This document provides an overview of Labour Economics as a course of study. It discusses key concepts like labour supply and demand, the actors in the labour market (workers, firms, government), and how labour market outcomes are determined. The document also outlines 11 lessons that will be covered in the course, with topics like wage theories, unemployment, labour mobility, and others. The overall goal is for learners to understand how labour markets function and be able to analyze labour market policies and issues.

1. 1
KENYATTAUNIVERSITY
INSTITUTEOFOPENDISTANCE&e-LEARNING
INCOLLABORATIONWITH
SCHOOLOFECONOMICS
DEPARTMENT:APPLIEDECONOMICS
UNITCODE:EAE304
UNITNAME:LABOURECONOMICS
WRITTENBY:
Dr.JamesN.Maingi

2. 2
Copyright©KenyattaUniversity,2016
AllRightsReserved
PublishedBy:
KENYATTAUNIVERSITYPRESS

3. 3
TableofContent
IntroductiontotheCourse……………………………………………………………..5
LESSONONE:INTRODUCTION………………………………………………....6
AnEconomicStoryofthelabourmarket………………………………………….......7
TheActorsintheLabourMarket……………………………………………………...8
LESSONTWO:LABOURSUPPPLY……………………………………...……...9
MeasuringofLabourForce……………………………………………………..……..9
TheWorkersPreferences…………………………………………………………….10
TheBudgetConstraint………………………………………………………………..11
PolicyRelevance22
LESSONTHREE:LABOURDEMAND………………………………….………24
TheShort-runLabourDemandCurveforaFirm……………………………………28
EmploymentDecisionintheLong-run………………………………………………29
Long-runDemandCurveforLabour………………………………………………...31
LESSONFOUR:WAGETHEORIES…………………………………………….36
SubsistenceTheoryofWages………………………………………………………..36
WageFundTheory…………………………………………………………………...37
ResidualClaimantTheory……………………………………………………………38
MarginalProductionTheory…………………………………………………………39
ModernTheoryofWages…………………………………………………………….40
LESSON FIVE:LABOURMARKETEQUILIBRIUM;WAGEANDEMPLOYMENT
DETERMINATION……………………………………………41
WageandemploymentdeterminationinPerfectlabourmarket……………………..41
Wage and employment determination in monopsony labour
market………………...47
Wage and employment determination in monoploly labour
market…………………48

4. 4
Wage and employment determination in a bilateral labour
market………………….49
MinimumWageModel………………………………………………………………50
LESSONSIX:LABOURMARKETDISCRIMINATION…………………….53
CausesofWageDiscrimination………………………………………………….......53
TheNeoclassicalTasteModel……………………………………………………….54
LabourMarketSegmentationApproach……………………………………………..57
FavourableEffectsofEliminationDiscrimination…………………………………..60
LESSONSEVEN:WAGEDIFFERNTIALS……………………………………..62
CompensationWageDifferential64
LESSONEIGHT:HUMANRESOURCEDEVELOPMENT……...……………66
TheSchoolModel……………………………………………………………………67
LESSONNINE:LABOURUNIONS……………...………………………………71
UnionsandManagement:CollectiveBargaining……………………………………71
UnionsInfluenceoverWages………………………………………………………..72
LESSONTEN:UNEMPLOYMENTANDUNDEREMPLOYMENT…...…….72
SeasonalUnemployment……………………………………………………………..75
StructuralUnemployment……………………………………………………………76
CyclicalUnemployment……………………………………………………………...76
JobSearch……………………………………………………………………………76
TheWageOfferDistribution………………………………………………………...77
Non-SequentialandSequentialSearch………………………………………………78
TheAskingWage…………………………………………………………………….78
LESSONELEVEN:LABOURMOBILITY……………………………………...82
MeaningofLabourMobility…………………………………………………………82
TypesofMobilityofLabour…………………………………………………………83
FactorsDeterminingMobilityofLabour…………………………………………….83
ObstaclesofMobilityofLabour……………………………………………………..84
DeterminationofWorkerMobility…………………………………………………..85

5. 5
INTRODUCTIONOFTHECOURSE
Thestudyoflaboureconomicsembracesmanyareasofinterest.Theymay
begroupedintothreebroadcategories.Thesearelabourmarketanalysis,
labourmarketproblemsandpoliciesandunionandmanagement:collective
bargaining.
Employersandworkersbuyandselllabourservicesinalabourmarket.
Becausethelabourservicesareusuallydifficulttoquantify,theyaretypically
measuredbynumberofworkers,hoursoflabourtimeorquantityofgoods
and/orservicesproduced.Youcangainunderstandingofthelabourmarket
byexaminingthesefundamentalfeatures:
 Supplyofanddemandforlabour
 Wagedeterminationandemployment
 Labour-marketimperfections
LEARNINGOUTCOMES
Thegoalofthiscourseistoenhancethecapacityoflearners
 Discuss the theories,concepts,policies and theirapplication in
analyzinglabourmarketsissues
 Undertakeevaluationoflabourmarketprogramsandpolicies
 Contributetoevidenced-basedpolicydiscourse.

6. 6
Lessonone
INTRODUCTION
1.0Introduction
Mostofuswillallocateasubstantialfractionofourtimetothelabourmarket.
Whatwedointhelabourmarkethelpsdetermineourwealth,thetypesof
goodswecanaffordtoconsume,whom weassociatewith,wherewegofor
vacation,whichschoolsourchildrenattend,andeventhetypeofpersonswho
findusattractive.Asaresult,wearealleagertolearnhowthelabourmarket
works.Laboureconomicsstudieshowlabourmarketswork.
1.1LessonObjectives
Bytheendofthelessonthelearnershouldbeableto:
1.Discussthepolicyissuesexaminedbymodernlaboureconomics
2.Describetheeconomicstoryofthelabormarket
3.Explaintheroleofeachactorinthelabourmarket
1.2PolicyIssuesExaminedByLabourEconomics
Theinterestinlabourmarketsarisenotonlyfrom ourpersonalinvolvement
butalso becausemanysocialpolicyissuesconcern thelabourmarket
experiences ofparticulargroups ofworkers orvarious aspects ofthe

7. 7
employmentrelationship between workers and firms.The policyissues
examinedbymodernlaboureconomicsinclude:
1)Whatis the impactofimmigration on the wage and employment
appointmentsofnative–bornworkers?
2)Dominimumwagesincreaseunemploymentrateoflessskilledworkers?
3)Whatistheimpactofoccupationalsafetyand health regulatorson
employmentandearnings?
4)Aregovernmentsubsidiesofinvestmentsinhumancapitalaneffective
waytoimproveaneconomicwell-beingofdisadvantagedworkers?
5)Whatistheimpactoftheaffirmativeactionprogram ontheearningsof
minoritiesandonthenumberofminoritiesthatfirmshire?
6)Whatistheimpactofunionsbothontheirmembersandontherestofthe
economy?
7)Dogenerousunemploymentinsurancebenefitslengthenthedurationof
unemployment?
8)Whyistheunemploymentratemuchhigherinlessdevelopedeconomies
thanindevelopedeconomies?
Theabovelistofsocial-economicissuesillustratewhythestudyoflabour
marketsisimportantandinteresting.Laboureconomicshelpsusunderstand
andaddressmanyofthesocialandeconomicproblemsfacingthemodern
societies.
1.3AnEconomicStoryofthelabourMarket
Laboureconomistsassignmotivestothevariousactorsinthelabourmarket
forexample,weview workersfortryingtofindthebestpossiblejoband
assumethatfirmsaretryingtomakemoney.Workersandfirmstherefore
enterthelabourmarketwithdifferentobjectives.Workersaretryingtosell
theirlabouratthehighestpriceandfirmsaretryingtobuylabouratthe
lowestprice.
Thetypesofeconomicexchangethatcanoccurbetweenworkersandfirms
arelimitedbythesetofgroundrulesthatthegovernmenthasenactedto
regulatetransactionsin thelabourmarket.Changesin theserulesand
regulations would obviouslylead to differentoutcomes.Forexample a
minimum wagelaw prohibitsexchangethatpayslessthanaparticular
amountperhourworked;occupationalsafetyregulationsforbidfirmsfrom

8. 8
offeringworkingconditionsthataredeemedtooriskytotheworkers’health.
Thestudyoflaboureconomicshelpsunderstandandpredicthow some
labourmarketoutcomesaremorelikelytobeobservedthanothers.Weneed
factand theory ofwhy workers and firms pursue some employment
relationshipsandavoidothers.Wepredicttheimpactonthelabourmarketof
changes in the governmentpolicies orchanges in the demographic
compositionofthelabourforce.Weneedtounderstandwhicheconomicand
socialfactorgenerateacertainlevelofemploymentandwhy.
1.4Theactorsinthelabourmarket
There are three main actors in the labourmarket:workers,firms and
government.Workersdecideswhethertoworkornot,how manyhoursto
work,whichskillstoacquire,whentoquitajob,whichoccupationtoenter,
whethertojoinalabourunionandhow muchefforttoallocatetothejob.
Eachofthesedecisionsismotivatedbythedesirestooptimize,tochoosethe
bestavailableoptionfrom thevariouschoices.Therefore,workerswillalways
actinwaysthatmaximizetheirwell-being.Addingupthedecisionsofmillions
ofworkersgeneratestheeconomy’slaboursupply,notonlyintermsofthe
quantitybutalsoqualityofskillsavailabletotheemployers.Aswewillsee
manytimes,personswhowanttomaximizetheirwell-beingtendtosupply
moretimeandmoreefforttothoseactivitiesthathaveahigherpayoff.The
laboursupplycurvethereforeisupwardsloping.
Thefirm isthesecondactorinthelabourmarket.Firm mustdecidehow
manyandwhichtypesofworkerstohireandfire,thelengthoftheworkweek,
andhow muchcapitaltoemploy.Thefirm willalwaysaim atmaximizing
profits.Thefirm willmaximizeitsprofitsbymakingtheproductiondecisions-
andhencethehiringandfiringdecisions-thatbestservethefirm’interest.In
effect,thefirmsdemandforlabourisaderiveddemand.
Thegovernmentisthethirdactorinthelabourmarket.Itcanimposetaxeson
aworker’searnings,subsidizethetrainingofaparticularcategoryofworkers,
andincreasethesupplyofaparticularcategoryofworkersbyencouraging
theirimmigrationfromabroadanddesignpoliciesandregulationsthatgovern
theoperationsofthelabourmarkets.Alltheabovewillchangetheequilibrium
thatwilleventuallybeattainedinthelabourmarket.Governmentregulations,
therefore,setthegroundrulesthatguideexchangeinthelabourmarket.
1.5Summary

9. 9
 Thethreeactorsinthelaboureconomicsaretheindividuals,firmsand
thepolicyinstitutionssuchasthegovernmentandtradeunions.
Activity
Statethepoliciesexaminedbythemodernlaboureconomics

10. 10
LessonTwo
LABOURSUPPLY
2.0Introduction
Thischapterdevelopstheframeworkthateconomistsusetostudylabour
supplydecisions.In this framework,individuals seekto maximize their
wellbeingbyconsuminggoodsandleisure.Goodshavetobepurchasedin
themarketplace.
Themodeloflabour-leisurechoicesisolatesthepersonswagerateand
incomeasthekeyeconomicvariablesthatguidetheallocationoftime
betweenthelabourmarketandleisureactivity.Inthischapter,weusethe
frameworktoanalyzestaticlaboursupplydecisions,thedecisionsthataffect
aperson’slaboursupplyatapointintime.
Themarketforlabour,likethemarketforanycommodity,isaffectedby
supplyanddemandforces.Butthereareanumberofdifferentconceptsof
laboursupplyandoflabourdemandthatmustbeidentifiedbeforeyoucan
understandthelabourmarket.
2.1LessonObjectives
Bytheendofthelessonthelearnershouldbeableto:
1.Definelabourandlabourforce
2.Determinehowindividuals/householdsallocatetimebetweenworkand

11. 11
leisure
3.Derivelaboursupplycurve
Beforeanalyzingthefactorsthatdeterminewages,ithelpstobeginwith
somedefinitions.
2.2MeasuringtheLabourForce
1 Labor:as defined in economics,means allper¬sonalservices,
includingtheactivitiesofwageworkers,professionalpeople,andindependent
businesspeople.Thus,"laborers"areworkersofanysort,whethertheyreceive
compensationintheform ofhourlywagesorintheform ofannualsala¬ries,
bonuses,orcommissions.
2 LaborForceThisconceptoflaborsupplyissimplytheemployable
population.Itisdefinedformea¬surementpurposesasallpeople16years
ofageorolderwhoareemployedplusallthosewhoareun¬employedbut
activelyseekingwork.LetEbethenumberofpersonsconsideredtobe
employed,andUthenumberofpersonsconsideredtobeunemployed.A
personparticipatesinthelabourforceifheorsheiseitheremployedor
unemployedandisactivelylookingforwork.Thesizeofthelabourforce(LF)
isgivenby:
LF=E+U
3 Labor-force Participation Rate This is the proportion ofthe total
population(P),orofoneormoresubgroupsofthepopulation,thatisinthe
laborforce.Subgroupsareclassifiedbyrace,sex,age,maritalstatus,and
otherdemographiccharacteris¬tics.
Labourforceparticipationrate=LF/P
2.3TheWorker’sPreferences
Theframeworkthateconomiststypicallyusetoanalyzelaboursupplyis
calledtheneoclassicalmodeloflabour–leisurechoice.Themodelisolates
thefactorsthatdeterminewhetheraparticularpersonworkandifso,how
manyhourshe/shechoosestowork.
Therepresentativepersoninourmodelreceivessatisfactionfrom consuming
goods(C)andfromconsumptionofleisure(L).

