curve
± to increase its hiring of labor, the firm must
pay a higher wage
Ñå
Mp y i the
ar Mar
et
ë The marginal expense (~) associated
with any input is the increase in total
costs of that input that results from hiring
one more unit
± if the firm faces an upward-sloping supply
curve for that input, the marginal expense will
exceed the market price of the input
[
Mp y i the
ar Mar
et
ë f the total cost of labor is ½, then
0½ 0
½ ½
0½ 0½
[
ar ÿi
ë We will assume that the goals of the
union are representative of the goals of
its members
ë n some ways, we can use a monopoly
model to examine unions
± the union faces a demand curve for labor
± as the sole supplier, it can choose at which
point it will operate
ë this point depends on the union¶s goals
[m
ar ÿi
The union may wish to maximize the total
Wage
wage bill (½).
This occurs where
~ 0
1 ½ workers will be
hired and paid a
wage of
This choice will
~ create an excess
Labor supply of labor
½1
[
ar ÿi
The union may wish to maximize the total
Wage
economic rent of its employed members
This occurs where
d
~
½2 workers will be
hired and paid a
wage of 2
Again, this will
~ cause an excess
Labor
½d supply of labor
[ô
ar ÿi
The union may wish to maximize the total
Wage
employment of its members
This occurs where
½Ñ workers will be
Ñ
hired and paid a
wage of Ñ
~
Labor
½Ñ
[å
Me i a ÿi
ë A monopsonistic hirer of coal miners
faces a supply curve of
½ 50
ë Assume that the monopsony has a
~ curve of the form
~ ½ = 70 ± 0. ½
ë The monopsonist will choose to hire 500
workers at a wage of $ 0
Me i a ÿi
ë f a union can establish control over
labor supply, other options become
possible
± competitive solution where ½ = 58Ñ and
= $ .66
± monopoly solution where ½ = Ñ 8 and
= $Ñ8.20
c
" ÿi araii Me
ë Suppose a firm and a union engage in a
two-stage game
± first stage: union sets the wage rate its
workers will accept
± second stage: firm chooses its employment
level
d
" ÿi araii Me
ë This two-stage game can be solved by
backward induction
ë The firm¶s second-stage problem is to
maximize its profits:
Ã= (½) ± ½
ë The first-order condition for a maximum is
(½) =
Ñ
" ÿi araii Me
ë Assuming that ½* solves the firm¶s
problem, the union¶s goal is to choose
to maximize utility
(,½) = *,½*()]
and the first-order condition for a
maximum is
D 2½ = 0
Õ2 = ½
[
" ÿi araii Me
ë This implies that the union should choose
so that its ~ is equal to the slope of
the firm¶s labor demand function
ë The result from this game is a ash
equilibrium
mprtat Pit t Nte:
ë A utility-maximizing individual will
choose to supply an amount of labor at
which the ~ of leisure for
consumption is equal to the real wage
rate
m
mprtat Pit t Nte:
ë An increase in the real wage rate
creates income and substitution
effects that operate in different
directions in affecting the quantity of
labor supplied
± this result can be summarized by a
Slutsky-type equation much like the
one already derived in consumer
theory
mprtat Pit t Nte:
ë A competitive labor market will
establish an equilibrium real wage
rate at which the quantity of labor
supplied by individuals is equal to the
quantity demanded by firms
ô
mprtat Pit t Nte:
ë Monopsony power by firms on the
demand side of the market will
reduce both the quantity of labor
hired and the real wage rate
± as in the monopoly case, there will be a
welfare loss
å
mprtat Pit t Nte:
ë Labor unions can be treated
analytically as monopoly suppliers of
labor
± the nature of labor market equilibrium in
the presence of unions will depend
importantly on the goals the union
chooses to pursue