Labour Economics FINC 407 Compiled PDF

FINC 407 Labour Economics Session 1 – Why Study Labour Economics Lecturer: Dr. Edward Asiedu, UGBS Contact Information: [email protected] College of Education Department of Distance Education 2017/2018  Session Overview This session will equip students...

FINC 407 Labour Economics Session 1 – Why Study Labour Economics Lecturer: Dr. Edward Asiedu, UGBS Contact Information: [email protected] College of Education Department of Distance Education 2017/2018  Session Overview This session will equip students with knowledge of the reasons behind the study of labour economics The labour market in developing economies Some basic concepts in labour economics The structure and patterns of unemployment in the Ghanaian Labour market Dr. Edward Asiedu Slide 2  Session Outline The key topics to be covered in the session are as follows: Why should Administrators /Economist be interested in labour economics Why study labour market in developing Countries Some Basic Concepts Structures and patterns of unemployment and labour market situations (Ghana) Dr. Edward Asiedu Slide 3  Reading List Borjas, G. J. (2000). Labour economics (Vol. 2). New York: McGraw-Hill. Ehrenberg, R. G., & Smith, R. S. (2016). Modern labour economics: Theory and public policy. Routledge. Kaufman, B.E. and J.L. Hotchkiss (2003). The Economics of Labour Markets, 6th edition, Dryden Press, Fort Worth Dr. Edward Asiedu Slide 4  Topic one WHY SHOULD ADMNISTRATORS/ECONOMIST BE INTERESTED IN LABOUR ECONOMICS Dr. Edward Asiedu Slide 5  Why should Administrators /Economist be interested in labour economics All of us will spend a substantial proportion of our life in the labour market. How we do in the labor market helps determine our wealth, the types of goods we can afford to consume, who we associate with, which schools our children attend, and even the types of persons who find us attractive. And therefore we are all eager to learn how the labor market works. Dr. Edward Asiedu Slide 6  Why should Administrator/Economist be interested in labour economics As administrators, we should have a good understanding of how labour market activities could impact the firm. Finally, we should have a good understanding of the different actors in the labour market. Dr. Edward Asiedu Slide 7  Topic Two WHY STUDY LOBOUR ECONOMICS IN DVELOPING COUNTRIES Dr. Edward Asiedu Slide 8  Why Study Labour Market in Developing Countries Unemployment in low income countries on average in almost all dimensions much higher than in rich countries. Unemployment among the youth is particularly very high. Structure of employment that relies more heavily on strength and endurance, and, therefore on good health. Dr. Edward Asiedu Slide 9  Why Study Labour Market in Developing Countries Working conditions that are often harmful to health. Malfunctioning of labour markets is often given as a principal explanation of the widespread poverty in developing countries. The labour market (malfunctioning) is the immediate locus of the problem of low and stagnant incomes of workers at the bottom of the distribution. Dr. Edward Asiedu Slide 10  Topic Three SOME BASIC CONCEPT Dr. Edward Asiedu Slide 11  Some Basic Concepts Labour Force: The term labour force refers to all those over 15 years of age who are employed, actively seeking work, or expecting recall from a layoff. Unemployed: Those in the labour force who are not employed for pay. People who are not employed and are neither looking for work nor waiting to be recalled from layoff by their employers are not counted as part of the labour force. Dr. Edward Asiedu Slide 12  Some Basic Concepts Q1: The total labour force thus consists of the employed and the unemployed. True/False Those in the labour force, whether employed or unemployed, can leave the labour force by retiring or otherwise deciding against taking or seeking work for pay (dropping out). Those who have never worked or looked for a job expand the labour force by entering it. Dr. Edward Asiedu Slide 13  Some Basic Concepts Unemployment rate: The ratio of those unemployed to those in the labour force While this rate is crude and has several imperfections, it is the most widely cited measure of labour market conditions. Labour force participation rate: This is the proportion of a country's working-age population that engages actively in the labour market, either by working or looking for work. Dr. Edward Asiedu Slide 14  Some Basic Concepts It provides an indication of the relative size of the supply of labour available to engage in the production of goods and services. When the unemployment rate is around 5 percent the labour market is considered tight (nearing full employment),indicating that jobs in general are plentiful and hard for employers to fill vacant positions and that most of those who are unemployed will find jobs quickly. Dr. Edward Asiedu Slide 15  Some Basic Concepts When the unemployment rate is higher say, 7 percent or above the labour market is described as loose, in the sense that workers are abundant and jobs are relatively easy for employers to fill vacant position. In principle, the labour market can be tight in some occupations or locations (regions) but loose in others Dr. Edward Asiedu Slide 16  Topic Four STRUCTURES AND PATTERNS OF UNEMPLOYMENT AND LABOUR MARKT SITUATION (GHANA) Dr. Edward Asiedu Slide 17  Structures and Patterns of Unemployment and Labour Market Situation (Ghana) The Ghana Statistical Service (GSS) has been conducting the Ghana Living Standards Survey (GLSS) since 1987 to collect data for monitoring the impact of policies and programs on the welfare of the population. Until the year 2012, the GSS had conducted five rounds of the GLSS; these surveys were undertaken in 1987, 1988, 1991/92, 1998/1999, and 2005/2006 Dr. Edward Asiedu Slide 18  Structures and Patterns of Unemployment and Labour Market Situations (Ghana) The Ghana Living Standards Survey (GLSS6) contains a Labour Force Module that is meant to collect data on labour indicators. Information on economic activity was collected on persons 5 years and older who engaged in any economic activity for pay (cash or in-kind) or profit or family gain for at least one hour during the seven days preceding the interview. Based on the GLSS6, almost four out of every five persons 15 years and older is economically active (79.6%). Dr. Edward Asiedu Slide 19  Structures and Patterns of Unemployment and Labour Market Situations (Ghana) Out of this population, 94.8 percent are employed and 5.2 percent unemployed. The unemployment rate is higher for females (5.5%) than males (4.8%). About 4.2 million persons aged 15 years and older (made up of 1.8 million males and 2.4 million females) are estimated to be time-related underemployed (under-utilization and one-hour criteria leads to lower unemployment rates). 22.5% of workers are employees Dr. Edward Asiedu Slide 20  Structures and Patterns of Unemployment and Labour Market Situations (Ghana) Agriculture continues to play a key role in employment creation in Ghana with 44.3 percent of the currently employed population working as skilled agricultural and/or fishery workers. The manufacturing sector employs less than 10 percent of the currently employed population (9.1%). Dr. Edward Asiedu Slide 21  Structures and Patterns of Unemployment and Labour Market Situations (Ghana) The results also show that the unemployment rate is higher for persons with secondary education (11.7%) and those with post-secondary diploma education (9.1%) but lower for persons with post graduate degrees (2.7%), teacher training and agriculture and nursing training (2.8%). Youth unemployment is highest at 10.9 percent (15-24 years) and lowest at 2.5 percent for those aged 65 years and older Dr. Edward Asiedu Slide 22  Structures and Patterns of Unemployment and Labour Market Situations (Ghana) The Ghana Statistical Service (GSS) has been conducting the Ghana Living Standards Survey (GLSS) since 1987 to collect data for monitoring the impact of policies and programs on the welfare of the population. Dr. Edward Asiedu Slide 23  Structures and Patterns of Unemployment and Labour Market Situations (Ghana) Dr. Edward Asiedu Slide 24  FINC 407 Labour Economics Session 2 – How the labour market works Lecturer: Dr. Edward Asiedu, UGBS Contact Information: [email protected] College of Education Department of Distance Education 2017/2018  Session Overview By the end of this sections students should be able to explain some working definitions of unemployment’ Explain how the labour market work And be able to distinguish the various objective of the actors in the labour market. Dr. Edward Asiedu Slide 2  Session Outline The key topics to be covered in the session are as follows: Some definitions in the GLSS work How the labour market work Actors in the labour market Dr. Edward Asiedu Slide 3  Reading List Borjas, G. J. (2000). Labour economics (Vol. 2). New York: McGraw-Hill. Ehrenberg, R. G., & Smith, R. S. (2016). Modern labour economics: Theory and public policy. Routledge. Kaufman, B.E. and J.L. Hotchkiss (2003). The Economics of Labour Markets, 6th edition, Dryden Press, Fort Worth Dr. Edward Asiedu Slide 4  Topic one SOME DEFINITIONS IN THE GLSS WORK Dr. Edward Asiedu Slide 5  Some Definitions in the GLSS Work Wo r k : r e f e r s t o a n y e c o n o m i c a c t i v i t y performed by the respondent that contributes to the economic production of goods and services. Examples are selling in a market/street, working in an enterprise/business or for government, working in one's own farm or enterprise, working on a household member's farm, etc. Dr. Edward Asiedu Slide 6  Some Definitions in the GLSS Work Currently employed: There are two situations in which a person can be classified as being currently employed. Either the person was actually engaged in any work (as defined above) during the reference week, or he/she had an attachment to a job or business but for some reasons did not work during the reference