12. 12
2.3.1Utilityandindifferencecurves
Thefactthatindividualstogetsatisfactionfrom consuminggoodsand
leisureissummarizedbytheutilityfunction: U=f(C,L).
Figure2.0
Pointsxandyliesonthesameindifferencecurveandyieldthesamelevelof
utility.Pointzliesonhigherindifferencecurveandyieldsmoreutility.
TheBudgetConstraint
Theperson’sconsumptionofgoodsandleisureareconstrainedbyhistime
andbyhisincome.Partoftheperson’sincomesuchaspropertyincome,
dividendsandlotterypricesisindependentofhow manyhourssheworks.
Thisisnonlabourincome(v).Let(h)bethenumberofhoursthepersonwill
allocatetoworkduringtheperiod,and(w)bethehourlywagerate.The
person’sbudgetconstraintcanbewrittenas:
C=Wh+V
Thatistheexpenditureongoods(C)mustbeequaltothesum oflabour
earnings(Wh)andnonlabourincome(V)
40,000utils
25,000utils
X
Z
Y
Hoursofleisure
Consumption
500
450
400

13. 13
Apersonhastwoalternativeusesforhertime;workorleisure.Thetotaltime
allocatedtoeachoftheseactivitiesmustbeequaltothetotaltimeavailable
intheperiodT,perweek.Sothat
T=h+L
Budgetconstraintcanbewrittenas:
C=W(T-L)+Vor
C=(WT+V)–WL
Figure2.1
Consumption
Hoursofleisure
EV
Budgetline
WT+V

14. 14
PointEindicatesthatifthepersondecidesnottoworkatallanddevotesT
hourstoleisureactivitiesshecanstillpurchaseVworthofconsumption
goods.PointEistheendowmentpoint.Ifthepersoniswillingtogiveupone
hourofleisure,shecanthenmoveupthebudgetlineandpurchasean
additionalW worthofgoods.Theworkermovesupthebudgetlineasshe
tradesoffanhourofleisureforadditionalconsumption.Theslopeofthe
budgetlineiswagerate.
2.3.2TheHours-of-WorkDecision
Thepersonwishestochoosetheparticularcombinationofgoodsandleisure
thatmaximizesherutility.Thismeansthatthepersonwillchoosethelevelof
goodsconsumptionandleisureactivitiesthatleadtothehighestpossible
leveloftheutility(U),givenbudgetconstraint.
Figure2.2
C
X
70 110
Hoursofwork
Hoursofleisure
E
U2
U0
U1
y
p
F
500
110 40 0
Aninteriorsolutiontothelabour–
leisuredecision

15. 15
PointPgivestheoptimalbundleofconsumptiongoodsandhoursofleisure
chosenbytheutility-maximizingworker.AtpointP indifferencecurveis
tangencyofthebudgetline.Atthissolutionworkerconsumes70hoursof
leisureperweekandwork40hrsandconsumes500worthofgoodsweekly.
2.3.2.1Whathappenstohoursofworkwhennonlabourincomechanges?
Theincreaseinnon-labourincomecanbetriggeredbythepaymentofhigher
dividendsontheworkersstockofportfolioorperhapsbecausesomedistant
relativeshad named theworkersasthebeneficiaryin theirwillforan
inheritance.Figure2.3showswhathappentohoursoflabourandleisure.
Consumption
F1
F0
70 80 Hoursofleisure
E0
U0
E1
U1
P0
P1

16. 16
TheincreaseinnonlabourweeklyshiftstheendowmentpointtoE1 sothat
thenewbudgetlineisgivenbyF1E1.Becausetheworkerswagerateisbeing
heldconstant,theslopeofthebudgetlineoriginatingatpointF1isthesame
astheslopeofthebudgetlineatpointE0.Theworkerwillmovefrom pointP0
toP1.Ifleisureisanormalgoodmeaningthattheworkerwillconsumemore
ofitasincomeincreasesthenhoursofworkfalls.
Ifleisureisaninferiorgoodmeaningthatasincomeincreasestheworkerwill
consumelessofitthenthehoursofworkincreases.Thisiswhatisshownby
figure2.4below.
Figure2.4
Consumption
P1
P0
E0
E1
U0
U1
60 70 Hoursofleisure

17. 17
Theimpactofthechangeinnonlabourincome(holdingwageconstant)on
thenumbersofhoursworkediscalledanincomeeffect
2.3.2.2Whathappenstohoursofworkwhenthewagechanges?
Considerawageincreasefrom $10to$20holdingnonlabourincomeV
constant.Thewageincreaserotatesthebudgetlinearoundtheendowment
point.
Fig2.5showswhathappentothehoursofworkandleisurewhenthewage
rateincreases.Thewageincreaseshiftstheoptimalconsumptionbudget
from pointPtopointR.Atthenewequilibrium;theindividualconsumesmore
leisurefrom70to75sothathoursofworkfallfrom40to35hours.
Figure2.5
Consumption
70 75
U
F
G
P
R
E
U0
U1
Slope=-10
Slope=-20

18. 18
HoursofLeisure
Fig2.6showsthatthewageincreasemovestheworkertoahigherindifferent
curveandshiftstheoptimalconsumptionbundlefrom PtoR.Thewage
increasereducestheleisurehours.
Figure2.6
Consumption
HrsofLeisure
Theabovetwodiagramsindicatethatthereisambiguityintherelationship
betweenhoursofworkandwagerate.
Regardlessofwhathappenstohoursofwork,wageincreaseexpandsthe
workersopportunityset.Inotherwords,aworkerhasmoreopportunities
whenshemakes$20anhourthanwhenhemakes$10anhour.Anincrease
inincomeincreasesthedemandforallnormalgoods,includingleisure.The
increaseinthewagethusincreasesthedemandforleisure,whichreduces
hoursofwork.Butthisisnotallthathappens.Thewageincreasealsomakes
leisuremoreexpensive.Whenworkerearns$20anhour,hegivesup$20
everytimehedevotesanhourtoleisureactivities.Asaresult,leisuretimeis
very expensive commodity forhigh-wage workers and relatively cheap
commodityforlow-wageworkers.
Highwageworkersshouldthenhavestrongincentivestocutbackontheir
consumptionofleisureactivities.Awageincreasethusreducesthedemand
forleisureandincreaseshoursofwork.
Ahighwageworkerwantstoenjoytherewardsofhishighincomeandhence
wouldliketoconsumemoreleisure.Thesameworkers,howeverfindsthat
R
U1
U0P
65 70

19. 19
leisureisveryexpensiveandthatshesimplycannotaffordtotaketimeoff
from work.Thesetwoconflictingforcesareillustratedbelow.Figure2.7and
figure2.8show thedecompositionoftheimpactofawagechangeinto
incomeandsubstitutioneffects.Specificallyfigure2.7showswhathappens
whenincomeeffectdominatesthesubstitutioneffect.
Figure2.7
Consumption
HrsofLeisu
Theworkersmaximizeshisutilitychoosingtheconsumptionbundlegivenby
pointP.Supposethewageincreasesto$20,thenewconsumptionbundleis
givenbyR.Thepersonisworking atfewerhoursatthehigherwage.
Movementfrom PtoRisatwo-stagemove.Thatis,thewageincrease
generatestwoeffects:itincreasestheworkersincomeanditraisestheprice
ofleisure.Toisolatetheincomeeffectwedrawabudgetlinethatisparallel
totheoldbudget(sothatitsslopeisalso$10)buttangenttothenew
indifferencecurve.ThisbudgetlineDgeneratesanewtangentpointQ.
Themovefrom initialpositionPtofinalpositionRcanthenbedecomposed
intofirst-stagemovefrom PtoQandasecond-stagemovefrom QtoR.Itis
easytoseethatthemovefrom PtoQisanincomeeffect.Inparticular,the
movefromPtoQarisesfromachangeintheworker’sincome,holdingwages
constant.TheIncomeeffectisolatesthechangeinconsumptionbundle
inducedbytheadditionalincomegeneratedbythewageincrease.Because
bothleisureandgoodsarenormalgoods;pointQmustlietothenortheastof
pointP(sothatmoreisconsumedofbothgoodsandleisure).Theeffectthus
R
Q
D
F
U0
U1
E
70 75 85 110
Decompositionoftheimpactofawage
changeintoincomeandsubstitution
effect

20. 20
increasesthedemandforleisure(form 70to85hrs)andreduceshoursof
workby15hrs.
Thesecond-stagemovefrom Q toR iscalledthesubstitutioneffect.It
illustrateswhathappenstotheworkersconsumptionbundledasthewages
increasesholdingutilityconstant.BymovingalonganIndifferencecurvethe
worker’sutilityisheldfixed.Thesubstitutioneffectthusisolatestheimpact
oftheincreaseinthepriceoftheleisureonhoursofworkholdingincome
constant.
Themovefrom QtoRgeneratesasubstitutionawayfrom leisuretimeand
towardsconsumptionofothergoods.Inotherwords,asthewagerises,the
workersdevotelesstimetoexpensiveleisureactivities(from 85to75hrs)
and increaseinconsumptionofgoods.Throughthesubstitutioneffect,
therefore,thewageincreasereducesthedemandforleisureandincreases
hoursofworkby10hrs.Thesubstitutioneffectimpliesthat,anincreasein
thewagerate,holdingincomeconstant,andincreaseshoursofwork.
Thedecreaseinhoursofworkgeneratedbytheincomeeffect(15hrs)
exceedstheincreaseinhoursofworkassociatedwiththesubstitutioneffect
(10hrs).Thestrongerincomeeffectthusleadstoanegativerelationship
betweenhoursofworkandthewagerate.Figure2.8showswhathappensto
hoursofworkwhensubstitutioneffectdominatestheincomeeffectofwage
increase.
Figure2.8
Consumption
F
U1
R
Q
U0
P

21. 21
HrsofLeisure
TheincomeeffectrepresentedbythemovementfromPtoQdecreaseshours
ofwork by 10hrs,whereas the substitution effectrepresented by the
movementfrom Q toRincreaseshoursofworkby15hrs.Becausethe
substitutioneffectdominates,thereisapositiverelationshipbetweenhours
ofworkandthewagerate.
Thereasonfortheambiguityintherelationshipbetweenhoursofworkand
thewageisnowclear.Asthewagerises,aworkerfacesalargeropportunity
setandtheincomeeffectincreaseshisdemandforleisureanddecreases
laboursupply.Asthewagerises,howeverwagebecomesmoreexpensive,
andthesubstitutioneffectgeneratesincentivesforthatworkertoswitch
from consumptionofleisuretoothertypesofconsumptionactivities.This
shiftfreesupleisurehoursandthusincreaseshoursofwork.
2.3.3Toworkornotwork?
Ouranalysisoftherelationbetweennon-labourincome,thewagerate,and
thehoursofworkassumedthatthepersonworkedbothbeforeandafterthe
changeinnon-labourincomeorthewage.Hoursofworkthenadjustedtothe
changeintheopportunityset.Butwhatfactorsmotivateapersontoenterthe
labourforceinthefirstplace.
Figure2.9
Cons
WHigh
X
Y
H

22. 22
Hrs of
Leisur
Thepersonwhodoesnotworkatallreceivesnoutility.Theperson,however,
canchoosetoenterthelabourmarketandselloffsomeofherleisuretime.
Thedecisionofwhethertoenterthelabourmarketornotboilsdowntoa
simplequestion:Arethetermsoftrade–therateatwhichleisurecanbe
tradedforadditionalconsumption–sufficientlyattractivetobribehim into
enteringthelabourmarket?
SupposeinitiallythatthepersonwagerateisgivenbyWlowsothathefaces
budgetlineGE.Nopointonthisbudgetlinecangivehim moreutilitythanU0.
Atthislowwage,theperson’sopportunitiesarequitemeager.Iftheworker
weretomovefrom theendowmentpointEtoanypointonthebudgetlineGE,
hewouldbemovingtoalowerindifferencecurveandbeworseoff.For
exampleatpointXhegetsonlyUG.AtwageWlow,thepersonchoosesnotto
work.Incontrast,supposethatthewageratewasgivenbyWhigh,sothatthe
workerfacesbudgetlineHE.Itiseasytoseethattherearemanypointson
thissteeperbudgetlinethatwouldincreasetheworkersutility.AtpointY,the
workergetsμH.AtthewageWhighheisbetteroffworking.
Thediagramindicatesthattheworkerdoesnotenterthelabourmarketatlow
wagerates(suchasWlow)butdoesenterthelabourmarketathighwage
rates(suchasWhigh).Aswerotatethebudgetlinefrom WlowtoWhigh,we
willencounterawagerate(W)thatmakeshim indifferentbetweenworking
andnotworking.(W)isknownasthereservationwage.Reservationwage
givestheminimum increaseinincomethatwouldmakepersonindifference
betweenremainingatendowmentatpointEandworkingthatfirsthour.
ReservationwageisgivenbytheslopeoftheindifferentcurveatpointE
Thisimpliesthatthepersonwillnotworkatallifthemarketwageislessthan

