Labour Economics Revision Booklet PDF

lOMoARcPSD|13540437 Labour Economics Revision Booklet Labour Economics (University of Nottingham) Studocu is not sponsored or endorsed by any college or university Downloaded by Tracy ([email protected])  lOMoARcPSD|13540437...

lOMoARcPSD|13540437 Labour Economics Revision Booklet Labour Economics (University of Nottingham) Studocu is not sponsored or endorsed by any college or university Downloaded by Tracy ([email protected])  lOMoARcPSD|13540437 Labour Economics Revision Booklet General Difference-in-differences Use the new figure minus the old figure for both. Then take the difference between the two. For effective usage  Randomly selected so good counterfactual  Information on the participants  Information before and after (further years)  Cost of programme / structure  Other outcomes from programme outside of data (social factors / personal factors) Topic 1 – Recent Developments in UK & OECD labour markets What is the difference between the labour force and the working age population? Labour force includes the people who are employed and the people who are unemployed. Working age includes all those people plus those who are inactive. Who are those that are said to be “inactive”? Those who are students, retired, sick, family or other reasons Why might it be difficult to distinguish between unemployed and inactive individuals? Because there are many people who move between the different groups. If someone moves from inactive to employed then they must have been looking for a job. Why is the claimant count measure of unemployment lower than the ILO definition? Because some people may be looking for a job, but ineligible or not want to claim unemployment benefits. What is the UK productivity puzzle? That when there was a recession, firms didn’t make as many workers redundant despite sales decreasing. This meant that output per worker decreased and thus productivity, whereas normally in a recession productivity increases as some of the least productive firms go out of business. What is the 90:10 ratio? The ratio of the wage at the 90th percentile to the wage at the 10th percentile. If it is 3 then, the 90th percentile were three times richer than the 10th percentile. It is a way of measuring inequality. What has been the recent trend in the male participation rate? It has been declining over the past 100 years What has been the recent trend in the female participation rate? It has been increasing over the past 100 years Topic 2 – Labour Supply What is the budget constraint for labour? C=wh+V Downloaded by Tracy ([email protected])  lOMoARcPSD|13540437 Consumption is equal to the wage rate multiplied by hours worked, plus non-labour income V C=w (T −L)+V Rewriting in terms of labour, we can see that h = T – L. Since it is total time minus time spent on leisure C=wT +V – wL Rearranging to find the slope and the intercept, where the slope is – wL and the intercept is wT +V What is the negative income tax rate? This question is asking about the working tax credit. Derive and explain the budget constraint, then show that the negative tax rate increases the slope of the line for w, to w (1+t). For people to start work, they must meet their reservation wage, if the new negative income tax rate increases beyond their reservation wage then they will enter work. Important to know; Some people may actually work less when there is a negative income tax rate, this is because there is an income effect from it, such as the diagram below. What is the reservation wage? In labour economics, the reservation wage is the lowest wage rate at which a worker would be willing to accept a particular type of job. How does an increase in non-labour income affect the reservation wage? The budget curves get shifted up parallel. Indifference curves are convex, so if we move vertically up they must get steeper. In other words, as we get richer we require more consumption to bribe us to give up an hour of leisure. This means that the reservation wage increases. Why is there a negative association with wages and hours of leisure in the short-run? This is because in the short-run, when there is an increase in wages, the substitution effect may outweigh the income effect. As wages get higher, the cost of leisure increases and thus the individual will substitute away from leisure and towards consumption. The income effect says that the individual will consume more of both leisure and consumption. However we cannot know which effect will be stronger. Downloaded by Tracy ([email protected])  lOMoARcPSD|13540437 Why does this association not happen in the long run? That is because in the long run any increases in future income is already predicted to be higher as a person gets older, due to key statistics, having more experience and education, so there is no lifetime income effect. The worker chooses to work more in later years, because they know they will earn more due to the model. Therefore when they do earn more, they don’t actually change any decisions, because the change in income was already anticipated and accounted for. What is the intertemporal substitution effect? People substitute their time over the life cycle to take advantages of changes in the price of leisure. What is the equation for the elasticity of labour supply? percent change in hours of work D / D s = = = percent change in wage rate D / D What is the replacement ratio? b The ratio of benefits to the going wage w Topic 3 – Labour Demand What is the firm’s production function? q=f ( E , K ) What denotes a firm’s profits? π = pq−wE−rK Assume initially that the firm is a price taker and thus can’t affect p, w or r. What is the Value Marginal