week. Dr. Edward Asiedu Slide 7  Some Definitions in the GLSS Work Currently unemployed (strict definition): A person is considered as currently unemployed if he/she was not engaged in any work (as defined above), had no attachment to a job or business, reported that he/she was available for work and had taken some specific steps to look for work. Time-related underemployment: The concept of time-related underemployment has been introduced to complement the statistics on unemployment. While unemployment represents a situation of total lack of work during the reference period, many other people Slide 8 may have jobs but suffer from partial lack of work. Dr. Edward Asiedu  Some Definitions in the GLSS Work The currently employed group can, therefore, be sub- classified as either in time-related underemployment or not. In operational terms, the time-related underemployed persons are defined as those whose total actual hours of work were less than 35 hours. Dr. Edward Asiedu Slide 9  Some Definitions in the GLSS Work Labour underutilization is a more comprehensive measure than the unemployment rate. In developing countries, the one-hour criterion defining employment leads to lower unemployment rates and complicates the interpretation of employment and unemployment statistics. Labour underutilization consists of that part of the population which has labour slack, low earnings and skill mismatch among the employed population. In other words, the employed population might have time-related underemployment, low pay and skill mismatches which are aspects of labour underutilization. Dr. Edward Asiedu Slide 10  Some Definitions in the GLSS Work Dr. Edward Asiedu Slide 11  Topic Two HOW DOES THE LABOUR MARKET WORK Dr. Edward Asiedu Slide 12  How does the Labour Market Work? Labour economists typically assign motives to the various "actors" in the labour market. We typically view workers, for instance, as trying to find the best possible job and assume that firms are trying to make money. Workers and firms, therefore, enter the labour market with different objective Workers are often trying to sell their labour at the highest price, whereas firms are often trying to buy labour at the lowest price Dr. Edward Asiedu Slide 13  How does the Labour Market Work? The types of economic exchanges that can occur between workers and firms are limited by the set of ground rules that the government has enacted to regulate transactions in the labor market. Changes in these rules and regulations would obviously lead to different outcomes. E.g, a minimum wage outlaws exchanges that pay less than a particular amount per hour worked; occupational safety regulations forbid firms from offering working conditions that are deemed too risky to the worker's health. Dr. Edward Asiedu Slide 14  How does the Labour Market Work? Thus, the deals that are eventually struck between workers and firms determine the types of jobs that are offered, the skills that workers acquire, the extent of labour turnover (people leaving the company), the structure of unemployment in the economy, and the observed earnings distribution. In a nutshell, aside understanding theories of the labour market, how the official unemployment rate is calculated and it's trend, we also want to understand which economic and social factors generate the levels of unemployment, and why Dr. Edward Asiedu Slide 15  Topic Three ACTORS IN THE LABOUR MARKET Dr. Edward Asiedu Slide 16  Actors in the Labour Market Q1: There are two leading actors in the labour market. True/False Workers, firms, and the government. Without workers, there is no "labour" in the labour market. Workers decide whether to work or not, how many hours to work, which skills to acquire, when to quit a job, which occupations to enter, whether to join a labour union, and how much effort to allocate to the job. Dr. Edward Asiedu Slide 17  Actors in the Labour Market Each of these decisions is motivated by the desire to optimize WHAT? Maximize their well-being. This means that persons who want to maximize their well-being will tend to supply more time and more effort to those activities that have a higher payoff. This is why we say the labour supply curve is often upward sloping. Dr. Edward Asiedu Slide 18  Actors in the Labour Market Adding up the decisions of millions of workers generates the economy's labour supply not only in terms of the number of persons who enter the labour market, but also in terms of the quantity and quality of skills available to employers. Dr. Edward Asiedu Slide 19  Actors in the Labour Market Dr. Edward Asiedu Slide 20  Actors in the Labour Market The labour supply curve gives the number of persons who are willing to supply their services to finance/engineering firms at a given wage. For example, 20,000 workers are willing to supply their services to finance/engineering firms if the finance/engineering wage is 1,000ghs per month. If the finance/engineering wage rises to 5,000ghs, then 30,000 workers will choose to be financial analyst/engineers. Dr. Edward Asiedu Slide 21  Actors in the Labour Market More generally, the labour supply curve relates the number of person-hours supplied to the economy to the wage that is being offered. The higher the wage that is being offered, the larger the labor supplied. Slide 22  Actors in the Labour Market Firms Each firm must decide how many and which types of workers to hire and re, the length of the workweek, how much capital to employ, and whether to offer safe working conditions to its workers. Like workers, firms also have motives (profit maximization). Dr. Edward Asiedu Slide 23  Actors in the Labour Market The labour demand curve gives the number of finance analyst/engineers that the firms will hire at different wages. Thus, at higher wages firms are willing to hire less people (demand curve is downward sloping). Adding up the hiring and ring decisions of millions of employers generates the economy's labour demand. Workers and firms, therefore, enter the labour market with conflicting interests. Dr. Edward Asiedu Slide 24  Actors in the Labour Market Many workers are willing to supply their services when the wage is high, but few firms are willing to hire them. Conversely, few workers are willing to supply their services when the wage is low, but many firms are looking for workers. As workers search for jobs and firms search for workers, these conflicting desires are "balanced out" and the labour market reaches an equilibrium. In a free-market economy, equilibrium is attained when supply equals demand. Dr. Edward Asiedu Slide 25  Actors in the Labour Market As drawn in Figure 1 , the equilibrium wage is 1,000ghs and 20,000 finance analyst/engineers will be hired in the labour market. This wage-employment combination is an equilibrium because it balances out the conflicting desires of workers and firms. Suppose, for example, that the finance/engineering wage were 5,000ghs above equilibrium. Dr. Edward Asiedu Slide 26  Actors in the Labour Market Firms would then want to hire only 10,000 finance analyst/ engineers, even though 30,000 finance analyst/ engineers are looking for work. What would happen to the excess labour? The excess number of job applicants would bid down the wage as they compete for the few jobs available. Suppose instead that the wage were 300ghs-below equilibrium Dr. Edward Asiedu Slide 27  Actors in the Labour Market Because workers are cheap, firms want to hire 30,000 workers, but only 10,000 are willing to work at that wage. As firms compete for the few available engineers, they bid up the wage. Dr. Edward Asiedu Slide 28  Actors in the Labour Market Government There is one last major player in the labour market, the government. The government can impose taxes on a worker's earnings, subsidize the training of more workers, impose a payroll tax on firms, and increase the supply of finance analysts/engineers by encouraging increased enrolment in the universities. Dr. Edward Asiedu Slide 29  Actors in the Labour Market All of these actions will change the equilibrium that will eventually be attained in the labour market. The government regulations, therefore, set the ground rules that will guide exchanges in the labour market. What would happen to labour market equilibrium conditions in the fresh pineapple industry if government signs and implements an export agreement between Ghana and Europe for fresh pineapples. Discuss with the aid of graphs. Dr. Edward Asiedu Slide 30  Actors in the Labour Market The agreement will shifted the labour demand curve in the pineapple sector from Do to Dl` resulting in higher wages and employment. If the agreement is canceled after 5years, the demand curve reverted back to its original level and wages and employment will fall. Dr. Edward Asiedu Slide 31  Actors in the Labour Market Dr. Edward Asiedu Slide 32  FINC 407 Labour Economics Session 3 – Labour Supply Lecturer: Dr. Edward Asiedu, UGBS Contact Information: [email protected] College of Education School of Continuing and Distance Education 2017/2018  Session Overview After going through this session, students should be able to explain how preferences of a workers are formed. Know workers utility function and how the concept of marginal utilities impact the hours of work. Knowledge of Indifference Curve (IC) and it properties. Understand how differences in the shape of the IC (steep and flat indifference curves) impacts work decision. Dr. Edward Asiedu Slide 2  Session Outline The key topic to be covered in the session is Labour Supply. More specifically: Workers preferences. Utility functions. The concept of marginal utility. Indifference curve Dr. Edward Asiedu Slide 3  Reading List Borjas, G. J. (2000). Labour economics (Vol. 2). New York: McGraw-Hill. Ehrenberg, R. G., & Smith, R. S. (2016). Modern labour economics: Theory and public policy. Routledge. Kaufman, B.E. and J.L. Hotchkiss (2003). The Economics of Labour Markets, 6th edition, Dryden Press, Fort Worth Dr. Edward Asiedu Slide 4  Topic