23. 23
thereservationwage,andthepersonwillenterthelabourmarketifthemarket
wageexceedsthereservationwage.Thedecisiontoworkthereforeisbased
oncomparisonofthemarketwage,whichindicateshowmuchtheemployers
arewillingtopayforanhour,andthereservationwage,whichindicateshow
muchtheworkerrequirestobebribedintoworkingthatfirsthour.
2.4TheLabourSupplyCurveforaWorker
Therelationbetweenhourofworkandthewagerateiscalledthelabour
supplycurve.Ittracesouttherelationshipbetweenthewagerateandhours
ofwork.
Figure2.10
Consumption
HrsLeisure
W=13
E
W=25
W=20
W=10
U
10070 80 90

24. 24
Figure2.11
Wage
HrsofWork
Atthewagesbelowthereservationwage($10)thepersondoesnotwork.At
higherwagesthan$10thepersonentersthemarket.Theupwardsloping
segmentofthelaboursupplycurveimpliesthatsubstitutioneffectsare
strongerinitially;thebackwardbendingsegmentimpliesthatincomeeffects
maydominateseventually.
Atreservationwagethepersonsupplieszerohourstothelabourmarketat
anywagelessthanorequalto$10.Oncethewagerisesabove$10,the
personchoosestoworksomehours,e.gheworks20hrswhenwage=$13,
40hrswhenwageis20and30hourwhenthewageis$25.
2.4.1Policyrelevancy:welfareprogramsandworkincentives
Cashgrantsandlaboursupply.
Considerasimpleprogram thatgrantseligibleperson’scash grante.g
unmarriedwomanorunemployedyoutharegivenacashgrantof$500per
monthaslongastheyremainoutsidethelabourforce.Iftheseperson’senter
thelabourmarket,thegovernmentofficialsimmediatelyassumethatthe
personnolongerneedpublicassistanceandaredroppedfromthewelfare.
Theimpactofthecashgrantonworkincentiveisillustratedbelow.
10
25
13
20
20 30 40
Laboursupplycurve

25. 25
Figure2.12
C
Intheabsenceoftheprogram,thebudgetlineisgivenbyFEandleadstoan
interiorsolutionatpointP,inwhichthepersonconsumes70hrsofleisureand
works40hrs.Assumethatapersondoesnothaveanynonlabourincome.
Theintroductionofacashgrantof$500nonworkersthenintroducespointG
intotheopportunityset.Atthispoint,awomancanpurchase$500worthof
consumptiongoodsifsheparticipatesinthewelfareprogram anddoesnot
work.Oncethepersonentersthelabourmarket,howeverthewelfaregrantis
takenawayandtheopportunitysetswitchesbacktotheoriginalbudgetline
FE.
TheexistenceofthecashgrantatpointG cangreatlyreducethework
incentives.Thepersonattainsahigherlevelofutilitybychoosingacorner
solutionbypointG(thatisthewelfaresolution)thanbychoosingtheinterior
solutionatpointP(worksolution).
Thistypeoftake-itorleaveitcashgrantcaninducemanyworkerstodropout
ofthelabourforce.Itshouldbeclearthatlow-wagepersonsaremostlikelyto
choosethewelfaresolution.Improvementintheendowmentpoint(from
point.EtopointG)increasestheworkers’reservationwage,thusreducingthe
likelihoodthatalow-wagepersonwillenterthelabourmarket.
2.5Summary
70
U0
E
110
U1
P G
500
Hrsofleisure

26. 26
 Thereservationwageisthewagethatmakesapersionindeffent
betweenworkingandnotworking.Apersonentersthelabourmarket
whenthemarketwagerateexceedsthereservationwage.
 Utility – maximization workers allocate theirtime so thatthe
last$spentonleisureactivityyieldsthesameutilityasthelast$spent
ongoods.
 Anincreaseinnonlabourincomereduceshoursofworkofworker.
 Theparticipationrateofmarriedwomeninthelaborforcehas
increasedsubstantiallyinrecentdec¬ades.
 Thesupplycurveoflabortoaparticularoccupationismoreelasticin
thelongrunthanintheshortrunbecausepeoplehavetimetotrain
fornewoccupations
 Theexistenceofabackward-bendinglaborsupplycurvetellsyouthat
peopleallocatetheirlimitedtimebetweenworkandleisure(i.e.,
non-work).
Activity
1 Wecandemonstratethatawelfareprogram thatincludesacashgrant
andataxonlabourearningsmustreducelaboursupply.
2 Whathappenstothereservationwageifnonlabourincomeincreases
andwhy?
3 Whateconomicfactorsdeterminewhetherapersonparticipateinthe
labourforce?

27. 27
LESSONTHREE
LABOURDEMAND
3.0Introduction
Labourmarketoutcomes,dependsnotonlyonthewillingnessofworkersto
supplytheirtimetoworkactivities,butalsoonthewillingnessoffirmstohire
thoseworkers.Wenowturn,thereforetoadiscussionofthedemandsideof
thelabourmarket.Ouranalysisoflabourdemandbeginsbyrecognizingthat
firmsdonothireworkerssimplybecauseemployerswanttosee“bodies”

28. 28
fillinginvariouspositionsinthefirm.Rather,firmshireworkersbecause
consumerswanttopurchaseavarietyofgoodsandservicesproducedbythe
worker.Thefirm’slabourdemand-justlikethefirm’sdemandforotherinputs
intheproductionprocess,suchasland,buildingsandmachines-isaderived
demandfromthewantsanddesiresofconsumers.
3.1LessonObjectives
Objectives
Bytheendofthelessonthelearnershouldbeableto:
1.Derivetheproductionfunction
2.Derivedemandcurveforlabourforafirmintheshort-run
3.Derivedemandcurveforlabourforafirminthelong-run
4.Isolatesubstitutionandincomeeffectofawagechange
3.2TheProductionfunction
Itdescribesthetechnologythatthefirm usestoproducegoodsandservices.
Assumethattherearetwofactorsofproduction(twoinputsintheproduction
process).i.enumberofemployeeshourshiredbythefirm(E)andcapital(K)
Q=F(E,K). Q=firmsoutput.Theproductionfunctionspecifieshowmuch
outputisproducedbyanycombinationoflabourandcapital.Thedefinitionof
thelabourinputmakestwoassumptionsthatareveryrestrictiveandthatare
worthnoting.Thenumberofemployee-hoursEisgivenbytheproductofthe
numberofworkershiredtimestheaveragenumberofhoursworkedper
person.Theproductionfunctionalsoassumesthatdifferenttypesofworkers
cansomehowbeaggregatedintoasingleinputthatwecalllabour.
3.2.1MarginalProductandAverageProduct
Themostimportantconceptassociatedwiththeproductionfunctionisthat
ofmarginalproduct.TheMarginalproductoflabour(MPE)isdefinedasthe
changeinoutputresultingfrom havinganadditionalworker,holdingconstant
thequantitiesofallotherinputs.Similarly,themarginalproductofcapital

29. 29
(MPk)isdefinedasthechangeinoutputresultingfrom aoneunitincreasein
thecapitalstock,holdingconstantthequantitiesofallotherinputs.We
assumethatthemarginalproductsofbothlabourandcapitalarepositive
numbers,sothathiringeithermoreworkersorcapitalleadstomoreoutput.
Wecanalsodefineaverageproductoflabour(Ape)astheamountofoutput
producedbyatypicalworker.
Ape=Q/E
Totalproductcurvegivestherelationshipbetweenoutputandthenumberof
workershiredinthefirm holdingcapitalfixed.Themarginalproductcurve
givestheoutputproducedbyeachadditionalworkerandtheaverageproduct
curvegivestheoutputperworker.
3.2.2Profitmaximization
A
B
C
80 4 Units
oflabor
(L)
Total
Output
(Q)
ΔQ
ΔL
3
Figure3.0:GraphsofProductionFunction
120
6
8
36
v
UnitsofLabor
(L)
MP,AP
10 4 8 MPL
3
2
APL
TPL
d
e
6
1
9
f
Panela
Total
Production
function
Panelb
Averageand
Marginal
Product
function

30. 30
Toanalyzethehiringdecisionsmadebythefirm,wemakeanassumption
aboutthefirm’sbehaviour.Thefirm’sobjectiveistomaximizeit’sprofitgiven
by:
π=PQ–WE-rK.
When P=priceofoutput
W=wagerate
r=priceofcapital
E=Employment
K=Unitsofcapital
Q=Unitsofoutput
Wealsoassumethatthefirm isaperfectlycompetitive;thusthefirm cannot
influenceprices.
3.2.3Theemploymentdecisionintheshort-run
Definetheshortrunasthetimespanthatissufficientlybriefthatthefirm
cannotincreaseorreducethesizeoftisplantorpurchaseorsellphysical
equipment.Intheshortrun,therefore,thefirm’scapitalisfixedatsomelevel.
Toobtainthevalueofwhateachadditionalworkerproduces,wemultiplythe
MPEXpricesoftheoutput.ThisquantityiscalledthevalueoftheMPE
VMPE=PxMPE
Also
VAPE=PxAPE
3.2.4 HowManyWorkersShouldtheFirmHire?
Thecompetitivefirm canhireallthelabouritwantsatconstantwageofW
dollas.Aprofitmaximizingfirmshasworkersuptothepointwherethewage
rateequalsthevalueofmarginalproductoflabour.VMPE=W
Figure3.1
W
W
22
38
VAPE

31. 31
Supposethewageinthelabourmarketis$22thenthefirm shouldhire8
workers.Atthislevelofemployment,theVMPE=W andVMPEisdeclining.
Theintuitionforthisresultisthatsupposethefirm decidestohireonlysix
workerse.g7worker,wouldgetmoreadditionalrevenuesthanitwouldpay
outtothatworker(26$and22$).Aprofitmaximizingfirmwillwanttoexpand
andhiremorelabour.Ifthefirm weretohiremorethaneightworkers,the
VMPEwouldbelowerthanthecostoftheline.From aprofitmaximizingpoint
ofview,itisnotworthhavingmorethaneightworkers.
NB.ThewagewouldequaltheVMPEifthefirm hiredjustoneworker.Atthat
point,however,theVMPE isupwardsloping;hiringjustoneworkerdoesnot
maximizeprofits.Ifthefirm hiredanotherworker,the2
nd
workerhiredwould
contributeevenmoretothefirm’srevenuethanthefirstworker.
Thisargumentshowswhythelaw ofdiminishingreturnsplayssuchan
importantroleinourtheoryifVMPE keptrisingthefirm wouldmaximize
profitsbyexpandingindefinitely.
Ifthecompetitivewagewereveryhighsuchas$38,thefirm wouldhire4
workerswhereVMPE=W.HowevertheVAPE(32)wouldlessthanthewage.
Becausetheper-workercontributiontothefirmislessthanthewage,thefirm
losesmoreandleavesthemarket.TheonlypointsontheVMPEcurvethatare
relevantforthe firm’s hiring decision are the once thatlie on the
download-sloping portion ofthecurvebelow thepointwheretheVAPE
intersectstheVMPEcurve.
3.3Theshort-runlabourdemandscurveforafirm.