Product for a firm? VMP E= p × MP E What is the optimisation point for employing labour for a firm? VMP E=w Downloaded by Tracy ([email protected])  lOMoARcPSD|13540437 Why is this the optimisation point? The demand curve for labour is the relationship between wages and employment for a profit maximising firm. We know that a profit maximising firm hires labour up to the point where the wage equals the value marginal product, so the value marginal product is the demand curve for labour. Why is the second-order condition required for profit maximisation? It ensures that the VMPE is declining (so we are at point C and not point A which are both stationary points. Show the condition that wage is equal to value marginal product is the same as price is equal to marginal cost. Marginal Product is the amount of units of output an extra unit of labour will produce. For 1 example MP could equal 5 and thus it takes of a worker to produce one unit, this is the 5 1 same as. The cost of labour is the wage rate, w so the Marginal Cost of one unit of MP E output is equal to the wage multiplied by the amount of labour to produce one unit, such 1 MC=w ×. The condition that the firm produces up to the point where MC = P means MP E 1 the equation can then be written as p=w ×. This can be rearranged to find the MP E marginal productivity condition w= p × MP E. What is the equation for the elasticity of labour demand? % change∈employment dSR = % change∈wage Why is it sometimes difficult to measure the elasticity for labour demand? Because the change could be due to supply and demand shifts and thus doesn’t show the true effect such the supply shift is not exogenous. What can be used to deal with this problem? Instrumental variables that measure only the shift in supply. What is an instrument variable for elasticity of labour demand? The interstate variation in the rate at which men were drafted to serve in WWII What is the marginal rate of technical substitution? DK M PE =- DE M PK What is the firm’s budget constraint? C = wE + rK How is this rearranged to form the Isocost line? C æw ö K = - çç ÷÷ E r èr ø What is the optimisation point? MPE / MPK = w / r What is the Rate of Substitution? Downloaded by Tracy ([email protected])  lOMoARcPSD|13540437 % change in K/E Elasticity of substitution = % change in w/r This measures the curvature of the isoquant. The elasticity of substitution gives the percentage change in capital/labour ratio resulting from a 1 per cent change in the relative price of labour. How easy it is to replace one input for another. It is different from the Marginal Rate of Technical Substitution. As the relative price of labour increases, the substitution effect tells us that the capital/labour ratio increases, therefore it is a positive number. Interpreting If the isoquant is right-angled (perfect complements) then the elasticity of substitution is infinite. If the isoquant is linear (perfect substitutes) then the elasticity of substitution is zero. Therefore the size of the substitution effect directly depends on the magnitude of the elasticity of substitution. What are Marshall’s rules of derived demand?  Labour demand is more elastic the greater the r of substitution  Labour demand is more elastic the greater the elasticity of demand for the output  Labour demand is more elastic the greater labour's share in total costs (almost…)  Labour demand is more elastic the greater the supply elasticity of other factors of production What is the cross elasticity of demand between inputs? %change∈ x i %ch ange∈w j This says what is the percentage change of input i, from of a per cent change in the price of unit j. This is important because as Capital rises so does the need for labour and vice versa, this says how a firm will react to changes in prices of the alternative input. What will the cross-elasticity be if the two input are substitutes? It will be positive and large What will the cross-elasticity be if the two inputs are complements? It will be negative and small. Topic 4 - Monopsony Why is the supply curve perfectly elastic for the normal firms? We have assumed so far that each firm is small and cannot influence either the price of its inputs (w) or the price of its output (p) In the normal market, why is the labour supply curve different for firm vs industry? In the normal model, firms are small and therefore cannot influence the wage rate and have to choose how many workers at a specific rate. However in the whole industry, the labour supply curve is upward sloping because as the wage rate increases, more people have their reservation wage met. What are sources of frictions in the labour market?  Mobility costs Downloaded by Tracy ([email protected])  lOMoARcPSD|13540437  Heterogeneous preferences  Ignorance  Search frictions  One company towns  Specific training Why is Marginal Cost higher than the supply curve? Because the firm has to pay more money to increase the amount of workers willing to work, so for every extra worker willing to work, the marginal cost goes up. The marginal cost is higher than the supply because the supply is the average cost of workers, whereas marginal is how much for an extra. MCE = VMPE What is the diagram for Monopsony? Firms employ up until the point where VMP = MC and pay a lower wage of the labour supply curve. How does the Minimum wage affect Monopsony differently? It affects the marginal cost curve by making firms pay a set wage rate. They end up employing more people than originally at the lower wage cost, and pay a higher rate to all their workers. This can be seen in the diagram below. What is the recruitment rate? The number of workers recruited is R(w). This represents the fraction