one LABOUR SUPPLY Dr. Edward Asiedu Slide 5  Labour Supply Worker's preferences: Labour supply decisions can be roughly divided into two categories: Decisions about whether to work at all and, if so, how long to work. The second category of decisions, deals with the questions that must be faced by a person who has decided to seek work for pay: the occupation or general class of occupations in which to seek offers (chapters 8 and 9) and the geographical area in which offers should be sought. Dr. Edward Asiedu Slide 6  Labour Supply Because labour is the most abundant factor of production, any country's well-being in the long run depends heavily on the willingness of its people to work. Majority of economies relies heavily on it’s production of goods and services. Dr. Edward Asiedu Slide 7  Labour Supply Typical framework that economists use to analyze labour supply behavior is commonly called the "neoclassical model of labour-leisure choice. In this framework, individuals seek to maximize their wellbeing by consuming goods (such as food, cars and homes) and leisure. Dr. Edward Asiedu Slide 8  Labour Supply The representative person in the model receives satisfaction both from the consumption of goods (which we denote by “C” and from the consumption of leisure “L”). If we do not work, we can consume a lot of leisure. But we will have to forgo the cars and commodities that make life much more enjoyable. Dr. Edward Asiedu Slide 9  Labour Supply Opportunity Cost of Leisure: The cost of spending an hour watching television is basically what one could earn if one had spent that hour working. Thus, the opportunity cost of an hour of leisure is equal to one's wage rate; the extra earnings a worker can take home from an extra hour of work. The idea that individuals get satisfaction from consuming goods and leisure is summarized by the utility function: U = f (C, L) Dr. Edward Asiedu Slide 10  Labour Supply The utility function transforms the person's consumption of goods and leisure into an index “U” that measures the individual's level of satisfaction or happiness. This index is called utility. The higher the level of index U, the happier the person. If we take the prices of goods as fixed, then they can be compressed into one index that is measured by money income (with prices fixed, more money income means. Dr. Edward Asiedu Slide 11  Labour Supply Since both leisure and money can be used to generate satisfaction (or utility), these two goods are to some extent substitutes for each other. If forced to give up some money income - by cutting back on hours of work, for example - some increase in leisure time could be substituted for this lost income to keep a person as happy as before. Slide 12 Dr. Edward Asiedu  Labour Supply Suppose a thoughtful consumer/worker were asked to decide how happy he or she would be with a weakly income of 64Ghs combined with 8 hours of leisure (point ‘a’ in Figure 6.2). Slide 13 Dr. Edward Asiedu  Labour Supply This level of happiness could be called utility level A. Our consumer/worker could name other combinations of money income (consumption) and leisure hours that would also yield utility level A. Assume that our respondent named five other combinations. All six combinations of money income and leisure hours that yield utility level A are represented by heavy dots in the Figure. The model of labor-leisure choice isolates the person's wage rate and income as the key economic variables that guide the allocation of time between the labor market and leisure activities Dr. Edward Asiedu Slide 14  Labour Supply Dr. Edward Asiedu Slide 15  Labour Supply Our worker/consumer could achieve a higher level of happiness if he or she could combines the 8 hours of leisure with an income of 100ghs per week (see graph). The curve connecting these dots is called an indifference curve, which connects the various combinations of money income (consumption) and leisure that yield equal utility. Dr. Edward Asiedu Slide 16  Labour Supply Utility and Indifference Curve Slide 17 Dr. Edward Asiedu  Labour Supply As a result, the utility function can be represented graphically in terms of a family (or a "map") of indifference curves. Indifference curves have a number of important properties:  Indifference curves are downward sloping.  Higher indifference curves indicate higher levels of utility.  Indifference curves are convex to the origin.  Indifference curves do not intersect. Dr. Edward Asiedu Slide 18  Labour Supply Dr. Edward Asiedu Slide 19  Labour Supply Some basic definitions` What happens to a person's utility as she allocates one more hour to leisure or buys an additional dollar's worth of goods? The marginal utility of leisure is defined as the change in utility from an additional hour devoted to leisure activities, holding constant the amount of goods consumed. Dr. Edward Asiedu Slide 20  Labour Supply Dr. Edward Asiedu Slide 21  Labour Supply Dr. Edward Asiedu Slide 22  Labour Supply Dr. Edward Asiedu Slide 23  Labour Supply Differences in Preferences Across Workers The map of the indifference curve presented illustrates the way a particular worker values the trade-o between leisure and consumption. Different workers will typically value this trade-off differently. In other words, some persons may like to devote a great deal of time and effort to their jobs, whereas other persons would prefer to devote most of their time to leisure. Dr. Edward Asiedu Slide 24  Labour Supply These interpersonal differences in preferences imply that the indifference curve maps may look quite different for different workers Figure below shows the indifference maps for two workers, Ama and Adwoa. Dr. Edward Asiedu Slide 25  Labour Supply Dr. Edward Asiedu Slide 26  Labour Supply Ama's indifference curves tend to be very steep...... indicating that her marginal rate of substitution takes on a very high value....... In other words, she requires a sizable monetary bribe (in terms of additional consumption) to convince her to give up an additional hour of leisure. Slide 27  Labour Supply Adwoa, on the other hand, has relatively at indifference curves, indicating that her marginal rate of substitution takes on a low value.........Adwoa, therefore, does not require a large bribe to convince her to give up an additional hour of work. Slide 28  Labour Supply Q3: Based on the IC of the two workers, we can say that Adwoa likes leisure more than Ama. True/False Dr. Edward Asiedu Slide 29  Labour Supply These interpersonal differences in the "tastes for work" are obviously important determinants of a person's labour supply decision. Workers who like leisure a lot (Ama) will tend to work few hours. And workers who do not attach a high value to their leisure time (like Adwoa) will tend to be workaholics Dr. Edward Asiedu Slide 30  FINC 407 Labour Economics Session 4 – Labour Supply Lecturer: Dr. Edward Asiedu, UGBS Contact Information: [email protected] College of Education Department of Distance Education 2017/2018  Session Overview After going through this session, students should be able To derive the worker’s budget constraint. Graph the budget line of the worker. Be able to explain and graph the tangency condition. Be able to explain the impact of changes in non-labour income on hours of work (paying attention to the graphical illustrations) Dr. Edward Asiedu Slide 2  Session Outline The key topic to be covered in the session is Labour Supply. More specifically: The budget constraint of a “typical worker”. Hours of work decisions. What happens to hours of work when non-labour income changes. Dr. Edward Asiedu Slide 3  Reading List Borjas, G. J. (2000). Labour economics (Vol. 2). New York: McGraw-Hill. Ehrenberg, R. G., & Smith, R. S. (2016). Modern labour economics: Theory and public policy. Routledge. Kaufman, B.E. and J.L. Hotchkiss (2003). The Economics of Labour Markets, 6th edition, Dryden Press, Fort Worth Dr Edward Asiedu Slide 4  Topic one THE BUDGET CONSTRAINT Dr. Edward Asiedu Slide 5  Labour Supply The Budget Constraint The worker's consumption of goods and leisure are constrained by her time and by her income. Part of the person's income (such as property income, dividends, lottery prizes, unconditional cash transfers) is independent of how many hours she works. We denote this "non labour income" by V. Dr. Edward Asiedu Slide 6  Labour Supply The Budget Constraint Let “h” be the number of hours the person will allocate to the labor market during the period, and “w” be the hourly wage rate. Thus, the value of expenditures on goods (C) must equal the sum of labour earnings (wh) and non- labour income (V). Dr. Edward Asiedu Slide 7  Labour Supply The person's budget constraint can be written as: C = wH +v................. (1) We assume that the wage rate is constant, so the person receives the same hourly wage regardless of how many hours she works. In this model, the person has two alterative uses for her time: work or leisure. Dr. Edward Asiedu Slide 8  Labour Supply The total time allocated to each of these activities must be equal to the total time available in the period, say T hours per week, so that T = h + L. The person's budget constraint can be rewritten (from equation1) as: C = w(T - L) + v.......................(2) C = (wT + v) - wL......................