32. 32
Thedemandcurvetellsuswhathappenstothefirm’semploymentasthe
wagechangesholdingcapitalconstant.
Figure3.2
VMPE =isthedownwardslopingpatternofthefirmsVMPE curve.The
short-rundemandcurveforlabourthereforeisgivenbytheVMPE. Sinceit
declinesasmoreworkersarehired,itmustbethecasethatfallinthewage
increasesthenumberofworkershired.
Thepositionofthelabourdemandcurvedependsonthecurveoftheoutput.
Since
VMPE =P.MPEtheshort-rundemandcurveshiftsupiftheoutputbecomes
moreexpensivee.gsupposethatoutputpriceincreases,shiftingtheVMPE
curvefromVMPEtoVMPE.Thusthereisapositiverelationbetweenshort-run
employmentandoutputprice.
3.3.1EmploymentDecisionintheLong-Run
Inthelong-run,thefirm’scapitalstockisnotfixed.Thefirm canexpandor
shrinkit’splantsizeandequipment.ThereforeintheLong–Run,thefirm
maximizesprofitbychoosingbothhowmanyworker’stobehiredandhow
muchplantandequipmenttoinvestin.
Isoqunt
Itdescribesthepossiblecombinationsoflabourandcapitalthatproducethe
NumberofWorkers
VMPE’’’
’’
VMPE
1298
18
22
Wage

33. 33
samelevelofoutputQ=f(E,K)
Figure3.3
Capital(K)
Labour(E)
Isocosts
Thefirm’scostofproductionCisgivenbyC=WE+rK
Iffirm decidetohireonlycapitalthenitcouldhireCo/runitsofcapitalorifit
couldhireonlylabour,thenithiresCo/wworkers.
Combinationsoflabourandcapitalthatthefirm couldhirewithacostoutlay
ofCoarecalledanisocostline.
Figure3.4
K
E
Costminimization
Aprofitmaximizingfirmthatisproducingq0unitsofoutputwantstoproduce
theseunitsatthelowestpossiblecost.
Figure3.5
q0
q1
C1/wC0/w
C0/r
C1/r
Higheriso-cost linesimplyhighercosts

34. 34
Thefirmchoosesthecombinationoflabourandcapital(100workersand175
machines)givenbypointP,whereisocostisthetargettotheisoquant.The
firm canproduceq0unitofoutputusingothercapital-labourcombinations
suchaspointAorBontheisoquant.Thischoicehowevercouldbemore
costlybecauseitplacesthefirmonahigherisocostline.
3.4Long-Rundemandcurveforlabour
Whathappenstothefirm’slong-rundemandforlabourwhenthewage
changes.Considerafirm thatproducesq0unitsofoutput.Assumethatthis
outputistheprofit-maximizinglevelofoutputinthesensethatatthatlevelof
productionoutputpriceisequaltoMC.Aprofit-maximizingfirm willproduce
thisoutputatthelowestcostpossible,soitusesamixoflabourandcapital
wheretheratioofmarginalproductsequalstheratioofinputprices.The
wageisinitiallyequaltow0.Theoptimalcombinationofinputsforthisfirmis
givenbelow.
Figure3.6
K
Co/r
q0B
P
A
E100
175
C
75
R
P

35. 35
E
SupposethemarketwagefallstoW1,how willthefirm respond?Thefirm
wouldmovefrom pointPtopointR.Thewagereductionincreasesthefirm
employmentfrom 25to40workersandincreasesoutputtoq1units.The
declineinthewagewilltypicallycutthemarginalcostofproducingthefirm’s
output.Wethenexpectthatthedropinthewagewouldencouragethefirm to
expandproduction.
Figure3.7
Price
BecausetheMCCurvedropsfrom MCOtoMC1,thewagecutencouragethe
P
Output200100
Mc1
Mc0

36. 36
firmstoproduce200unitsofoutputratherthan100units.
Thereforethefirmwilljumptoahigherisoquantasshownbelow.
Figure3.8
Capital
Thetotalcostofproducing200unitsofoutputneednottobesameasthe
costofproducingonly100units.Asaresultthenewiso-costlineneednot
originatefromthesamepointintheverticalaxisastheoldiso-costline.
Theemploymentwillincreasefrom 25to50,workers.Thefirm willalways
hiremoreworkerswhenthewagefalls.ThepositioningofRalsoimpliesthat
thefirm willusemorecapital.Thisneednotalwaysbethecase.Ingeneral,a
wagecutcaneitherincreaseordecreasetheamountofcapitaldemanded.
Figure3.9
Wage
E
100
200
Employment25 50
P
R
DLR
5025
W1
W0
Long-rundemandcurve

37. 37
3.5Substitutionandscaleeffect
Thewagecutreducesthepriceoflabourrelativetothatofcapital.The
declineinthewageencouragesthefirm toreadjustitsinputmixsothatitis
morelabourintensive.Inaddition,thewagecutreducestheMCofproduction
andencouragesthefirm toexpand.Asthefirm expands,itwanttohiremore
workers.
Figure3.10
Capital
ThefirmisinitiallyatpointP,whereitfacesawageequaltoWO,produces100
unitsofoutputandhires25workers.WhenthewagefallstoW1,thefirm
movestopointR,producing200unitsofoutputandhiring50workers.
Themovefrom PtoRisoftwostages.Inthefirststage,thefirm takes
advantageofthelowerpriceoflabourbyexpandingproduction.Inthesecond
stage,thefirm takesadvantageofthewagechangebyrearrangingitsmixof
inputs(i.e.byswitchingfromcapitaltolabour),whileholdingoutputconstant.
Toconductthisdecomposition,weintroduceanew isocostlineDD.DD is
tangenttothenewisoquant(q=200),butparalleltotheisocostthatthefirm
facedbeforethewagereduction.ThetangencypointisgivenbyQ.
ThemovefromPtoQisthescaleeffect.Scaleeffectindicateswhathappens
tothedemandforthefirm’sinputsasthefirmexpandsproduction.Aslongas
capitalandlabourarenormalinputsthescaleeffectincreasesboththefirm’s
employment(from25to40workers)andcapitalstock.
Inadditiontoexpandingitsscale,thewagecutencouragesthefirm toadopt
adifferentmethodofproduction,onethatismorelabourintensivetotake
Employment504025
D
200
100
D
R
Q
P
C0/r
C1/r

38. 38
advantageofthenow-cheaperlabour.Thesubstitutioneffectindicateswhat
happenstothefirm’semploymentasthewagechanges,holdingoutput
constantandisgivenbythemovefrom QtoR.Holdingoutputconstantat
200units,thefirm adoptamorelabour-intensiveinputmixsubstitutingaway
from capitaland toward labour.Substituting effectraises the firm’s
employmentfrom 40 to 50 workers.NB:The substitution effectmust
decreasethefirm’sdemandforcapital.
Boththesubstitutionandscaleeffectinducethefirm tohiremoreworkersas
wagefalls.
Theabovediagram indicatesthatthefirm hiresmorecapitalwhenwagefalls,
sothatthescaleeffect(whichincreasesthedemandforcapital)outweighs
thesubstitutioneffect(whichreducesthedemandforcapital).Thefirmwould
uselesscapitalifthesubstitutioneffectdominatedthescaleeffect.
3.6Summary
 Intheshort-run,aprofitmaximizingfirm hireworkersuptothepoint
wherethewageequalsthevalueofmarginalproductoflabour
 Inthelong-run,aprofitmaximizingfirmhireseachinputuptothepoint
wherethepriceoftheinputsequalsthevalueofmarginalproductof
theinput.Thisconditionimpliesthattheoptimalinputmixisonein
whichtheratioofmarginalproductoflabourandcapitalequalsthe
ratioofinputprices.
Activity
1 Whyistheshort-rundemandcurvedownwardsloping?
2 Whatmixofinputsshouldbeusedtoproduceagivenlevelof
output?

39. 39
LESSONFOUR
WAGETHEORIES
4.0Introduction
Wagesarethepricepaidfortheuseoflabor.Theyareusuallyexpressedas
timerates,suchasacertainamountperhour,day,orweek.Theyarealso

40. 40
expressed as piece rates,such as a certain amountperunitofwork
performedorProductproduced.
4.1LessonObjectives
Bytheendofthelessonthelearnershouldbeableto:
1.Explainthevarioustheoriesofwages
4.2THEORIESOFWAGES
Differenttheorieshavebeenputforwardfrom timetotimetoexplainhow
wagesaredetermined.Earlyeconomistsattemptingtoexplainhowlabours
share ofthe community’s wealth should be determined,proposed the
followingtheories.
4.2.1 Subsistencetheoryofwages:
Thisisalsocalledtheironorbrazenlawofwages.Accordingtothistheory,
labourpowerisacommoditywhosepriceisdeterminedbythecostof
productioni.e.theminimumsubsistenceexpensesrequiredforthesupportof
theworkerandhis/herfamilyinorderthatcontinoussupplyoflabouris
maintained. Theproponentsofthistheoryarguedthatwagestendtosettle
attheleveljustsufficienttomaintaintheworkerandhisfamilyataminimum
subsistencelevel.Ifatanytimewagesexceededthislevel,itissaidthat
workerswouldbeencouragedtomarry;theirnumberswouldincreaseuntil
thelargersupplyoflabourbringsdownthewagestothesubsistencelevelas
aresultofcompetitionbetweenworkersforjobs.Ifontheotherhandwages
slippedbelow thesubsistencelevel,therewouldbereductioninpopulation
throughdiscouragedmarriagesanddeathsduetoundernourishmentleading
toashortageinthesupplyoflabour.Thistendencywillcontinuetooperate
untilwagesareraisedtoreachtheminimumsubsistencelevel. Accordingto
thistheory,therefore,wagescannotfallbelow orriseabovetheminimum
subsistencelevel.

41. 41
Criticisms
I. BasedonMalthusianTheoryofpopulation:Thesaidtheoryisbasedonthe
Malthusian theory population which incidentally has a number of
shortcomings.
II. Empiricallywrong:criticsmaintainthatthetheoryisnotonlyempirically
wrongbutalsohistoricallyincorrect. Experiencesshowsthatarisein
wagesisnotalwaysaccompaniedbyincreaseinpopulation,ratheritis
followedbyadeclineintherateofpopulationgrowth.
III. Thetheoryisunabletoexplaincausesofwagedifferentials: Thelabour
marketischaracterizedbywagerateheterogeneity.Ifwageweretobe
equaltothesubsistencelevel,thewageswouldinmostcasebeuniform.
IV. One-sided Theory: Thistheoryapproachesthepopulation ofwage
determinationfrom thesideofsupplyandcompletelyignoresthedemand
side. Itisthereforeunbalanced.
V. Thetheorydisregardofproductivity: accordingtothistheory,wagerate
forallworkerstendtobeequaltotheminimum subsistencelevel.Butit
doesn’thavetobesobecauseworkersdifferintheirlevelofproduction.
4.2.2 WageFundTheory:
Accordingtothistheory,wagesaredeterminedatanygiventimebytheratio
betweenthetotalsupplyoflabourandthewagefundwhichconsistthatpart
ofcirculatingcapitalwhichissetasidebytheentrepreneursforthepurchase
oftheservicesoflabour.Thusaccordingtothistheory,wagescanonly
increaseeitherwhenwagefundincreasesortheworkforcegoesdown. The
theoryarguesthatthewagefundcanbeincreasedbysavingwhichisnot
underthe controlofworkers.This implies thatifworkers wantan
improvementintheirwages,theirnumbersshouldbereduced.
Criticisms
I. Unscientific:Thetheoryhasbeendisregardedongroundsthatitisnot
scientificsinceitrestsupontheideaofafixedfund. Wagesarepaidout
ofafirm’sincomeandnotoutofafixedfundsetapartbyentrepreneurs
forpurposeofpurchasingservicesoflabour.
II. Differencesinwages:Thistheorycannotexplaintheexistenceofwage
differentialsamongworkers.Criticsmaintainthatifwagesarenotpaid

42. 42
outofafixedfundandthewageratedependsuponthenumberofworkers
inemployment,thenitfollowsthatwageratemustbeuniform throughout
thecountry. Thisisnotthecase.
III. Homogeneityoflabour: Thetheoryrestsuponhomogeneityoflabour
whenworkershavedifferentlevelsofefficiencyandproductivity.
IV. IgnorestheinfluenceofTradeUnions:Inmostworld,tradeunionsareable
toeffectarisewagelevelsbyeitherrestrictingthesupplyorincreasing
productivity. The wage fund theory is incomplete to explain the
phenomenon.
V. Ignoresproductivity. Themaindefectofthetheoryisthatitcompletely
ignorestheeffectofproductivityonwages. Productivityisamajorfactor
forwagecompensations.
4.2.3 Residualclaimanttheory.
ThistheorywasdevelopedbyanAmericanEconomistFrancisA.Walker.
Thetheorystatesthatworkersshouldbepaidafterallotherinputsof
productionhavebeenpaid.Capitalispaidtheinterest,landownersarepaid
theirrentandbusinessownersarepaidtheirprofits.Whatremainsiswhat
goestoworkersaswages.Thetheorymaintainsthatwagesareequaltothe
wholeproductminuspaymentstotheotherfactorsofproduction.Thetheory
regardsworkersastheresidualclaimantoftheproductoftheindustry. The
theoryholdsouttoworkersapossibilityofincreasingtheirwagesandthus
improvingtheirlotiftheyworkedhard.

43. 43
Criticisms
I. Entrepreneuristheresidualclaimant: Thetheorydonotexplainwhy
labourshouldberegardedastheresidualclaimanttotheproductofthe
individualwheninrealsenseitistheentrepreneurandnottheworkerwho
istheresidualclaimant.
II. Onesidetheory.Thetheoryconcentratesonthedemandsidetothe
completeneglectofthesupplyside.
III. Determinationofrents,interestandprofits. Theproponentsofthetheory
didnotexplainhowthepaymenttotheotherfactorsofproductionwasto
bearrivedat.
4.2.4MARGINALPRODUCTIONTHEORY
Thistheorystatesthatthepriceofafactorisdeterminedbyitsmarginal
productivity.Thewagesinacompetitivemarkettendtobeequaltothe
marginalproductoflabour. Marginalproductivityisanadditiontototal
productivityresultingfromtheemploymentofanadditionalunitoflabour.The
theoryassetsthatnoworkerunderconditionsofperfectcompetitioncan
expecttoreceivewagesabovetheabovethevalueofitsmarginalproductof
labourareequalisreached.Inacompetitivemarket,payingfactorsof
production according to theirmarginalproductivity means an efficient
allocationoffactorsofproductioninaproductiveprocess.Wagerateisequal
tothevalueofmarginalproductivityoflabour.
Criticisms
I. Thetheoryassumesthatallunitsoflabourarenothomogenous,sothat
anyworkerisasproductiveastheotherfactor.Thisisnotfivesince
workershavedifferentattributes.
II. Itassumesthattheamountoflabourusedintheproductioncanbe
continuously varied. This may notbe always true and in the
circumstancestheuseoflabourcannotbepusheduptothepointwhenits
marginalproductivitybecomesequaltowagerate.
III. Assumesperfectmobilityoflabourwhichisnotrealistic.
IV. Theoryisvalidonlyunderperfectcompetitionwhichdoesnotexist. It
breaksdowninreallife.