of workers who gain a job each month. Downloaded by Tracy ([email protected])  lOMoARcPSD|13540437 What is the separation rate? The separation rate is s(w). This represents the fraction of employed workers who quit their job each month. What does increasing the wage do to the recruitment rate and the separation rate? It reduces the separation rate and increases the recruitment rate What is the equation that says firms must pay higher wages to get more staff? R(w) E= s( w) What is a tax wedge? The tax wedge is the difference between what employees take home in earnings and what it costs to employ them. Topic 5 – General equilibrium (Tax/ Minimum wage) Draw a diagram for two markets that open up to labour mobility Payroll Taxes What is the current rate of Minimum Wage in the U.K? It is £6.50 for those who are over 21; younger people have a lower minimum wage. Topic 6 – Human Capital Downloaded by Tracy ([email protected])  lOMoARcPSD|13540437 What is the wage-schooling locus? It describes the relationship between schooling and income; such how much extra years of schooling will earn you. Draw the wage-schooling locus How is it determined? It is determined in the labour market by the intersection of supply and demand for each type of worker. Why is it upward sloping and concave? It is upward sloping because extra years of education must provide a financial gain as a way of increased earnings because there are foregone earnings and sometimes a physical cost of education. It is concave because there is law of diminishing returns to capital, such that the marginal returns decrease as years of schooling increase. What is the Present Value for next year? y P V (y t +1 )= t 1+ r What is the Present Value if income is the same for a large amount of years? ( )» What is the formula for the present value for someone who doesn’t get higher education? What is the formula for the present value for someone who gets higher education? What is the Marginal Rate of Return (MRR)? Downloaded by Tracy ([email protected])  lOMoARcPSD|13540437 New Rate−Old Rate It can be worked as a percentage x 100. It says how much a worker will Old Rate earn from doing one more year of education. The worker should choose extra education up until the point where MRR = discount rate. Why do people choose different levels of schooling?  Because they have different MRR  Because they have different discount rates What is the problem with unobserved ability? The problem is that unobserved ability causes a correlation between si and ui. High ability workers have high s and high u, low ability workers have low s and low u. OLS estimates are biased if any of the right-hand side variables are correlated with the error term. What are the problems with estimating the return to education? There is no counterfactual so have to take people with different levels of schooling and different incomes. However education is not randomly assigned. What is the difference between selection bias and ability bias? “Ability bias” is the idea that workers who are good at earning money in the labour market (high ability workers) choose to do more years of schooling. “Self-selection” is the idea that workers maximise their NPV, and workers differ in their wage-schooling locus. Some workers might get a lot of benefit from education, others might benefit less. So comparing workers who have high s with workers who have low s would be misleading. This idea is more complex than simple ability bias, because it says that there is no single thing that can be called “ability”. Some work- ers are relatively better at some career paths (e.g. attending college and entering a high- skill occupation) while others are relatively better at other career paths (e.g. leaving school early and setting up a business). What is an instrumental variable? A variable that is correlated with the other explanatory variable but not with the dependant variable. It is different to a proxy. For example in the estimating education’s effect, it is a variable with correlates with years of schooling, but not with the wage the worker earns or the unobserved ability earnings. The instrumental variable is to get rid of selection bias, because it causes people to change their amount of years of schooling, but not their wage. What studies are there which use an instrumental variable? Angrist and Krueger found that the rate of return to schooling was...about the same as the OLS estimate. An example of an instrumental variable is the one in America where children ended up having one year less of education from having to start school when they are aged 6. Other natural experiments include – Draft lotteries – French student riots – Changes in school leaving age – Studies of twins What does measurement error and endongeninity mean? Measurement error is not an actual error of measure but a difference between the actual coefficient and the given coefficient. If there is selection bias, then people with education are chosen even though they chose education because of their higher rates of return. Therefore there is Endogenuinity, when an explanatory variable relates to the error. Downloaded by Tracy ([email protected])  lOMoARcPSD|13540437 What is the difference in how specific and general training programmes should be funded? General training programmes, where skills could be used in a number of firms, should be funded by the individual. Specific training programmes should be funded by the individual and the employer because then both parties have an incentive not to terminate the relationship and impose a cost on the other party Topic 7 – Wage Inequality What is the gini coefficient? It pits the share of total income against the