(3) This last equation is in the form of a line, and the slope is the negative of the wage rate (or -w). The budget line is illustrated by the Figure below: Dr. Edward Asiedu Slide 9  Labour Supply Dr. Edward Asiedu Slide 10  Labour Supply Point E in the graph indicates that if the person decides not to work at all and devotes T hours to leisure activities, she can still purchase V cedis worth of consumption goods. Point E will be called the endowment point. If the person is willing to give up 1 hour of leisure, she can then move up the budget line and purchase an additional w cedis worth of goods. Each hour of leisure has a price, and the price is given by the wage rate. Dr. Edward Asiedu Slide 11  Labour Supply If the worker gives up all her leisure activities, she ends up at the intercept of the budget line and can buy (wT+ V) cedis worth of goods. Slide 12 Dr. Edward Asiedu  Labour Supply Q1: The consumption and leisure bundles that lie below the budget line are available to the worker; the bundles that lie above the budget line are not available to the worker. True/False Q2: Point E (endowment point), tells the person how much she can consume if she does not enter the labor market. True/False Q3: The absolute value of the slope of the budget line is the interest rate. True/False Dr. Edward Asiedu Slide 13  Topic Two THE HOURS OF WORK DECISION Dr. Edward Asiedu Slide 14  Labour Supply The Hours-Of-Work Decision We make one important assumption about the person’s behavior: she wishes to choose the particular combination of goods and leisure that maximizes her utility. This means that the person will choose the level of goods consumption and leisure activities that lead to the highest possible level of the utility index U-given the limitations imposed by the budget constraint. Dr. Edward Asiedu Slide 15  Labour Supply If a worker has 100 Ghc of non labor income per week, faces a market wage rate of 10 Ghc per hour, and has 110 hours of nonsleeping hours time to allocate between work and leisure activities (assuming she sleeps roughly 8 hours per day). Graph the budget line for the worker. Dr. Edward Asiedu Slide 16  Labour Supply Hours of Work Decision Slide 17  Labour Supply Slide 18 Dr. Edward Asiedu  Labour Supply At the chosen level of consumption and leisure, therefore, the marginal rate of substitution (the rate at which a person is willing to give up leisure hours in exchange for additional consumption) equals the wage rate (the rate at which the market is willing to let the worker substitute 1 hour of leisure time for consumption) Dr. Edward Asiedu Slide 19  Topic Three WHAT HAPPENS TO HOURS OF WORK WHEN NON LABOUR INCOME CHANGES Dr. Edward Asiedu Slide 20  Labour Supply What Happens to Hours of Work When Non labour Income Changes? The increase in V might be caused by the payment of higher dividends on the worker's stock portfolio or perhaps because some distant relatives named the worker as the beneficiary in their wills. Dr. Edward Asiedu Slide 21  Labour Supply Slide 22 Dr. Edward Asiedu  Labour Supply Illustrates what happens to hours of work when the worker has an increase in V holding the wage constant. The impact of the change in non labour income (holding wages constant) on the number of hours worked is called an income effect. As indicated earlier however, we assume leisure to be a normal good. The income effect, therefore, implies that an increase in non labour income, holding the wage rate constant, reduces hours of work. Slide 23 Dr. Edward Asiedu  FINC 407 Labour Economics Session 5 – Labour Supply Lecturer: Dr. Edward Asiedu, UGBS Contact Information: [email protected] College of Education Department of Distance Education 2017/2018  Session Overview By the end of this session students should be able to: Explain the impact of wage change on hours of work. Tell when a worker should enter the labour market. Calculate the elasticity of labour supply. Explain the backward bending labour supply curve. Dr. Edward Asiedu Slide 2  Session Outline The key topic to be covered in the session is Labour Supply: More specifically: What happens to hours of work when wage changes? To work or not to work? The backward bending labour supply curve. Elasticity of labour supply. Dr. Edward Asiedu Slide 3  Reading List Borjas, G. J. (2000). Labour economics (Vol. 2). New York: McGraw-Hill. Ehrenberg, R. G., & Smith, R. S. (2016). Modern labour economics: Theory and public policy. Routledge. Kaufman, B.E. and J.L. Hotchkiss (2003). The Economics of Labour Markets, 6th edition, Dryden Press, Fort Worth Dr Edward Asiedu Slide 4  Topic one WHAT HAPPENS TO HOURS OF WORK WHEN WAGE CHANGES Dr. Edward Asiedu Slide 5  Labour Supply What Happens to Hours of Work When the Wage Changes? Consider a wage increase from 10 to 20ghs an hour, holding non labour income V constant. The wage increase rotates the budget line around the endowment point E, as illustrated. The rotation of the budget line shifts the opportunity set from FE to GE. Dr. Edward Asiedu Slide 6  Labour Supply Dr. Edward Asiedu Slide 7  Labour Supply The two panels presented in Figure 2-8 illustrate the possible effects of a wage increase on hours of work. In Figure a, the wage increase shifts the optimal consumption bundle from point P to point R. At the new equilibrium, the individual consumes more leisure (the increase is from 70 to 75 hours), so that hours of work fall from 40 to 35 hours. Dr. Edward Asiedu Slide 8  Labour Supply Figure b, however, illustrates the opposite result. The wage increase again moves the worker to a higher indifference curve and shifts the optimal consumption bundle from point P to point R. This time, however, the wage increase reduces leisure hours (from 70 to 65 hours); so the length of the workweek increases from 40 to 45 hours. It seems, therefore, that the effect of wage increase is ambiguous prediction without making more assumptions. Dr. Edward Asiedu Slide 9  Labour Supply Both panels in show that regardless of what happens to hours of work, a wage increase expands the worker's opportunity set. Put differently, a worker has more opportunities when she makes 20ghs an hour than when she makes 10ghs an hour. We know that an increase in income increases the demand for all normal goods, including leisure. The increase in the wage thus increases the demand for leisure, which reduces hours of work. The increase in the wage thus increases the demand for leisure, which reduces hours of work. Dr. Edward Asiedu Slide 10  Labour Supply But this is not all that happens. The wage increase also makes leisure more expensive. When the worker earns 20ghs an hour, she is giving up 20ghs every time she devotes an hour to leisure activities. As a result, leisure time is a very expensive commodity for high-wage workers and a relatively cheap commodity for low-wage workers. High wage workers, therefore, have strong incentives to cut back on their consumption of leisure activities. A wage increase thus reduces the demand for leisure and increases hours of work. Slide 11 Dr. Edward Asiedu  Labour Supply This discussion highlights the essential reason for the ambiguity in the relation between hours of work and the wage rate. A high-wage worker wants to enjoy the rewards of her high income, and hence would like to consume more leisure. The same worker, however, finds that leisure is expensive and that she simply cannot afford to take time o from work. Dr. Edward Asiedu Slide 12  Labour Supply It is instructive to think of the move from point P to point R as a two-stage move. The two stages correspond exactly to our discussion that the wage increase generates two effects: it increases the worker's income and it raises the price of leisure. To isolate the income effect, suppose we draw a budget line that is parallel to the old budget line but tangent to the new indifference curve. This budget line generates a new tangency point Q. Dr. Edward Asiedu Slide 13  Labour Supply The move from initial position P to final position R can be decomposed into a first-stage move from P to Q, and a second-stage move from Q to R. It is easy to see that the move from point P to point Q is an income effect. The second-stage move from Q to R is called the substitution effect. It illustrates what happens to the optimal consumption bundle as the wage increases, holding utility constant. Dr. Edward Asiedu Slide 14  Labour Supply By moving along an indifference curve, the worker's utility is held fixed. The substitution effect thus isolates the impact of the increase in the price of leisure on hours of work, holding utility or real income constant. The move from point Q to point R generates a substitution away from leisure time and toward consumption of other goods. Slide 15  Labour Supply Slide 16 Dr. Edward Asiedu  Labour Supply As the wage rises, people have a larger opportunity set and the income effect increases the demand for leisure and decreases labour supply. As the wage rises, however, leisure becomes more expensive, and the substitution effect generates incentives for workers to switch from the consumption of leisure to other types of consumption activities. This shift frees up leisure hours and thus increases hours of work. Dr. Edward Asiedu Slide 17  Labour Supply To summarize the relation between hours of work and the wage rate: An increase in the wage rate increases hours of work if the substitution effect dominates the income effect. An increase in the wage rate decreases hours of work if the income effect dominates the substitution effect. Dr. Edward Asiedu Slide 18  Topic Two TO WORK OR NOT TO WORK? Dr. Edward Asiedu Slide 19  Labour Supply Our analysis of the relationship between non-labour income, the wage rate, and hours of work assumed that the person worked both before and after the change in nonlabor income or the wage. But what factors motivate a person to enter the labour force in the first place? Slide 20 Dr. Edward Asiedu  Labour Supply Slide 21 Dr. Edward Asiedu  Labour Supply Suppose initially that the person's wage rate is given by w-low so that the woman faces budget line GE. No point on this budget line can give her more utility than Va. At this low wage, the person's opportunities are quite meager. If the worker were to move from the endowment point E to any point on the budget line GE, she would be moving to a lower indifference curve. For example, at point X the woman gets only VG utils. At wage `w- low' therefore, the woman chooses not to work Dr. Edward Asiedu Slide 22  Labour Supply In contrast, suppose that the wage rate was given by `w-high’ so that the woman faces budget line HE. It is easy to see that there are many points on this higher budget line that would allow the worker to