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  1. 1. Labor MarketsMay 10, 2013
  2. 2. Announcements• Homework due today – pass to aisle!• New homework assigned: Due nextWednesday, May 22
  3. 3. Schedule for Remainder of CourseMon Wed FriMay 13: Finish Info, startLabor15 17: Class Cancelled20 22 Start Environmental 2427 29 Start Public Goods 31June 3 5 Final Review 1 7 Final Review 2June 12: Final
  4. 4. Last Class• Credible signaling– Which professional should drive a fancy car?– Must be “expensive to lie” and “cheap to tell truth”• Statistical discrimination– Solution to one type: Guarantees for maternity leave
  5. 5. Today• Finish discussion of Information by talking aboutadverse selection and moral hazard• Introduction to labor markets
  6. 6. Adverse Selection• Adverse selection: the pattern in which insurance tends to bepurchased by those who are most costly for companies to insure.• Any situation in which informed buyers (or sellers) make purchasing(or sales) decisions based on their unobservable characteristics in away that negatively affects those who are less uninformed .• Leads to inefficient outcomes—markets can “unravel”.
  7. 7. Moral Hazard• Moral hazard: the tendency for people to expend less effortprotecting those goods that are insured against damage or theft?• Can increase the cost of insuring people—if it’s bad enough, moralhazard could make it impossible for companies to profitably insurepeople.7
  8. 8. How Do Adverse Selection and MoralHazard Affect the Insurance Market?• Insurance companies typically offer a menu of insurance prices.– (a) High deductible, low premium: You cover first $1000 indamages and pay $30 per month.– (b) Low deductible, high premium: You cover first $500 indamages and pay $50 per month.• The deductible helps alleviate moral hazard.• The price structure helps alleviate adverse selection by enabling theinsurance company to distinguish between good (a) and bad (b)drivers.
  9. 9. In addition to mandatory insurance coverage, Clark purchases asupplementary plan. Compared to the rate for the mandatoryplan, he probably paysA. moreB. about the same if he is a maleC. about the same if he is over 30 years oldD. about the same if he shows his clean driving record
  10. 10. Labor Markets: Learning Goals1. Analyze how wages and employment are determined in competitivelabor markets2. Compare and contrast the various hypotheses economists have proposedto explain earnings differences3. Discuss recent trends in U.S. income inequality and justifications forincome redistribution4. Describe and analyze some methods used to reduce poverty in the U.S.
  11. 11. The Economic Value of Work• Why do people’s incomes vary widely?– Why do doctors earn more than plumbers?– Why do doctors earn more than teachers?– Why did Michael Jordon earn more playing basketball than baseball?• Equilibrium wage and quantity are determined by the supply of anddemand for a each category of labor.• What factors determine the supply and demand of labor?
  12. 12. Firms Seek to Maximize Profits• Profits=(total revenue)-(total cost)=TR-TC• How much labor should firms hire to maximize profits?• Assume that labor is the only input to production.
  13. 13. Some terms• Marginal product of labor (MPL)– The additional output a firm gets by employing one additional unit of labor.– The law of diminishing returns to labor: If the amount of capital and other inputs isheld fixed, the greater the quantity of labor employed, the less each additionalworker adds to production.– MPL decreases as you hire more workers, holding other inputs constant.• Value of marginal product of labor (VMPL)– The dollar value of the additional output a firm gets by employing one additionalunit of labor (p*MPL)13
  14. 14. Output and Total RevenueQL L$Q(L)p*Q(L)
  15. 15. ProfitsL$p*Q(L)w*L
  16. 16. Hiring at The Westend Bakery• Sells bread for a price of $2 per loaf.• Going wage is $15 per hour• Calculate MP and VMP• VMP = D = MB# ofWorkersOutput perHour0 01 202 353 454 505 52
  17. 17. Demand for Labor• Individual firm demand is given by VMP• What about many firms?
  18. 18. Individual Labor Supply• Suppose the wage increases– Substitution effect: work more• Leisure is more expensive.– Income effect: work less• Leisure is a normal good.• A higher wage may increase or decrease the quantity of laborsupplied by the individual
  19. 19. Why Do People’s Wages Differ?• w=VMPL• VMPL=p*MPL• Differences in p− Some goods and services are valued more than others.• Differences in MPL− Some workers are more productive than others.− Why?
  20. 20. Human Capital Theory• Human capital:a collection of factors such as education, training,experience, intelligence, energy, work habits, trustworthiness, andinitiative that affects a worker’s marginal productivity.• Human capital theory: holds that a workers wage is proportional tohis or her stock of human capital
  21. 21. Human Capital Theory and Earnings Differences• Some people have more human capital than others.– These people are paid more.– People with a college degree• Some jobs require more human capital.– These jobs pay more.– Doctors• There are differences in the relative supply and demand of different types ofhuman capital.– People who possess the types of human capital that are in high demand andshort supply will earn more.22
  22. 22. U.S. Industries with High/Low ExpectedEmployment and Wage Growth• High growth– Home healthcare services– Management scientific and technical consulting services.– Junior colleges, colleges, universities and professional schools.23Source: BLS, Employment Projections
  23. 23. U.S. Industries with High/Low ExpectedEmployment and Wage Growth• Low growth:– Printing and related support activities.– Apparel knitting mills.– Postal service24Source: BLS, Employment Projections