percentage of households that own that income. The A equation is. It is the difference between the perfect equality Lorenz curve and the A+ B actual Lorenz curve divided by the area under the perfect Lorenz curve. What is the Lorenz Curve? It a line which shows how income in a country is spread across the population. It is the cumulative distribution of income across the population. What would the gini coefficient be if there were perfect income equality? It would be equal to 1 since the area of A would be equal to A + B and thus 1/1. What are the usual reasons given for the wage inequality? The “usual suspects” for explaining the increase in the inequality of earnings: 1. Trade. Increased trade and outsourcing with countries where unskilled labour is cheaper, thereby reducing the wages and employment of domestic unskilled workers. Developed countries import goods that are made from low skilled. Therefore these industries are hurt most in the developed countries. 2. Technology. Increased rate of growth of the relative demand for more skilled workers, largely as a result of the spread of new technology in the workplace. Technology can be a substitute for low-skilled workers such as machinery, where as is usually a complement for high-skilled workers meaning the demand would rise. 3. Shortage of skilled workers. Changes in the supply of different groups of workers: a shortage of skilled workers due to a decline in the size of cohorts entering the labour market, and a glut of unskilled workers due to increased Downloaded by Tracy ([email protected])  lOMoARcPSD|13540437 immigration rates. In America, some research was done that found that there was an increase in unskilled immigration which led to some decrease in wages. 4. Changes in labour market institutions (Machin (1997) and Fortin & Lemieux (1997) suggest that quite a high proportion of the increase in inequality may be due to institutional changes) What are the arguments for trade being the reason for inequality? Because countries import goods from low skilled countries and export from their skilled workforce. This reduces the demand for low skilled. If international trade has caused the shift in demand away from less-skilled workers, it ought to be because exporting (skill intensive) industries expanded and non-exporting (unskilled intensive) industries shrunk. This is a “between industry” effect. Instead, various authors have found that the increase in demand for skilled workers has occurred in all industries, even those that produce non-traded goods. So, the increase in the demand for skilled workers has been a “within industry” effect What are the arguments for technology being the reason? That technology requires higher skilled labour and thus they are more in demand. However it is extremely difficult to measure technological growth. Also technology growth has happened at the same time as the growth in trade. What are the changes in labour market institutions?  Declining power of Trade Unions  Reduction or abolition of the minimum wage  Public sector employment Topic 8 – Job Search and Unemployment What is the job search model? It says that there is imperfect information for the workers about which wages there are. It says that workers do know about the distribution of the wages but not which firms are offering which ones. What are the assumptions of the model?  Workers are identical  Know distribution but not which firms offer which rate  Workers prefer higher rate to lower rate What are the two strategies?  Optimal Sample size (How many jobs a worker should apply for)  Optimal stopping rule (If a worker should accept a job offer) What are the conditions for accepting a job offer? If the job offer is above that of wr How do you derive the reservation wage, wr? From looking at the marginal benefit and marginal cost of search such marginal benefit is. Downloaded by Tracy ([email protected])  lOMoARcPSD|13540437 What is the formula for Reservation wage if there are benefits given (marginal cost)? λ w r=b + ( 1−F ( w )) ( E ( w|w> wr )−wr ¿ r What’s the reservation wage if a worker can look whilst it has a job? w r=b What are the determinants of wr? 1. Benefit level, b 2. Job offer arrival rate, λ 3. Discount rate, r 4. Distribution of wages Does change in Job offer arrival rate, λ, positively or negatively effect employment? If λ, increases, unemployment duration falls ceteris paribus But when, λ, goes up, individuals respond by increasing the reservation wage, so the final result is ambiguous What is the New Deal? Introduced by the Labour party in 1998, it aimed to get more long term unemployed into work. It gave subsidies to taking on long-term unemployed and gave subsidies for the cost of training them. What are other reasons why the reservation wage may fall in real life application? Due to unemployment level being withdrawn or due to liquidity constraints What is the hazard rate or the exit rate? It is the job finding rate. Expressed as a percentage a decimal of people who have found a job compared to those who haven’t. What will be the general rule for difference in marginal revenue of search for those young unemployed versus those who are older? The Marginal Revenue of search will be higher for those that are younger because they will be able to gain those benefits for the rest of their lives, whilst those who are older have less time. What is the Marginal Cost of Search? It is the wage rate as that’s how much it costs to reject one period Downloaded by Tracy ([email protected])  lOMoARcPSD|13540437 Where w r is the reservation wage, b is the benefit level, r is the discount level and The job offer arrival rate,  Downloaded by Tracy ([email protected])