increase her utility. For example, at point Y the woman gets VH utils. At the wage `w-high' therefore, the woman would be better off working. Dr. Edward Asiedu Slide 23  Labour Supply In sum, the analysis reveals that the woman does not enter the labour market at low wage rates (such as w- low) but does enter the labor market at high wage rates (such as w-high). As we rotate the budget line from wage `w-low' to wage `w-high' we will typically encounter a wage rate, call it , that makes her indifferent between working and not working. We call the wage the reservation wage. Dr. Edward Asiedu Slide 24  Labour Supply The reservation wage gives the minimum increase in income that would make a person indifferent between remaining at the endowment point E and working that first hour. In the Figure, the reservation wage is given by the absolute value of the slope of the indifference curve at point E. Dr. Edward Asiedu Slide 25  Labour Supply The reservation wage has one important property. The person will not work at all if the market wage is less than the reservation wage; and the person will enter the labour market if the market wage exceeds the reservation wage. The decision to work, therefore, is based on a comparison of the market wage (which indicates how much employers are willing to pay for an hour of work) and the reservation wage (which indicates how much the worker requires to be bribed into working that first hour). Dr. Edward Asiedu Slide 26  Labour Supply This implies that a high reservation wage makes it less likely that a person will enter the labour force. The reservation wage will typically depend on the person’s tastes for work, which, as we have seen, determine the slope of the indifference curve, as well on many other factors. Dr. Edward Asiedu Slide 27  Labour Supply For instance, the assumption that leisure is a normal good implies that a higher level of non labour income increases the reservation wage, making it less likely that a person will participate in the labour force. Q4: Hours of work will be zero for any wage below the reservation wage. True/False Dr. Edward Asiedu Slide 28  Topic Thee THE BACKWARD BENDING LABOUR SUPPLY CURVE Dr. Edward Asiedu Slide 29  Labour Supply Dr. Edward Asiedu Slide 30  Labour Supply Dr. Edward Asiedu Slide 31  Labour Supply Dr. Edward Asiedu Slide 32  Labour Supply The labour supply elasticity gives the percentage change in hours of work associated with a 1 percent change in the wage rate. The sign of the labour supply elasticity depends on whether the labour supply curve is upward sloping (Dh/Dw > 0) or downward sloping (Dh/Dw < 0), and hence is positive when substitution effects dominate and negative when income effects dominate. Dr. Edward Asiedu Slide 33  Labour Supply Dr. Edward Asiedu Slide 34  Labour Supply When the labour supply elasticity is less than one in absolute value, the labour supply curve is said to be inelastic. If the labour supply elasticity is greater than one in absolute value (indicating that hours of work are greatly affected by the change in the wage) the labour supply curve is said to be elastic. Q5: From our example, is labour supply elastic or inelastic? Dr. Edward Asiedu Slide 35  FINC 407 Labour Economics Session 6 – Labour Demand Lecturer: Dr. Edward Asiedu, UGBS Contact Information: [email protected] College of Education Department of Distance Education 2017/2018  Session Overview By the end of this session students should be able to: Identify a production function. Calculate and distinguish between marginal and average products, value of marginal and average products. Determine the profit maximizing level of employment of a firm. Dr. Edward Asiedu Slide 2  Session Outline The key topic to be covered in the session is Labour demand: More specifically: Employer’s decision. The production function. Profit maximization. Th profit maximizing employment level. Dr. Edward Asiedu Slide 3  Reading List Borjas, G. J. (2000). Labour economics (Vol. 2). New York: McGraw-Hill. Ehrenberg, R. G., & Smith, R. S. (2016). Modern labour economics: Theory and public policy. Routledge. Kaufman, B.E. and J.L. Hotchkiss (2003). The Economics of Labour Markets, 6th edition, Dryden Press, Fort Worth Dr Edward Asiedu Slide 4  Topic one LABOUR DEMAND: EMPLOYER’S DECISION Dr. Edward Asiedu Slide 5  Labour Demand Employer's Decisions Labour market outcomes, depend not only on the willingness of workers to supply their time to work activities, but also on the willingness of firms to hire those workers. We now turn, to a discussion of on labour demand. The hiring and ring decisions made by firms create and destroy many jobs at any time Dr. Edward Asiedu Slide 6  Labour Demand Our analysis of labour demand begins by recognizing that firms do not hire workers simply because employers want to see "bodies" filling in various spots in the firm. Rather, firms hire workers because consumers want to purchase a variety of goods and services. Dr. Edward Asiedu Slide 7  Labour Demand In effect, firms are the "middlemen" that hire workers to produce those goods and services. The firm's labor demand-just like the firm's demand for other inputs in the production process, such as land, buildings, and machines-is a "derived demand," derived from the wants and desires of consumers Dr. Edward Asiedu Slide 8  Topic one LABOUR DEMAND: PRODUCTION FUNCTION Dr. Edward Asiedu Slide 9  Labour Demand Production Function We begin the study of labour demand by specifying the firm’s production function. The production function describes the technology that the firm uses to produce goods and services. For simplicity, we will initially assume that there are only two factors of production: the number of employee hours hired by the firm (E) and capital (K) the aggregate stock of land machines, and other physical inputs. Dr. Edward Asiedu Slide 10  Labour Demand We write the production function as: q = f(E, K) where q is the firm's output. We will simply refer to the labor input "E' as the number of workers hired by the firm. Dr. Edward Asiedu Slide 11  Labour Demand Slide 12 Dr. Edward Asiedu  Labour Demand Dr. Edward Asiedu Slide 13  Labour Demand Dr. Edward Asiedu Slide 14  Labour Demand Figure below graphs the data in our example -the shape of the production function. Figure 4-1a illustrates the total product curve. This curve describes what happens to output as the firm hires more workers. The total product curve is obviously upward sloping. The marginal product of labour is the slope of the total product curve-that is, the rate of change in output as more workers are hired. Dr. Edward Asiedu Slide 15 Labour Demand Slide 16  Labour Demand In our numerical example, output first rises at an increasing rate as more workers are hired. This implies that the marginal product of labour is rising, perhaps because of the initial gains resulting from assigning workers to specific tasks. Eventually, output increases at a decreasing rate. In other words, the marginal product of labour begins to decline, so the next worker hired adds less to the firm's output than a previously hired worker. Slide 17 Dr. Edward Asiedu  Labour Demand In our example, the marginal product of the third worker hired is 20 units, but the marginal product of the fourth worker is 19 units, and that of the fifth worker declines further to 17 units. The assumption that the marginal product of labour eventually declines follows from the law of diminishing returns. Recall that the marginal product of labour is defined in terms of a fixed level of capital. The first few workers hired may increase output substantially because the workers can specialize in narrowly defined tasks. Dr. Edward Asiedu Slide 18  Labour Demand As more and more workers are added to a fixed capital stock (that is, to a fixed number of machines and a fixed amount of land), the gains from specialization decline and the marginal product of workers declines. We can also define the average product of labour (or APE) as the amount of output produced by the typical worker. This quantity is defined by APE = q/E. Dr. Edward Asiedu Slide 19  Topic Two LABOUR DEMAND: PROFIT MAXIMIZATION Dr. Edward Asiedu Slide 20  Labour Demand Profit Maximization To analyze the hiring decisions made by the firm, we make an assumption about the firm's behavior. In particular, the firm’s objective is to maximize its profits. Slide 21 Dr. Edward Asiedu  Labour Demand Profit Maximization The firm's profits are given by: profit = pq - wE - rK q is the output; w is the wage rate (that is, the cost of hiring an additional worker); and r is the price of capital; where p is the price at which the firm can sell its output. Slide 22 Dr. Edward Asiedu  Labour Demand Slide 23 Dr. Edward Asiedu  Labour Demand The value of the marginal product of labour is the increase in revenue generated by an additional worker-holding capital constant. Suppose the price of the output equals 2ghs. The eighth worker hired would then contribute 22ghs to the firm’s revenue. Dr. Edward Asiedu Slide 24  Labour Demand Dr. Edward Asiedu Slide 25  Topic Three LABOUR DEMAND: HOW MANY WORKERS SHOULD A FIRM HIRE? Dr. Edward Asiedu Slide 26  Labour Demand How Many Workers Should the Firm Hire? Firm's employment is at the point where the value of marginal product of labour equals the wage rate and the value of marginal produfct curve is downward sloping. VMPE = W................... and VMPE is declining In other words, at the point where the firm maximizes profits, the marginal gain from hiring an additional worker equals the cost of that hire, and it does not pay to further expand the firm because the value of hiring more workers is falling. Dr. Edward Asiedu Slide 27  Labour Demand The intuition for this result is as follows: Suppose the firm decides to hire only six workers. If the firm hired the seventh worker, it would get more in additional revenues than it would cost to hire that worker (the value of marginal product of the seventh worker is Ghc26 and the wage is only