44. 44
V. Thetheoryimpliesthatemploymentcanbeincreasedbyreducingwages
sothatmorelabourisemployedsoastomakewagesequaltomarginal
production.Theargumentisfallacioustakingintoaccountdownward
wagerigidityandmaynotapplyinthecaseofthenationaleconomy.Total
employmentinacountrydependsoneffectiveoraggregateddemand
whichexplainstheeconomy’sproductiveandabsorptivecapacities.
4.2.5ModernTheoryofWages
Accordingtothistheory,wagesaredeterminedbytheinteractionofthe
forcesofdemandandsupplyinthelabourmarketatanygiventime..Thisis
alsocalledthemarkettheoryofwagesorthedemandandsupplytheory.
Themajordisadvantageofthistheoryisthatlabourmarketisnotperfect
since itis characterized by monopoly,monopsony,bilateralmonopoly
conditions, trade unions, employer’s associations and government
interventionwhichcreateimperfectioninthemarket.
Summary
 Therearevarioustheoriesofwages
Activity

45. 45
Explainthemoderntheoryofwagedetermination
LESSONFIVE
LABOURMARKETEQUILIBRIUM:WAGEANDEMPLOYMENT
DETERMINATION
5.0Introduction
Thischapteranalysesthepropertiesofequilibrium inaperfectlycompetitive
labourmarket.Wewillseethatifmarketsarecompetitiveandiffirmsand
workersarefreetoenterandleavethesemarkets,theequilibrium allocation
ofworkerstofirmsisefficient;thesortingofworkerstofirmsmaximizesthe
totalgainthatworkersandfirmsaccumulatebytradingwitheachother.
Wewillalso analyzethepropertiesoflabourmarketequilibrium under
alternativemarketstructures,suchasmonopsonies(wherethereisonlyone
buyeroflabour),monopolies(wherethereisonlyoneselleroftheoutput)
andbilateralwherethereisonebuyeroflabourandoneselleroftheoutput.
5.1LessonObjectives
Bytheendofthelessonthelearnershouldbeableto:
1.Determinetheequilibriumwageandemploymentin
 Perfectlabormarkets
 Imperfectlabormarkets
 MonopsonyLabourMarket
 Monopolylabourmarkets
 Bilateralmonopolylabourmarkets
2.Explaintheminimumwage
5.2Wage-DeterminationModels

46. 46
How arewagesdeterminedinthemarketatanygiventime?Theanswer
dependsonthetypeofmarketmodelthatisassumedtoexistinaparticular
situation.Thereareseveralpossibilities.
5.2.1WageandEmploymentDeterminationinPerfectLabourMarkets
Itischaracterizedby;ManyBuyers,ManySellers,perfectknowledgeforboth
workersandthefirms,perfectmobilityofworkers,minimum government
intervention,homogeneousworkersandidenticaljobs.Conventionally,the
demandforandsupplyoflabourarefunctionsofwages(W/p).Equilibrium in
thecompetitivelabourmarketisdeterminedbytheforcesofdemandand
supply.Itrequiresthataggregatedemandforlabourbeequaltotheaggregate
supply. ThusNd=Ns=Ld=Ls.WhreNdistheaggregatedemandforlabour,
Nsistheaggregatesupplyoflabour,LdisthedemandcurveforlabourandLs
isthesupplycurveoflabour
Figure5.0
RealWage
N*
Unitsof labour
Itisassumedthattheaggregatelabourdemandandsupplyfunctionsare
suchthattheyproduceuniqueequilibriumatE*. Theequilibriumisexpected
tobestablebecausearealwagerateabovetheequilibrium W/Pwillgenerate
excesssupplyandforagivenpricelevel,themoneywagewillbebiddownas
workerscompleteforjobs. Thiswillincreaselabourdemandandreduce
laboursupply. ThisadjustmentwillcontinueuntilE*isrestored. Therefore
thedirectcompetitionbetweenworkerstheirwillingnesstotoleratewage
reductionswillensurethatE*isstable.
E*
Nd(
w
/p)=Ns(
w
/p)
w
/p
w
/p
Ld(
w
/p)
Ls(
w
/p)

47. 47
Stabilityinthismodelrequiresthatadjustmentintherealwagesoccur
throughadjustmentsinthemoneywageforagivenprice.
Labourmarketsdonotoftenoperateundercompetitiveconditionsbecauseof
certainfeaturesthatpreventmoneywagesfrom beingflexible.Thefeatures
resultinrigiditiesinmoneywagesmakingittofailtoadjustfreelytoeliminate
excessdemandorexcesssupplyoflabourinstantly. Thesefeaturesare:-
(a)Institutionalrigidities
(b)Misperceptionsaboutchangesinwagesandprice.
(c)Difficultiescausedbyuncertaintiesandformationofexpectations.
(d)Governmentregulations
(e)Contracts
(f)Efficientlywagetheory
(g)Caseofinsidersandoutsiders:
Institutionalrigidities
a)Unionexplanation
Thisoccursbecauseunionssuccessfullyresistanyattemptbyfirmsto
reducewagesorundercuteachotherinmoneywages. Theyresistany
attemptbyfirmsto encourage the process. The unionsdo however
welcomewageincreases. Hencethereisdownwardmoneyrigidity.
Theinitialmoneywageemploymentequilibrium isat(Wo,No). Themoney
wageWo isregardedbyworkerscollectivelyasrepresentingaminimum
standardoflivingwhichmustbeprotectedatallcosts. Forequilibriumtobe
attained,adownwardadjustmentofwageswouldberequired. However
downward pressureonwagesisresisted and disequilibrium willpersist
indefinitely.
(ii)Efficientlywagetheory. Accordingtothistheory,firmsmayprefertoset
wagesabovecompetitivelevelsbecausetheyarguethathighwageswould
motivateworkerstoimproveproductivity. Withsuchwages,employees
wouldearneconomicrentswiththecurrentemployer,athingwhichtheywill
strivetomaintainbyimprovingproductivityandloyaltysoastoreduce
chancesoflayoffs. Ifallfirmsfinditprofitabletopaywagesthatarehigher
thanthecompetitivelevel,thelevelofemploymentwillfallbelowcompetitive
levels.High unemploymentrates lowerprobability thatan unemployed

48. 48
individualwillfindajob. Sothethreatofunemploymentinduceshigher
effortsonthepartoftheemployed.
iii) Caseofinsidersandoutsiders: Whenallfirmsareisolatedfrom labour
marketcompetitiontheunemployed(outsiders)arenotregardedasperfect
substitutesfortheexisting employees(insiders). Insidersareexisting
employees,whosepositionisprotectedbyexistenceofsignificantlabour
marketadjustmentcostssuchastraining,hiringandfiringcosts.Outsidersof
whounemployedarethemostimportantcanonlyexertanindirectpressure
onthewageandjobsecurityofinsidersbecausetheyarepreventedfordirect
competitionbytheinsiders.Insiderswillhaveundergoneonthejobtraining
withtheemployerandthisgivesthem advantageovertheoutsiders. Firms
willhaveabargainingnichetosecurehigherwages.Theoutsiderscannot
thereforebiddowntheinsiderswageinordertosecureemployment.
(IV)Misperceptionsaboutchangesinwagesandprices
Inreallife,economicagentsmayattachgreatersignificancetonominal
wagesthatrealwages. Thismaybeduetoperceptionormoneyillusion.
Completemoneyillusiononthepartofworkersinvolveconsideringmoney
wagesastheimportantindicatorofwell-being.Allpricemovementsare
thereforeignored. Oneexplanationforthisirrationalbehavioristhatisifthe
economyhavehadlongperiodsofpricestabilityworkerswillbecomfortable
withthecurrentmoneywages. Whenpricesstarttofluctuateworkerswho
arenotusedtoitwillpersistwiththeirhabitofignoringthepricechanges
sincetheywillregardthem asbeingrelative.Thusanincreaseinpricewillbe
presumedtobeoffsetelsewherebysimilarpricereductiononothergoodsas
regardedastemporaryhenceignore.
When priceinstabilitycontinuesforalong time,moneyillusion willbe
consideredtobeirrationalandworkerswillrecognizetheeffectchangesin
priceontheirrealwages.
(V)Theroleofexpectations
Inthiscase,wenotetheexistenceofincompleteinformationwhichgenerates
theneedforformationofexpectationsbyeconomicagents. Itisconsidered
thatfirmsknowthepriceforcertainandareabletomakeinformedjudgment
overfutureprices.Workershoweverguessesabouttheexpectedpricelevel
byrelyingontheirpastmistakestoimproveontheirforecastaboutfuture
pricelevels. Sotheremaybedifficultyincalculatingrealwagesbecauseof
uncertainitityaboutfuturepricelevels.

49. 49
Governmentmay intervene in labourmarketthrough minimum wage
regulationsothatthereisawagefloorbelowwhichfirmsarenotallowedto
pay.Ifthewagefloorisabovethecompetitivemarketlevel,thenitwouldpose
rigidity.
5.3.2WageandEmploymentDeterminationinImperfectLabourMarkets
Theforegoingmodelofwageandemploymentdeterminationdisclosesa
greatdealaboutsupply-and-demandforcesinthelabormarket.Butthe
modelisidealizations,orsimplifications,ofreal¬ity.Intherealworld,the
labormarketcontainsmanycomplexitiesandimperfections.Asaresult
actualwageandemploymentlevelsmaydifferfrom whatthemodelpredict.
Whataresomeofthemainsourcesoflabor-marketimperfections?
1.WorkerHeterogeneity
Mostworkersdonotsellhomogeneousunitsatlaborasthelabor-market
modelsassume.Thisisbecausepeopledifferinbothnaturalendowment
andintheskillsandexperiencestheyhavetooffer.Someworkersdevote
extrayearstoschoolingandtospecializedtraining.Inreturntheyearnhigher
lifetimeincomesthanthosewho nevermakethesacrificesneededto
improvetheirqualifications.Theseeffortsatjobpreparationandtrainingare
called"humancapitalinvestment."Ithelpsex¬plainsomeofthevariationsin
wageandemploy¬mentlevelsthatexistinreal-worldlabormarkets.
2.ImperfectKnowledge
Neitherworkers noremployers have complete in¬formation aboutjob
opportunitiesandjobseekers.Consequently,bothsearch.
(i)WorkerJob SearchThosewho areseeking em¬ploymentweighthe
benefitsoflookingforworkagainstitscosts.Thechiefbenefitsarethe
addi¬tional,orperhapsbetter,jobopeningsthatmaybediscoveredfrom
furthersearch.Themaincostsarethesumoftwotypes:
1.Thedirectexpenses(suchastravelingcostsandthecostsofmeals
awayfromhome)thatarein¬curredinlookingforemployment.
2.Theopportunitycostoflostincomefromquittingajobinordertolookfor
work,orfromnottakingjobsthatareavailable.
Asthejobsearchcontinues,desirablenewopen¬ingsbecomehardertofind.
Discouragementbeginstosetinasthemarginalbenefitoffurthersearch
declines while the marginalcostrises.When marginalbenefitequals
marginalcost,fur¬thersearchisnolongeradvantageous.Atthatpointthe
workerstopslookingandacceptsemploy¬ment.