Ghc22). A profit-maximizing firm, therefore, will want to expand and hire more labour. If the firm were to hire more than eight workers, however, the value of marginal product is lower than the cost of the hire. Dr. Edward Asiedu Slide 28  Labour Demand Dr. Edward Asiedu Slide 29  Labour Demand Note that the figure also indicates that the wage would equal the value of marginal product if the firm hired just one worker. At that point, however, the value of marginal product curve is upward sloping. If the firm hired another worker, the second worker hired would contribute even more to the firm's revenue than the first worker. Dr. Edward Asiedu Slide 30  FINC 407 Labour Economics Session 7 – Labour Demand Lecturer: Dr. Edward Asiedu, UGBS Contact Information: [email protected] College of Education Department of Distance Education 2017/2018  Session Overview By the end of this session students should be able to: Graph and explain the short run labour demand curve. Explain the properties of an isoquant. Draw an isocost and isoquant. Determine the long and short run profit maximizing conditions of a firm. Explain the dynamics of equilibrium conditions in the labour market. Dr. Edward Asiedu Slide 2  Session Outline The key topic to be covered in the session is Labour demand: More specifically: The short run labour demand curve. Long run employment decision. Equilibrium in the labour market. Dr. Edward Asiedu Slide 3  Reading List Borjas, G. J. (2000). Labour economics (Vol. 2). New York: McGraw-Hill. Ehrenberg, R. G., & Smith, R. S. (2016). Modern labour economics: Theory and public policy. Routledge. Kaufman, B.E. and J.L. Hotchkiss (2003). The Economics of Labour Markets, 6th edition, Dryden Press, Fort Worth Dr Edward Asiedu Slide 4  Topic One LABOUR DEMAND: THE SHORT RUN LABOUR DEMAND CURVE FOR A FIRM Dr. Edward Asiedu Slide 5  Labour Demand Dr. Edward Asiedu Slide 6  Labour Demand The position of the labour demand curve depends on the price of the output. Q1. What happens to the labour demand curve when output becomes expensive? Dr. Edward Asiedu Slide 7  Labour Demand Dr. Edward Asiedu Slide 8  Labour Demand The short-run demand curve shifts up if the output becomes more expensive. If the wage were 22ghs, the increase in output price raises the firm's employment from 8 to 12 workers. Therefore, there is a positive relationship between short-run employment and output price. We use an elasticity to measure the responsiveness of labour demand in the industry to changes in the wage rate. Dr. Edward Asiedu Slide 9  Labour Demand Dr. Edward Asiedu Slide 10  Topic Two LABOUR DEMAND: EMPLOYMENT DECISION IN THE LONG RUN Dr. Edward Asiedu Slide 11  Labour Demand Employment decision in the long-run In the long run, the firm's capital stock is not fixed. The firm can expand or shrink its plant size and equipment. Therefore, in the long run the firm maximizes profits by choosing both how many workers to hire and how much plant and equipment to invest in. An isoquant describes the possible combinations of labour and capital that produce the same level of output. Dr. Edward Asiedu Slide 12  Labour Demand Slide 13 Dr. Edward Asiedu  Labour Demand The isoquant, therefore, describes the production function in exactly the same way that indifference curves describe a worker's utility function. Dr. Edward Asiedu Slide 14  Labour Demand Dr. Edward Asiedu Slide 15  Labour Demand Dr. Edward Asiedu Slide 16  Labour Demand Isocosts The firm's costs of production, which we denote by C, are given by; C = wE + rK The line connecting all the various combinations of labor and capital that the rm could hire with a cost outlay of C cedis is called an isocost line. Let's draw the isocost line. Slide 17  Labour Demand Slide 18 Dr. Edward Asiedu  Labour Demand Dr. Edward Asiedu Slide 19  Labour Demand Dr. Edward Asiedu Slide 20  Labour Demand Slide 21 Dr. Edward Asiedu  Labour Market Equilibrium Note that the figure also indicates that the wage would equal the value of marginal product if the firm hired just one worker. At that point, however, the value of marginal product curve is upward sloping. If the firm hired another worker, the second worker hired would contribute even more to the firm's revenue than the first worker. Dr. Edward Asiedu Slide 22  Labour Demand Slide 23 Dr. Edward Asiedu  Labour Demand Dr. Edward Asiedu Slide 24  Labour Demand Dr. Edward Asiedu Slide 25  Labour Demand The elasticity of substitution gives the percentage change in the capital-labor ratio resulting from a 1 percent change in the relative price of labor. As the relative price of labor increases, the substitution effect tells us that the capital-labor ratio increases (that is, the firm gets rid of labor and replaces it with capital). Dr. Edward Asiedu Slide 26  Topic Thee EQILIBRIUM IN THE LABOUR MARKET Dr. Edward Asiedu Slide 27  Labour Market Equilibrium Dr. Edward Asiedu Slide 28  Labour Market Equilibrium Dr. Edward Asiedu Slide 29  FINC 407 Labour Economics Session 8– Compensating wage differential and Human Capital Lecturer: Dr. Edward Asiedu, UGBS Contact Information: [email protected] College of Education Department of Distance Education 2017/2018  Session Overview By the end of this session students should be able to: Explain the theory of compensating wage differential. The concept of human capital (finding the present value of future income Dr. Edward Asiedu Slide 2  Session Outline The key topics to be covered in the session are : Compensating wage differential. Human capital Dr. Edward Asiedu Slide 3  Reading List Borjas, G. J. (2000). Labour economics (Vol. 2). New York: McGraw-Hill. Ehrenberg, R. G., & Smith, R. S. (2016). Modern labour economics: Theory and public policy. Routledge. Kaufman, B.E. and J.L. Hotchkiss (2003). The Economics of Labour Markets, 6th edition, Dryden Press, Fort Worth Dr Edward Asiedu Slide 4  Topic One COMPENSATING WAGE DIFFERENCIAL Dr. Edward Asiedu Slide 5  Compensating Wage Differential The model of competitive labour markets that we developed in the last chapter implies that as long as workers or firms can freely enter and exit the marketplace, there will be a single wage in the economy if all jobs are alike and all workers are alike. It is obviously the case that the labour market is not characterized by a single wage: workers are different and jobs are different. Workers differ in their skills. And jobs differ in the amenities they offer. Dr. Edward Asiedu Slide 6  Compensating Wage Differential Firms that have unpleasant working conditions must offer some offsetting advantage (such as a higher wage) in order to attract workers; firms that offer pleasant working conditions can get away with paying lower wage rates. Dr. Edward Asiedu Slide 7  Compensating Wage Differential Compensating wage differentials arise to compensate workers for the nonwage characteristics of jobs. Workers differ in their preferences for job characteristics, and firms differ in the working conditions they offer. Dr. Edward Asiedu Slide 8  Compensating Wage Differential The Market for Risky Jobs Suppose there are only two types of jobs in the labour market. Some jobs offer a completely safe environment, and the probability of injury in these jobs is equal to zero. Other jobs offer an inherently risky environment, and the probability of injury in those jobs is equal to one. Dr. Edward Asiedu Slide 9  Compensating Wage Differential We will assume that the worker has complete information about the risk level associated with every job. In other words, the worker knows whether she is employed in a safe job or a risky job. Workers care about whether they work in a risky job or a safe job. And they also care about the wage (w) they earn on the job. We can then write the worker's utility function as: Utility = f(w, risk of injury on the job) Dr. Edward Asiedu Slide 10  Compensating Wage Differential The marginal utility of income gives the change in utility resulting from a Ghc1 increase in the worker's income, holding constant the risk on the job. We assume that workers prefer higher wages so that the marginal utility of income is positive. The marginal utility of risk gives the change in utility resulting from a one-unit change in the probability of injury, holding constant the worker's income. Dr. Edward Asiedu Slide 11  Compensating Wage Differential We assume initially that risk is a "bad" so that the marginal utility of risk is negative. Suppose the "safe job" (that is, the job where workers do not get injured) offers a wage rate of Wo cedis. Figure 6-1 illustrates the worker's indifference curve (Uo) that goes through the point summarizing the "employment package" offered by the safe job. Slide 12 Dr. Edward Asiedu  Compensating Wage Differential At point P the worker gets a wage of Wo and has a zero probability of injury. The indifference curves that describe a worker's choices between income and risk of injury are upward sloping because risk is a “bad”. Suppose that the worker is currently at point P in the indifference curve. Dr. Edward Asiedu Slide 13  Compensating Wage Differential The only way to persuade the worker to move to the riskier job and hold her utility constant is by increasing her wage. She would obviously be worse o if she moved to a riskier job and her wage fell. The curvature of the indifference curve reflects the usual assumption that indifference curves are convex. Dr. Edward Asiedu Slide 14  Compensating Wage Differential Dr. Edward Asiedu Slide 15 Compensating Wage Differential Slide 16  Compensating Wage Differential We defend the worker's reservation price as the amount of money it would take to bribe her into the accepting the risky job - - - or the difference Dw^ = w^1- w0. If the worker’s income were to increase by D^ w dollars as she switched from the safe job to the risky job, she would be indifferent about being exposed to the additional risk. The reservation price , therefore, is the worker’s answer to the old-age question, “How much would it take for you to do