50. 50
(ii) EmployerJob Search Employers adjustto limited labor-market
information quite differentlyfrom workers.Two types ofmanagement
policieshelpexplainwhy.
First,thereisatrade-offbetweenwagecostsandsearchcosts.Otherthings
remainingthesame,firmsthatpayabove-averagewageratessoonbe¬come
widelyknown.Thesefirmsfindthattheycanattractworkersmoreeasilyand
spendlessonrecruitmentthanfirmsthatpaybelow-averagewages.Thisis
onereasonwhywageandemploy¬mentlevelsinactuallabormarketsmay
varysignif¬icantlyfromwhattheoreticallabor-marketmodelspredict.
Second,manycompaniesfollow apolicyofpro¬motionfrom within.Such
firms place a minimum dependence on outside recruitment,preferring
in¬steadtocreatetheirowninternallabormarkets.Eachfirm'sinternal
market contains its own rules governing job movement within the
organization.Totheextentthatcompaniesrelyonsuchmarkets,theylimit
theabilityofworkerstomovefrom onefirm toanother.Thisimpedesworker
mobilityandthereforereducestheefficiencyofexternallabormarkets..
3.SegmentedLaborMarkets
Athirdsourceofimperfectionthattendstoreducetheefficiencyoflabor
marketsliesinthestructureofthesemarkets.Insteadofbeingintegratedinto
aunifiedwholeasthetheoreticalmodelsassume,real-worldlabormarkets
appeartobesegmented.Eachmarkethasitsowncharacteristicsthathelp
determinewageand/oremploymentlevels.Twotypesthatareespecially
relevanttodayarethejob-competitionmarketandduallabormarket.Both
types,proposedbyvariouslaborexperts,arehy¬potheses.Theyattemptto
explainfurtherhowsomemodernlabormarketsoperate.
(i)Job-competitionMarketThisisalabormarketinwhichthenumberand
types ofjobs are determined mainlybyprevailing technology.Workers
com¬petewitheachothertofillparticularjobopeningsassociatedwith
existing plantand equipment.(A factory,forexample,needsaspecific
numberofop¬erators,maintenance people,supervisors,etc.to run its
machines.)Wagesforthesejobsareestab¬lishedlargelybyinstitutionaland
legislativecondi¬tions.Theseincludeindustrycustom,union-man¬agement
contracts,andminimum-wagelaws.Marketforcesplayarelativelyminorrole
inaffect¬ingwages.Thefunctionofjob-competitionmar¬kets,therefore,isto
allocateworkerstoagivennumberofvacanciesatprevailing,relativelyfixed,
wagerates.
(ii) DualLaborMarketThisisactuallytwodistinctmarkets.Oneisa
primarylabormarket,inwhichjobsarecharacterizedbyrelativelyhighwages,

51. 51
fa¬vorableworkingconditions,andemploymentsta¬bility.Theotherisa
secondarylabormarket,inwhichjobs,whentheyareavailable,payrelatively
low wages,providepoorworkingconditions,andarehighlyunstable.Both
white-collarworkers and blue-collarworkers,manyofwhom are union
members,accountformostoftheparticipantsintheprimarymarket.In
contrast,thecompetitively"disadvantaged"—theunskilled,theundereducated,
andthevictimsofracialprejudice—arecon¬finedtothesecondarymarket.
Imperfectlabourmarketismadeupofmonopsony,monopolyandbilateral
labourmarketasexplainedbelow.
5.3.3WageandEmploymentDeterminationInaMonopsonyLabourMarket:
OneBuyer,ManySellers
Amonopsonyisamarketstructureconsistingofasinglebuyerandmany
sellersofagoodorservice.Hence,itmaybethoughtofasa"buyer's
monop¬oly." Anexam¬plewouldbeafirm thatisthesoleemployerina
companytown,ashasbeenthecaseinmanyminingcommunities.Similarly,
insomefarm areasasin¬glefood-processingplantdominatesemployment
formanymilesaround.Itcanalsorepresentthefederationofemployers.
Table5.0
AMonopsonyModelofWageDetermination
CostScheduleofLabourFactor
Unitsoflabourfactor
F
average cost of
labourfactor=(wage
rate orsupplyprice
oflabour),ACForS
Total
costof
labor
factor,
TCF
Marginal
costoflabor
factor,MFC
1 $5 $5
$7
2 6 12
9
3 7 21
11
4 8 32
13

52. 52
5 9 45
Figure5.3
O QUANTITYOFLABOUR
Notefrom thesecondcolumnofthetable5.0thatthemonopsonistmust
offerahigherwagerateunitforallunitsinordertoacquiremorelabor.The
resultisthatthemarginalcostoflaborwillbegreaterthantheaveragecost
ateachinput,asshowninthefigure.
Themostprofitableinputlevelisdetermined,asalways,bythelocationof
thepointatwhichMCF=MRP.Thus,themonopsonistwillemployLunitsof
laborandpaythelowestpossiblepriceforthatquantityoflabor,namelyLT
perunit.Asaresult,input,ascomparedtotheamountatN,willberestricted.
Further,thepriceperunit,ascom¬paredtothewageNW,willbelowerthan
itwouldhavebeenifthemonopsonistwereaperfectlycom¬petitivebuyer
intheinputmarket.
5.3.4WageandEmploymentDeterminationinMonopolyLabourMarket:One
Seller,ManyBuyers
Supposeaunionofallskilledworkersinaparticulartrade(suchasprintingor
plumbing),facesamarketconsistingofmanybuyersofthatparticularskill.
Theunionisthenanexampleofalabormonopoly.Whatlevelofwagesand
whatcorresponding volume oflaboroutputwillresult? The modelis
illustratedinfigure5.4
Wage
MCF
ACF
or
S
Averagecostof
laborfactorACF,
orlaborsupplyS,
availabletothe
firm
MRP=D
(Firm’sdemand
forlabor)
Competitive
input
Monopsony
wage
Compe-
titive
wage
W
T
Monopson
y
L
N

53. 53
Figure5.4
Amonopolymodelofwagedetermination
O N1 N
ThecurvesSandDrepresentthenormalsupplyanddemandcurvesforlabor
inafreemarket.Theequilibrium quantityoflaborwillbeatN andthe
equilibriumwagewillbeatW.Amonopolyunion,however,willseektorestrict
thesupplyofitslaborinordertoattainahigherwageforitsmembers.The
unionwillthusshiftthesupplycurvetotheleftfrom StoS'.Thiswillreduce
theequilibrium quantityoflabortothelevelatN1andraisetheequilibrium
wagetothelevelatW1.
Thisanalysishelpsexplainwhysomelaborunions,especiallycertaincraft
unions,haveestab¬lishedlongapprenticeshiprequirements,highini¬tiation
fees,andsimilarobstaclestoentry.Thesameistrueofcertainprofessional
associationsinsuchfieldsasmedicine,law,andengineering.Theirmotives,
atleastpartly,havebeentocurbthesupplyoflaborinthemarketandthusto
boostwagerates.Ofcourse,therearealsounionsthatdonotseekto
maximizewages.TheymaytrytomaximizethemodelinExhibit3wouldhave
tobemodifiedreflect.theseobjectives.
5.3.5WageandEmploymentDeterminationInaBilateralMonopolyLabour
Market:OneBuyer,OneSeller
Abilateralmonopolyisamarketstructureinwhichamonopsonistbuysfrom
amonopolist.Thesimplestversion,whichcombinesthemainfeaturesofthe
previousmonopsonyandmonopolymodels,isshowninfigure5.5
Wage
W1
W
S’(restricted
supply)
S(unrestricted
supply)
D

54. 54
Figure5.5
ABilateralMonopolyModelofWageDetermination
O N1 N
QUANTITYOFLABOUR
Boththebuyerandthesellerareseekingtomaxi¬mizetheirnetbenefits
fromthetransaction.Therefore,letusassumethatthetwopartiescanagree
onagivenquantitytobeexchanged,saytheamountatM.Itfollowsthatthe
monopsonistwillwishtopurchasethatquantityfarthelowerpriceatU.On
theotherhand,themonopolistwillwanttosellthatquantityforthehigher
priceatV.Whatwillbethetransactionprice?
Thewagelevelwillbesomewherebetweenthemonopsonist'spreferredrate
atUandthemonop¬olist'spreferredrateatV.Thepreciselevelwilldepend
ontherelativebargainingstrengthofthetwoparties.
SupposeawagelevelofapproximatelyW isne¬gotiated.Managementwill
thenfinditprofitabletohiremoreworkers— uptotheamountatN.This
suggestsaninterestingconclusion.Inabilateralmonopoly,wagesand
employmentmayapproximatecompetitivelevelsmorecloselythanwould
occurundermonopolyormonopsonyalone.
5.4Minimum-WageModel
Wage
Monopol
y
Uniona
Preferred
wage
S’(restricted
supply)
S Monopoly
Union’s
Supply
Oflabour
MRP=D
Monopoly
D Employer’s
demand
Oflabour
Monopoly
Uniona
Preferred
wage
Undeterminat
e
New
Benefit
V
W
U

55. 55
Unionsarenottheonlygroupsinsocietythatcanaffectwagesand
employment.Governmentcantoo.Oneofthewaysitcandothisisby
imposingaminimumwage.
Theobjectivesofsuchlegislationare:
1.Topreventfirmsfrom payingsubstandardwageswhenlabor-market
conditionsenablethemtodoso.
2.Toestablishawagefloorrepresentingsomemin¬imallevelofliving.
3.Toincreasepurchasingpowerbyraisingthein¬comesoflow-wage
workers.
Analyzing the Effects ofMinimum Wages Whatare the economic
consequencesofminimum wages?Someoftheanswersarenotcertain
be¬causeminimum wageshavemanyeffectsandim¬plications.Youcan
gainsomeappreciationofthesebyexaminingthemodelsinExhibit7.
Figure4.9
Minimum-WageModel:RaiseWorkers'Wages
Wages
W’ S
W
D
Laborsurplus(unemployment)

56. 56
0 K E L
WorkersThousands
Thefree-marketequilibriumwageisatWandthecorrespondingequilibrium
levelofemploymentisatE.Ifsocietydeemsthiswageratetobe"toolow,"
itwillsupportlegislationtoraisetherateto,say,W’.Atthiswagelevel,
employerswillwanttohirethenumberofworkersequaltothedistanceOK.
However,thenumberofworkersthatwilloffertheirlaboratthiswagelevel
isOL.Thequantityoflaborsuppliedthusexceedsthequantitydemanded
atthewageW’.Hencethereisasurplusoflabor—apoolofunem¬ployed
humanresources—equaltotheamountKL.
Itisinterestingtonotethatthelaborsurplusconsistsoftwotypesof
unemployedpeople:
1.ThosewhowerepreviouslyemployedatawageofW andhavebecome
unemployedatawageofW’.
2.ThosewhowerenotpreviouslyinthelaborforceatthewageofW but
havedecidedtoenteritatthewageofW’.
5.5Summary
1.Determinationoftheequilibriumwageandemployment
2.Minimumwage
5.labourmarketimperfections
Activity
Whatisminimumwage

57. 57
LESSONSIX
LABOURMARKETDISCRIMINATION
6.0Introduction
We will demonstrate that differences in earnings and employment
opportunitiesmayariseevenamongequallyskilledworkersemployedinthe
samejobsimplybecauseoftheworkersrace,gender,nationalorigin,sexual
orientation,orotherseeminglyirrelevantcharacteristics
These differences are often attributed to labourmarketdiscrimination.
Discrimination occurs when participants in the marketplace take into
accountsuchfactorsasraceandsexwhenmakingeconomicdecisions
Thereisagreatvarietyofoccupationswhichwomenhavebeguntoclaim as
fieldsforindividualeffortfrom whichnointelligent,refinedmanwhoviews
thingsastheyreallyarewouldseektoexcludethem.
Womenarealongwayfrom jobequalitywithmen.Despitesubstan¬tial
progress,variousstudiesshowthatwomenoftenearnconsiderablylessthan
meninthesameoccupationalcategory.
Much the same is true of certain minority groups.Blacks,Asians,
homosexuals,andmem¬bersofothergroupshavelongbeenvictimsof
discriminationinemployment.Letuslookatsomeoftheeffectsofjob
discrimination,andsomeofthe'effectsthatwouldoccurifitwereeliminated.
6.1LessonObjectives

58. 58
Bytheendofthelessonthelearnershouldbeableto:
1.Explainthecausesofwagediscrimination
2.Explaintheoreticalmodelsofwagediscrimination
3.Discusstheeffectsofeliminatingdiscrimination
6.2Whatarethecausesofwagediscrimination?
The economic analysis ofdiscrimination is based on the premise that
significantwageandemploymentdifferencespersistbetweengroupsinthe
labourforcethatarenotjustifiedbydifferenceinproductivityandhuman
capitalinvestment.labourmarketdiscriminationisthereforeanddoexist
whenworkerswithidenticalproductivecapabilitiesreceivedifferentrewards
fortheireffort.Employmentdiscriminationiswhenblackpeopleforexample
bear a disproportionate burden of unemployment. Occupational
discriminationoccurswhenfemales,forexample,arerestrictedfrom entering
certainoccupations,and/orcrowdedintoothers,despiteequalcapabilities
betweenthemandmales.
6.3Theoreticalmodelsofwagediscrimination
Attheoreticallevel,there are two main schools ofeconomic thought
regardingdiscriminations. Oneistheneoclassicaltheorystemmingfromthe
World ofBecker(1957)whichisbased onthenotionthatprejudiceis
expressedindiscriminatorytastesonthepartofemployers,workersand
consumer.The alternative is the segmented labourmarketapproach
(two-marketmodel),which can trace its heritage back to theory of
non-competinggroupsintheworkofMill(1885).
6.3.1The NeoclassicalTasteModel
Themoderneconomicanalysisofdiscriminationinthelabourmarketis
foundeduponseminalworkofAmericanEconomistBecker(1957). Becker
integrated the conceptofdiscrimination with mainstream neoclassical

59. 59
microeconomicanalysisbysuggestingthatonegrouphasa“taste”for
discriminatingagainstanothergroupandthatthistastewasafactorinto
utilityfunction.Heidentifiedanumberofgroupsthatcouldbeascribedtoa
tastefordiscrimination:workers,employersandconsumers. However,most
oftheneoclassicalanalysisofdiscriminationhascentredontheemployeras
theagentofdiscrimination. Accordingly,weshallsettheneoclassical
employertastemodel.
In the standard neoclassicaltheory,we assume thatfirms are profit
maximizers.Inotherwordstheirutilityisafunctionofprofit.U=f(π)and
workers’utilityisafunctionofwageincomesandleisure U =F(W,L).
Discrimination is introduced by allowing firms to have “a taste for
discrimination. Inthistheoryitisarguedthatemployershaveatasteoffor
discrimination in the sense thattheirutility is adversely affected by
employmentof,andwagespaidto,thegroupbeingdiscriminatedagainst,in
thiscaseweassumefemales(F). Althoughthemonetarycostofemploying
malesandfemalesaregivenbytheirwages,Wm andWfrespectively,the
disutilityexperiencedfromhiringwomenaffectsthenetcostsuchthat
WF=WF(1+d)
Wheredisthediscriminationcoefficient. Ifanemployerfavourswomen
workers,dwillassumeanegativevalue.Ifthefirm iscompletelyindifferent
betweenmalesandfemale;whenitcomestohiringworkers,d=0.Yetifan
employerdiscriminatesagainstwomenthendwillbepositive.
Asfirmsemploymoreandmorefemaleworkers,uptoamaximum of100%,
theyrequiremoreprofittocompensatethemfortheassociateddisutility.
Figure6.0
D1
SF
1.0
0.75
0.66
Wageratio
Wf/Wm

60. 60
O L0 L3 L2
L1 Employment
D2
D3

61. 61
Thehorizontalportionofdemandcurverepresentthelabourdemandof
non-discriminatingemployers(d=0)since,ifmajorityandminorityworkers
areassumedtobeequallyproductive,non-discriminatorwouldbewillingto
hireminorityworkerswheneverWf≤Wm.Beyondthekink,theremaining
employershaveincreasingamountsofprejudice(d>0)andwouldonlyhire
minorityworkers atsuccessivelylowerrelative wages.Finally,ifsame
minorityemployerspracticedfavourism towardsminorityworkers,then(d<
0),andtheinitialofthedemandcurvewouldthenlieabove1.
Thediagram showsasituationwhereaconventionallyslopedfemalelabour
supplycurve(SF)encounterthreedifferentsetsofdemandconditions. The
first,D1representsasituationwherethereislackofanydiscrimination.It
identifiesamaximum potentialemploymentlevelL1,atwageratesequalto
thoseofmaleworkershencewf/wm =1.
Ifacertainproportionofemployersdiscriminateagainstwomenintheirhiring
practicesthisgivesthedemandcurveforfemalelabour,Kinkatemployment
levelLO.ConsiderD2non-discriminatingfirm’sdemandconditionsapplyto
LO;beyond Lo,prejudiced employers require a wage differentialto
compensatethem forthelossofutilityarisingfrom thehiringofmorefemale
workers.Discriminationcreatesagapbetweenwagesofmenandwomen.
Intheexamplefemaleworkerswouldearnonlythree–quotasofwhatamale
workerlearns(WF/WM =0.75).InactualfemaleemploymentlevelofL2is
lessthanthepotentialmaximum becauseofdiscriminationinthelabour
market.Thehigherthediscriminationthewiderthegap.
Eventhoughproportionsoffirmsarepreparednottodiscriminateagainst
employingwomen,theywillpaythegoingmarketrate⅔ ofamaleworker’s
wagerateinthecaseofD3.Inthiscasefemalewageshaveincreased
overtimerelativetomen’sandtheearninggaphasnarrowed.Thisimplicates
achangeinemployertastes. Suchachangecouldbebroughtaboutby
competitionfrom lessdiscriminatingfirms,oritcouldbeduetogreater
awarenessoftheworthofwomenworkersacquiredfrom information,direct
experienceofenforcementofequalpartopportunitieslegislation.
Afundamentalassumptionofthismodelisthatmaleandfemaleworkersare
equallyproductive.
Higherπsattractothernon-discriminatingfirmsintothemarketandshould
enticeexistingfirmstochangetheirrecruitmentpoliciesinfavourofwomen
workers. New entrantswillincreaseoutputanddepresspricesandIIs.
Discriminatingfirmsmustthereforeeitheremployfemaleworkersorface
makinglosses,decliningmarketsharesandeventuallygivingoutofbusiness.

62. 62
New entrantsandalteredhiringpoliciesincreasethedemandforfemale
workers,ashiftfrom D3toD2.Thisincreasesfemaleemploymentandraise
women’swageratesrelativetothoseofmen. Thesexearningsgapnarrows
ascompetitiveforcestendthelabourmarkettowardstheequalityWf=Wm.
Discriminationcanonlyexistintheshortrunifthecompetitivemechanism
failstooperateeffectivelyasinthecaseoflabourmarketimperfections.
Conditionunderwhichdiscriminationcanpersisteveninthelongrun:-
 Iffirmspossessadegreeofmarketpowerinanoligopolisticmarket
structures.
 IffirmsdonotaimatmaximizingIIs,discriminationcouldbetoleratedasa
drainonIIs.
 Theerosionofdiscriminationcompetitioncouldbealengthyaincomplete
processbecauseoftheadjustment(hiringandfiring)costsassociated
withreplacingmalewithfemaleworkerstotakeadvantageofthefactthat
Wm >Wf.
 Prospectsofreducingdiscriminationmaywellvaryoverthebusiness
cyclei.e.recessionandboom.
 Anotheraspectofsexdiscriminationisbaseduponwhatisperceivedto
bewomen’sstrategicweaknessinthelabourmarket,theircomparative
immobility.
6.3.2LabourMarketSegmentationApproach
Thistheorymaintainsthateconomyshouldmoveawayfrom theconceptof
thecompetitivelabourmarketandviewthemarketasbeingsplitintoavariety
ofconstituentparts,whichinteractsimperfectlywitheachothertoonlyavery
limitedextent. Variantsofthesegmentedmarketapproachinclude;thedual
labourmarkethypothesiswhichidentifiesprimaryandsecondarysectorsof
employment;thejobcrowdinghypothesiswhichidentifiespredominantly
maleandmainlyfemaleoccupationinthecaseofsexdiscrimination;andthe
insider–outsidertheorywhichsplitsthelabourmarketintothosewhowork
orareunemployedunionisedandthosewhoareunemployedorwhoare
non-unionisedworkers.

63. 63
6.3.3Duallabourmarkethypothesis(Two-MarketModel)
Inthistheory,itisconsideredthatthelabourmarketissegmentedinto
primaryandsecondarysectors. Jobsintheprimarymarketorsections
deemedtopossessservicesofthefollowingcharacteristics;-
 Highwages
 Goodworkingconditions
 Employmentstability
 Chancesofadvancement
 Equityand dueprocessin theadministration ofworkers,job in the
secondarymarket,incontrast,tendtohavelowwagesandfringebenefits.
 Poorworkingconditions.
 Highlabourturnover
Little chances of advancement and often arbitrary and conspicuous
suspension. Theduallabourmarkethypothesiswouldsuggestthatmale
femaledifferentialreflectthefactthatmaleworkersarebyandlargeinvolved
in the primary market,whereas female workers tend to dominate the
secondarywill.
Anopportunityfordiscriminationexistswhenamarketcanbedividedinto
homogeneoussubmarkets.Priceandquantitycanthenbeestablishedin
eachsubmarketthroughtheseparateinteractionsofsupplyanddemand.An
illustrationofthisisshowninthetwo-marketmodeloffigure8.2
Figure6.1
SexDifferencesintheLabourMarket
(a)PrimarymarketMales(m) (b)Secondarymarket
Females(F)
WAGERATE
Wm
Wm+f
Wf
O
Wf
O
WAGERATE
Sf
D

64. 64
QM QM+F QF
NUMBEROFWORKERS NUMBEROFWORKERS
Fig¬ure(a)representsaprimarylabormarketformales.Figure(b)depictsa
secondarylabormarketforfemales.(Thesamemodelcouldbeusedto
ana¬lyzediscriminationbetweenwhitesandblacks,skilledandunskilled,or
othercompetinggroups.)
InFigure(a),thedemandcurveDforlaborintheprimarymarketintersects
thesupplycurveofmales,SM.Thisresultsinanequilibrium wageratefor
malesatWM andanequilibriumquantityofmaleemployment,QM.
Becausewomenaretosomeextentexcludedfrom theprimarymarket,they
mustseek employ¬mentelsewhere—namely,in the secondary mar¬ket
representedbyFigure(b).Inthismarket,occu¬pationsarelessproductive
thanintheprimarymarket.Asaresult,Figure(b)showsthatthede¬mandfor
women'sservicesisless,andthesupplyoffemaleslookingforjobsis
smaller,thanthedemandforandsupplyofmen'sservicesinFigure(a).The
economicconsequenceofthisisthattheequilib¬riumwagerateforfemales,
WF,andtheequilibrium quantityoffemaleemployment,QF,arelessthanWM
andQM.
How can thisbe corrected?.The idealsolution would be to eliminate
discriminationbypermittingwomentocompetewithmenintheprimary
market.Ifthisweredone,thesupplycurveoffemalesSFinfigure(b)would
beaddedtotheSM infigure(a).Thiswouldyieldanewtotalmarketsupply
curveofmalesandfemales,SM+F.Thesecondarymarketwouldnolonger
exist.
6.3.4Jobcrowdinghypothesis
Accordingtothistheoryanywagedifferentialbetweenmaleandfemale
workersisduetothefactthatmenandwomenareessentiallyindifferent
jobs. Discriminationcouldequallyresultiffemalesareexcludedfrom jobs
whichtheyhavetheabilitytodo. Thisiswhenasectionoftheworkersare
restrictedfrom enteringcertainoccupationandand/orcrowdedintoother
areasdespiteexistenceofcomparablecapabilitiesbetweenthetwogroupsof
workers. Ifsuchjobstendtobehighwagejobsthenthiswillcreatewage
differentialsbetweenmalesandfemales. Thusjobsegregationoccursasa
resultoffemaleworkersbeingfacedwithdifficultiestoaccesstocertainjobs
makingthemtobecrowdedintotheremainingmoreeasilyaccessedjobs.

65. 65
Figure6.2
D
W1
WE
LO
Employment
FJobs
D
W1
WE
L1 LO
Employment
Mjobs
Wage
Rate
S1
S0
S0
S2

66. 66
Inacompetitivemarketsituation,theinteractionbetweentheoriesofdemand
andsupplywillleadtoidenticalequilibrium wageinbothmarketsWE. When
discriminationintermsofentrycriteriasetsin,thepotentialnumberoffemale
workersinpotentialmalejobsgodownshiftingthesupplycurveupwardsto
S1.ThewagerategoesuptoW1andemploymentlevelreducestoL1.The
femaleworkersrelocatestotheeasilyaccessedjobsinfemaledominated
labourmarketsandincreasessupplytoS2. WagerateisW2onhiringwomen.
Theentrycriteriamaytaketheform oflengthytrainingoranemployment
historywhichexcludesaccessto adisproportionatenumberofwomen.
Womenaretherebycrowdedintotheremainingmoreeasilyaccessiblejobs.
6.4FavorableEffectsofEliminatingDiscrimination
Asyoucanseefrom Figure(a),theeliminationofdiscriminationwouldhave
severalmajoreffects.
First,totalemploymentwouldberaisedfrom thelevelatQM tothelevelat
QM+F.Thiswouldalsoleadtoincreasedproductionbecausewomenwouldbe
employedinmoreproductivejobsthanbefore.Consequently,societywould
benefitbyreceivingalargervolumeofoutput.
Second,the equilibrium wage of females would increase,and the
equilibrium wageofmaleswoulddecrease,tothelevelatWM+F.Further,the
in¬crease in wages received bywomen would more than offsetthe
decreaseinwagesreceivedbymen.Society,therefore,wouldexperiencea
netmone¬tarygain.
Theincreasedwagesreceivedbywomenwouldnotcomefrom thereduced
wagesreceivedbymen.Itwouldcomefrom thegaininproductivityandthe
ad¬ditionaloutputthatwouldresultfromtheeliminationofdiscrimination.
6.5Summary
1 Therearevariouscoursesofwagediscriminationinthelabour
markets
2 Therearethreetheoriesthathavebeenadvancedtoexplainhow
wagediscriminationaffectthelabourmarkets

67. 67
Activity
1 Whatisthediscriminationcoefficient?
2 Discuss the implications of employer discrimination for the
employmentdecisionsofthefirmfortheprofitabilityofthefirm.