something that you would rather not do?” Slide 17 Dr. Edward Asiedu  Compensating Wage Differential We define the worker's reservation price as the amount of money it would take to bribe her into accepting the risky job--or the difference aw = WI - wo0. If the worker's income were to increase by aw dollars as she switched from the safe job to the risky job, she would be indifferent about being exposed to the additional risk. The reservation price, therefore, is the worker's answer to the age-old question, "How much would it take for you to do something that you would rather not do?" Dr. Edward Asiedu Slide 18  Topic Two HUMAN CAPITAL Dr. Edward Asiedu Slide 19  Human Capital The theory of compensating differentials suggests that wages will vary among workers because jobs are different. Wages will also vary among workers because workers are different. We each bring into the labor market a unique set of abilities and acquired skills, or human capital. For instance, some persons learn how to be research biologists while other persons lea how to be musicians. Dr. Edward Asiedu Slide 20  Human Capital Under this chapter we will discuss how we choose the particular set of skills that we offer to employers and how our choices affect the evolution of earnings over the working life. We acquire most of our human capital in school and in formal and informal on the-job training programs. The skills we acquire in school make up an increasingly important component of our stock of knowledge. Slide 21 Dr. Edward Asiedu  Human Capital This chapter analyzes why some workers obtain a lot of schooling and other workers drop out at an early age. Workers who invest in schooling are willing to give up earnings today in return for higher earnings in the future. For example, we earn a relatively low wage while we attend college or participate in a formal apprenticeship program. Slide 22 Dr. Edward Asiedu  Human Capital However, we expect to be rewarded by higher earnings later on as we collect the returns to our investment. We will also discuss if the money spent on education is a good investment. In particular, how does the rate of return to schooling compare with the rate of return on other investments? Dr. Edward Asiedu Slide 23  Human Capital Present Value Any study of an investment decision-whether it is an investment in physical or in human capital-must contrast expenditures and receipts incurred at different time periods. In other words, an investor must be able to calculate the returns to the investment by comparing the current costs with the future returns. Dr. Edward Asiedu Slide 24  Human Capital For reasons that will become obvious momentarily, however, the value of a dollar received today is not quite the same as the value of a dollar received tomorrow. The widely used notion of present value allows us to compare cedis amounts spent and received in different time periods. Suppose somebody gives you a choice between two monetary offers: You can either have 100ghs today or 100ghs next year. Which offer would you take? Dr. Edward Asiedu Slide 25  Human Capital A little reflection should convince you that 100ghs today is better than 100ghs next year. After all, if you receive 100ghs today, you can invest it, and you will then have 100 X (1 + 0.05) Ghc next year (or Ghc105), assuming that the rate of interest is 5%. Note, that receiving 95.24ghs today (or 100Ghc /1.05) would be worth 100Ghc next year. Dr. Edward Asiedu Slide 26  Human Capital Dr. Edward Asiedu Slide 27  Human Capital In effect, a future payment of y Ghana cedi is discounted so as to make it comparable to current cedis. The discussion clearly suggests that receiving y Ghc2 years from now is not equivalent to receiving y Ghc today or even to receiving y Ghc next year. Dr. Edward Asiedu Slide 28  Human Capital Dr. Edward Asiedu Slide 29  FINC 407 Labour Economics Session 9– Human Capital and Labour Mobility Lecturer: Dr. Edward Asiedu, UGBS Contact Information: [email protected] College of Education Department of Distance Education 2017/2018  Session Overview By the end of this session students should be able to: Understand the schooling model. Understand the wage gap among workers with different level of education. Understand the stopping rule of education. Examine the migration decision of family. Dr. Edward Asiedu Slide 2  Session Outline The key topics to be covered in the session are : Human capital (Schooling model) Labour mobility Dr. Edward Asiedu Slide 3  Reading List Borjas, G. J. (2000). Labour economics (Vol. 2). New York: McGraw-Hill. Ehrenberg, R. G., & Smith, R. S. (2016). Modern labour economics: Theory and public policy. Routledge. Kaufman, B.E. and J.L. Hotchkiss (2003). The Economics of Labour Markets, 6th edition, Dryden Press, Fort Worth Dr Edward Asiedu Slide 4  Topic One HUMAN CAPITAL: THE SCHOOLING MODEL Dr. Edward Asiedu Slide 5  Human Capital – The Schooling Model What factors motivate some workers to remain in school while other workers drop out before they finish high school? We begin our analysis of this important question by assuming that workers acquire the skill level that maximizes the present value of lifetime earnings. Dr. Edward Asiedu Slide 6  Human Capital – The Schooling Model Consider the situation faced by an 18-year-old female who has just received his high school cert and who is contemplating whether to enter the labor market or attend college and delay labour market entry by an additional 4 years? Suppose that there is no on-the-job training and that the skills learned in school do not depreciate over time. Dr. Edward Asiedu Slide 7  Human Capital – The Schooling Model These assumptions imply that the worker's productivity does not change once he leaves school, so that real earnings (that is, earnings after adjusting for inflation) are constant over the life cycle Dr. Edward Asiedu Slide 8  Human Capital – The Schooling Model Dr. Edward Asiedu Slide 9  Human Capital – The Schooling Model Dr. Edward Asiedu Slide 10  Human Capital – The Schooling Model The student also has to pay for tuition, books, and a variety of other fees. Because college has no intrinsic value to the student, employers who wish to attract a highly educated (and presumably more productive) workforce will have to offer higher wages, so that Wcol> WHS. Dr. Edward Asiedu Slide 11  Human Capital – The Schooling Model In a sense, the high wage paid to workers with more schooling is a compensating differential that compensates workers for their training costs. Dr. Edward Asiedu Slide 12  Human Capital – The Schooling Model If university graduates earned less than high school graduates, no one would get a university education because we are assuming that workers do not get any other benefits from attending college. Present Value of Age-Earnings Profiles. Slide 13 Dr. Edward Asiedu  Human Capital – The Schooling Model Slide 14 Dr. Edward Asiedu  Human Capital – The Schooling Model Where r gives the worker's rate of discount. There are 47 terms in the sum, one term for each year that elapses between the ages of 18 and 64. The present value of the earnings stream if the worker gets a college diploma is: Dr. Edward Asiedu Slide 15  Human Capital – The Schooling Model Dr. Edward Asiedu Slide 16  Human Capital – The Schooling Model The first four terms in this sum give the present value of the direct costs of a college education, whereas the remaining 43 terms give the present value of lifetime earnings in the post-college period. We assume that a person's schooling decision maximizes the present value of life time earnings. Dr. Edward Asiedu Slide 17 Human Capital – The Schooling Model Slide 18  Human Capital – Wage Schooling Locus The simple rule that a person should choose the level of schooling that maximizes the present value of earnings obviously generalizes to situations when there are more than two schooling options. The person would then calculate the present value associated with each schooling option (for example, 1 year of schooling, 2 years of schooling, and so on), and choose the amount of schooling that maximizes the present value of the earnings stream. Slide 19 Dr. Edward Asiedu  Human Capital – Wage Schooling Locus There is, however, a different way of formulating this problem that provides an intuitive "stopping rule. This stopping rule tells the individual when it is optimal to quit school and enter the labor market. Figure 7-2 illustrates the wage-schooling locus, which gives the salary that employers are willing to pay a particular worker for every level of schooling. Dr. Edward Asiedu Slide 20  Human Capital – Wage Schooling Locus The salary for each level of schooling is determined by the intersection of the supply of workers with that particular schooling and the demand for those workers. From the worker's point of view, the salary associated with each level of schooling is a constant Dr. Edward Asiedu Slide 21  Human Capital – Wage Schooling Locus Slide 22 Dr. Edward Asiedu  Human Capital – Wage Schooling Locus The person would then calculate the present value associated with each schooling option (for example, 1 year of schooling, 2 years of schooling, and so on), and choose the amount of schooling that maximizes the present value of the earnings stream. There is, however, a different way of formulating this problem that provides an intuitive "stopping rule. This stopping rule tells the individual when it is optimal to quit school and enter the labor market. Dr. Edward Asiedu Slide 23  Human Capital – Wage Schooling Locus Because the wage-schooling locus is concave, the marginal rate of return to schooling must decline as a person gets more schooling. The Marginal Rate Return (MRR) to schooling schedule gives the percentage change in annual earnings resulting from each additional year of school.. Dr. Edward Asiedu Slide 24  Human Capital – Wage Schooling Locus Dr. Edward Asiedu Slide 25  Human Capital - Stopping Rule Stopping rule In other words, the stopping rule that tells the worker when he should quit school is given by: Stop schooling when the marginal rate of returns to schooling = r Dr. Edward Asiedu Slide 26  Human Capital - The Wage Gap among Workers who Differ in Education The schooling model summarized tells us how a particular worker decides how much schooling to acquire, and as a result also tells us how a worker places in the income distribution in the post school period. Workers who get more schooling ear more (although they also give up more). The model isolates two factors that lead different workers to obtain different levels of schooling and hence to have different earnings. Dr. Edward Asiedu Slide 27  Human Capital - The Wage Gap among Workers who Differ in Education Workers either have different rates of discount or they face different marginal rate of return schedules Consider a labor market with two workers who differ only in their discount rates, as illustrated in Figure 7- 4a. AI's discount rate is rAL and Bo's lower discount rate is rB0. The figure shows that Al (who has a higher discount rate) drops out of high school and gets only 11 yeas of education: Bo gets a high school diploma. Dr. Edward Asiedu Slide 28  Human Capital - The Wage Gap among Workers who Differ in Education As we saw earlier, workers who discount future earnings heavily do not go to school because they are "present oriented”. Dr. Edward Asiedu Slide 29  Human Capital - The Wage Gap among Workers who Differ in Education Dr. Edward Asiedu Slide 30  Human Capital – Differences in Ability It is often assumed that higher ability levels shift the marginal rate of return schedule to the right, so that the earnings gain resulting from an additional year of schooling outweighs the increase in forgone earnings. In other words, a more able person gets more from an additional year of schooling. As illustrated in Figure 7-5a, Bob's MRR schedule lies to the right of Ace's. Because both Bob and Ace have the same rate of discount and because Bob gets more from an additional year of schooling. Dr. Edward Asiedu Slide 31  Human Capital – Differences in Ability Bob gets more schooling (12 years versus 1 1 years). Dr. Edward Asiedu Slide 32  Human Capital – Estimating the Rate of Return to Schooling As suggested by the discussion in the previous section, the typical method for estimating the rate of return to schooling uses data on the earnings and schooling of different workers and estimates the percentage wage differential associated with one more year of schooling-after adjusting the data for differences in other worker characteristics, such as age, sex etc. The typical study estimates a regression of the form: Dr. Edward Asiedu Slide 33  Human Capital – Estimating the Rate of Return to Schooling Log = αs + other variables Where w gives the worker's wage and s gives the number of years of schooling acquired by this worker. The α gives the percent wage differential between two workers who differ by 1 year schooling (holding other variables constant), and is typically interpreted as the rate of return to schooling. Dr. Edward Asiedu Slide 34  Topic Two LABOUR MOBILITY Dr. Edward Asiedu Slide 35  Labour Mobility A competitive labor market equilibrium allocates workers to firms so as to maximize the total value of labor's product. Workers are continually searching for better jobs (that is, jobs where they are more productive and earn higher wages), and firms are searching for better workers. This chapter describes the mechanism that labor markets use to improve the allocation of workers to firms, namely labor mobility. Dr. Edward Asiedu Slide 36  Labour Mobility Like all other human capital investments, mobility decisions are guided by the comparison of the present value of lifetime earnings in the alterative employment opportunities. Let PV (NY) be the present value of the earnings stream if the person stays in Kumasi. This quantity is given by: Dr. Edward Asiedu Slide 37  Labour Mobility Similarly, the present value of the earing stream if the person moves to California is given by: Dr. Edward Asiedu Slide 38  Labour Mobility The worker moves if the net gain is positive. A number of empirically testable propositions follow immediately from this framework: An improvement in the economic opportunities available in the destination increases the net gains to migration and raises the likelihood that the worker moves. An improvement in the economic opportunities at the current region of residence decreases the net gains to migration, and lowers the probability that the worker moves. Dr. Edward Asiedu Slide 39  Labour Mobility An increase in migration costs lowers the net gains to migration and reduces the likelihood of a move. All these implications deliver the same basic message: Migration occurs when there is a good chance that the worker will recoup his human capital investment. Dr. Edward Asiedu Slide 40  Labour Mobility – Family Migration Thus far, our discussion of geographic migration focuses on the behavior of a single worker as he or she compares employment opportunities across regions and chooses the one location that maximizes the present value of lifetime earnings. However, most migration decisions are not made by single workers, but by families. Dr. Edward Asiedu Slide 41  Labour Mobility – Family Migration The migration decision, therefore, should not be based on whether a particular member of the house hold is better off at the destination than at the origin, but on whether the family as a whole is better off. Dr. Edward Asiedu Slide 42  Labour Mobility – Family Migration The impact of the family on the migration decision can be easily described. Suppose that the household is composed of two persons, a husband and a wife. Dr. Edward Asiedu Slide 43  Labour Mobility – Family Migration Let's denote by tPVH the change in the present value of the husband's earnings stream if he were to move geographically (say from Kumasi to California). And let tPVw be the change in the present value of the wife’s earnings stream if she were to make the same move. Dr. Edward Asiedu Slide 44  Labour Mobility – Family Migration Note that change in PVH can also be interpreted as the husband's gains to migration if he were single and were making the migration decision completely on his own. These gains are called the husband's "private" gains to migration. If the husband were not tied down by his family responsibilities, he would migrate if the private gains in change in PVH were positive. Similarly, the quantity change in PVw gives the wife's private gains to migration. Dr. Edward Asiedu Slide 45  Labour Mobility – Family Migration Dr. Edward Asiedu Slide 46  FINC 407 Labour Economics Session 10– Labour Market Discrimination Lecturer: Dr. Edward Asiedu, UGBS Contact Information: [email protected] College of Education Department of Distance Education 2017/2018  Session Overview By the end of this session students should be able to: Understand the actions of some employers in the labour market. Understand the reason why employers will employ a particular group of workers. Understand and examine the impact of employee discrimination on a firm’s profit. U n d e r s t a n d a n d e x a m i n e t h e i m p a c t o f e m p l o y e r ’s discrimination on a firm’s profit. Dr. Edward Asiedu Slide 2  Session Outline The key topic to be covered in the session Labour market discrimination More specifically: The Discrimination Coefficient. Employer discrimination. Employee discrimination. Statistical discrimination. Dr. Edward Asiedu Slide 3  Reading List Borjas, G. J. (2000). Labour economics (Vol. 2). New York: McGraw-Hill. Ehrenberg, R. G., & Smith, R. S. (2016). Modern labour economics: Theory and public policy. Routledge. Kaufman, B.E. and J.L. Hotchkiss (2003). The Economics of Labour Markets, 6th edition, Dryden Press, Fort Worth Dr Edward Asiedu Slide 4  Topic One LABOUR MARKET DISCRIMINATION Dr. Edward Asiedu Slide 5  Labour Market Discrimination In previous chapters we analyzed how differences in the characteristics of jobs or the skills of workers generate wage dispersion in competitive markets. We will now demonstrate that differences in earnings and employment opportunities may arise even among equally skilled workers employed in the same job simply because of the workers' race, gender, national origin, sexual orientation, or other seemingly irrelevant characteristics. Dr. Edward Asiedu Slide 6  Labour Market Discrimination – Race and Gender in the Labour Market We o f t e n " r e a d " a p e r s o n ' s s o c i o e c o n o m i c background to learn more about that person's productivity and skills. For instance, we all know that teenagers are more likely to engage in reckless driving. Dr. Edward Asiedu Slide 7  Labour Market Discrimination – Race and Gender in the Labour Market This information is useful to a stranded motorist who has been offered a ride from a teenage driver. Similarly, employers, workers, and customers will use race, gender, and any other relevant traits to fill in information gaps about participants in the market place. Dr. Edward Asiedu Slide 8  Labour Market Discrimination – Race and Gender in the Labour Market In the US, the data shows that men earn more than women, and whites earn more than non-whites. In particular, white men have the highest annual earnings of any of the groups (GHC36,942). In contrast, white women earn only GHC21,208, black men ear GHC24,510, and Hispanic women earn GHC16,459. Dr. Edward Asiedu Slide 9  Labour Market Discrimination – Race and Gender in the Labour Market This differences in annual earnings arise partly because of differences in educational attainment. Only about 17 percent of white men do not have a high school diploma, as compared to about a quarter of black men and 45 percent of Hispanic men. Similarly, 27 percent of white men are college graduates, as compared to 22 percent of white women, 13 percent of black men, and 11 percent of Hispanic men. Dr. Edward Asiedu Slide 10  Labour Market Discrimination – Race and Gender i