68. 68
LESSONSEVEN
WAGEDIFFERENTIALS
7.0Introduction
Wagesareequalinalllabourmarketsifworkersarehomogeneous,alljobs
are identicalin terms ofnon-monetary advantages and disadvantages,
marketsareperfectlycompletivethereisperfectknowledgeandperfect
mobilityoflabour.However,workers are nothomogenous because of
differenceinnaturalability,skillsandtraining.Somepeopledonothavethe
physicalrequirementorthenaturalabilityrequiredforparticularjobs.Jobsdo
notofferidenticalnon-monetaryadvantagesanddisadvantages.Somejobs
meanworkinginpleasantconditionswithconvenienthoursofworkfor
example university professorwhile others require working in dirty and
unpleasantconditionssuchascoalminers.Theremaybelackofinformation
bybothemployersandworkersandthereislackofmobilityofworkersdueto
distance,familytiesandrestrictionsputbythetradeunions.Becauseofthe
abovereasonssomeworkersreceivelowwages,othersreceivesmodestbut
higherwages,whileyetothersarepaidveryhighwages.Thisisreferredtoas
wagedifferentials.
Wagedifferentialsamongworkerscanbeanalyzedonthebasisofmany
differentcharacteristicssuch asoccupation,industry,geographicalarea,
genderand race.Ofthese differentdimensions ofthe wage structure,
occupationaldifferentialsareoneofthemostimportantbecausetheycapture
theinfluenceofseveraloftheprincipaldeterminantsofearningsinthelabour
market.Chiefamong thesearedifferencesamong workersin levelsof
education and training and differencesamong jobsin termsofvarious
noneconomicattributessuchasstatus,prestige,andthequalityofworking
conditions.
7.1LessonObjectives
Bytheendofthelessonthelearnershouldbeableto:
Explainthecompensatingwagedifferentials
7.2CompensatingWageDifferentials
Occupationsdifferonefrom anotherintermsofmanycharacteristics,such
aseducationandtrainingrequired,thepleasantnessorunpleasantnessofthe
work,thestatusandprestigeinwhichtheoccupationisheld,theprobability
ofsuccessinthatlineofwork,andthelevelofwagesintheoccupation.
Adam smith’s greatestinsightwas to realize thatpeople choose an

69. 69
occupationbasednotonthewagealone,butonthewholepackageof
attributes,bothnegativeandpositive.Smithpostulatedthateachworker
comparesthetotaloftheadvantagesanddisadvantagesofeachoccupation,
andchoosestheoneyieldingthehighestlevelofnetadvantages.Sincesome
occupationsaremoredesirablethanothersifwagerateswereequal,workers
wouldcrowdintothedesirableoccupationsandshuntheundesirableones.
AsSmithdeduced,therefore,forequilibrium tooccurinthelabourmarket,the
wageratemustriseintheundesirableoccupationsandfallinthedesirable
occupationsuntilthetotaladvantagesand disadvantagesareequalized
acrossoccupations.Differencesinratesofpayamongoccupationsthus
representcompensatingwagedifferencesinthesensethattheyequalizethe
netattributesofeachoccupation.
In equilibrium,occupationalwage difference willexistbecause ofthe
followingreasons:-
A JobAttributes
Manyfactorsaffecttheattractivenessofoneoccupationrelativetoanother.
Adam Smith referred to these considerations as the agreeableness or
disagreeablenessoftheoccupations.Someoccupationshaveveryagreeable
featuressuchashighsocialstatusflexibleworkinghours,orroom for
considerableautonomyandcreativity.Examplesaredoctors,professors,and
singers.Other occupations have very disagreeable features such as
unpleasantworkingconditions,monotonousortediouswork,orlow social
status.Examplesincludebutchery,assembly-lineworkerandjanitor.While
these factors do notdirectly affectthe monetary return derived from
employmentinanoccupation,theydoneverthelesshaveastronginfluence
onitsrelativeattractivenesstopeople.
To illustrate the effectofjob attributes on wage differentials,assume
occupationsAandBareidenticalineveryaspectexceptthatoccupationB
involvesworkthatisoflowsocialprestige.IfthewagesinoccupationAandB
wereequal,everyonewouldseekemploymentinoccupationAandwould
refusetoconsiderworkinoccupationB.Toachieveequilibrium inthelabour
market,thewagemustriseinoccupationBrelativetoAuntilitisjusthigh
enoughtocompensateforthenegativeattributeoflowprestige.
B Differencesinthecostsofacquiringskills.Occupationsdifferinthe
amountofmoneythatindividuals spend in orderto acquire the skills
necessarytoenteranoccupation. Thefactthatanoccupationrequiresa
higherhumancapitalinvestmentwillresultinworkersrequiringawage
premiuminordertobeinducedtoenterthatoccupation.

70. 70
C Differencesininternalratesoftimepreference.Peopledifferintheir
internalratesoftimepreference. Becauseofthis,theequilibrium wagelevel
willdependonthestateofdemandandthisaffectsthesizeofthepremium
tobepaid.
D Differencesintypesofjob.Somejobsarehighlyskilledwhileothers
arelessskilled.Highlyskilledjobswillrequirehighpaywhilelessskilledjobs
willdemandlowwage
E Occupationalvariabilityofearnings;twooccupationsmayhavethe
sameaverageannualwagebutdifferinthevariabilityofearningswithinthe
occupation. Apersonwhochoosestheprofessionwithhighwagevariability
issubjectedtoaconsiderableriskbecauseofnotbeingabletodetermine
withcertaintyhowhe/shewillfacetheriskofunemployment.
F TheRisk
Supposethereonlytwotypesofjobsinlabourmarket.Somejobsoffera
completelysafeenvironment,andtheprobabilityofinjuryinthesejobsis
equaltozero.Otherjobsofferaninherentlyriskyenvironmentandthe
probabilityofinjuryinthesejobsisequaltoone.Wewillassumethatthe
workerhascompleteinformationabouttherisklevelassociatedwith
everyjob.Inotherwords,theworkerknowswhetherheorsheisemployed
inasafejoborariskyjob.
Workerscareaboutwhethertheyworkinariskyjoborsafejob.Andthey
alsocareaboutthewage(w)theyearnonthejob.Wecanthewritethe
workersutilityfunctionas
Utility=f(w,riskofinjuryonthejob)
Theonlywaytopersuadetheworkertomovetheriskierjobandholdhis
utilityconstantisbyincreasinghiswage.
G Typeoflabourmarket.Amarketdominatedbytradeunionsoftenearn
more thatsimilarpeople who selltheirlabourservices in more
non-unionizedhence,competitivemarkets
Workerswhoselltheirlabourservicesin
H Otherreasons
 Wagesvarieswithage
 Wagesvarieswithyearsonthejob
 Wagesvarieswithsexandrace
 Wagesvarieswithage

71. 71
 Wagesvarieswiththelevelofeducation
7.3Summary
Thecompensatingwagedifferentialcanaffectthewagelateinthelabour
market.RiskIanimportantelementinthelabourmarketanditaffectthe
wagerateandthelevelofemployment.
Activ
LESSONEIGHT
HUMAN-RESOURCEDEVELOPMENT
8.0Introduction
Thetheoryofcompensating differentialssuggeststhatwageswillvary
among workerbecausejobsaredifferent.Wageswillalso varyamong
workersbecauseworkersaredifferent.Peoplebringintothelabourmarketa
uniquesetofabilitiesandacquiredskillsorhumancapital.Thischapter
discusseshow we choose the particularsetofskillsthatwe offerto
employersandhow ourchoicesaffecttheevolutionofearningsoverthe
workinglife.
Weacquiremostofourhumancapitalinschoolandinformalandinformal
on-the-jobtrainingprograms.Theskillsweacquireinschoolsmakesupan
increasinglyimportantcomponentofourstockofknowledge.
Thechapteranalyseswhysomeworkersobtainalotofschoolingandother
workersdropoutatanearlyage.Workerswhoinsistinschoolingarewilling
togiveupearningstodayinreturnforhigherearningsinthefuture.
Thischapterexaminestheimpactofdifferencesinsetofworker’sabilities

72. 72
andacquiredskillsorhumancapitalonthedeterminationofwagesand
employment.
8.1LessonObjectives
Bytheendofthelessonthelearnershouldbeableto:
1.Discusstheschoolingmodel
2.Explainwhatdeterminesthedecisiontogoforfurtherstudiesornot
usingthePresentvalueofage–earningsprofiles
Adam SmithinTheWealthofNations(1776)observed,investmentinhuman
re¬sourcesyieldsbenefitstotheindividualaswellastothenation.Thatis,it
yieldsprivateaswellassocialreturns.Thesereturnsarebasedonabilities
andskillsthatareobtainedfromacquisitionofknowl¬edge.
Formaleducation,ofcourse,isonlyonemethodofimprovingpeople's
knowledgeandskills.Othermethodsconsistofvariouskindsofjobtraining
andworkexperienceprograms.Allofthem togetherconstitutewhatmaybe
calledhumanresourcepol¬icies.Thesemaybedefinedasdeliberateefforts
undertaken in the private and public sectors to de¬velop and use the
capacitiesofhumanbeingsasactualorpotentialmembersofthelaborforce.
8.2TheSchoolModel
Someworkersobtainalotofschoolingandotherworkersdropoutatanearly
age.Workerswhoinsistinschoolingarewillingtogiveupearningstodayin
returnforhigherearningsinthefuture.
Wedonotstopaccumulatingskillsandknowledgethedaywefinallyleave
school.Instead,wecontinuetoaddourhumancapitalstockthroughoutmuch
ofourworkinglives.Hereweanalyzehowworkerschooseparticularpartfor
theirpost-schoolinvestmentsandinvestigatehow thesechoicesinfluence
theevolutionofearningsoverthelifecycle.
Weassumethattheworkerchoosesthelevelofhumancapitalinvestments
thatmaximizesthepresentvalueoflifetimeearnings.
Presentvalue(p.v)ofpaymentofyincomeisgivenby
p.v.=y/(1+r)

73. 73
wherer=rateofinterest/discount.
Assumethatworkersacquiretheeducationlevelthatmaximizesthepresent
valueoflifetimeearnings.Educationandotherformsoftrainingarevalued
onlybecausetheyincreaseearnings.
Thediagram belowillustratestheeconomictrade-offinvolvedintheworkers
decision.Itshowstheage-earningsprofilei.e.thewagepathoverthelife
cycle)associatedwitheachalternative.
Figure8.0
Uponenteringthelabourmarket,highschoolgraduatesearnswHsannually
untilretirementageat65.ifthepersonchoosestoattendcollege,hegivesup
wHsinlabourearningsandincursdirectcostofHtocovertuition,booksand
fees.Aftergraduation,heearnsWc0lannuallyuntilretirement.
Thediagram indicatesthataworkerfacestwodifferenttypesofcostsifhe
goestocollege.Ayearspentincollegeisayearspentoutofthelabourforce.
Thisistheopportunitycostofgoingtoschool.ItisgivenbywHs.Thestudent
alsohasout-of-pocketexpensesofitfortuition,books,andavarietyofother
fees.Employerswhowishtoattractahighereducated(andpresumablymove
productive)workforcewillhavetoofferhigherwages,sothatWc0l>wHs.The
high wage paid to worker’s with,more schooling is a compensating
differentialthatcompensateworkersfortheirtrainingcosts.
22
0
WHs
WCOL
W
H
18 65 Age

74. 74
8.3Presentvalueofage–earningsprofiles
PVoftheearningsstreamiftheworkergetsonlyahighschooleducationis
P.VHs=WHs + WHs + WHs +….. +WHs
(1+r) (1+r) (1+r)
n
TheP.Voftheearningsstreamiftheworkergetsacollegediplomais
P.Vcol=-H–H– H - H +Wcol+Wcol+Wcol+-Wcol
(1+r) (1+r)
2
(1+r)
3
(1+r)
4
(1+r) (1+r)
5
(1+r)
6
Directcostofattendingcollege TheCollegeearningstream
A person’s schooling decision maximizes the PV oflifetime earnings.
ThereforetheworkerattendscollegeifthePVoflifetimeearningswhenhe
getsacollegeeducationexceedsthePVoflifetimeearningswhenhegets
onlyahighschooldiploma.
Pvc06>PvHs
Egnumericalexample
Supposeaworkerlivestwoperiodsandchoosesfrom twoschooloptions,he
canchoosenottoattendschoolatallinwhichcasehewouldearn20,000in
eachperiod.
P.v0=20,000+20,000
(1+r)
Hecanalsochoosetoattendschoolinthefirstperiod,incur5,000worthof
directschoolingcostsandenterthelabourmarketinthesecondperiod
earning47,500
P.v=-5,000+47,500
(1+r)
Supposer=5%
Pv0=39,048 Pv1=40,238
Theworkerchoosestoattendschool.
NB.Ifr=15%
Pv0=37,391 Pv1=36,304
Theworkerswouldnotgotoschool
Fromtheabove,therateofinterestplaysacrucialroleindeterminingwhether
apersonchoosestogotoschool.Thehighertherthelessthelivelyaworker
willinvestineducation.Thisisbecauseaworkerwhohasahighdiscountrate
attachesaverylowvaluetofutureearningopportunities.Becausethereturn

75. 75
toaninvestmentineducationarecollectedinthefar-offuture,personswith
highdiscountratesrequirelessschooling.
Therateofdiscountdependsonhowwefeelaboutgivingupsomeoftoday’s
consumptioninreturnforfuturerewards–orowntimepreference.Some
peoplearepresentorientedandsomearenot.Personswhoarepresent
orientedhaveahighdiscountrateandwouldbelesslikelytoinvestin
schooling.Poorerfamilieshaveahigherrateofdiscountthanwealthier
families.
8.4Summary
 Thewage-schoolinglocusgivesthesalarythataworkerearnsifheor
shecompleteaparticularlevelofschooling
 Workerschoosethepointonthewage-schoolinglocusthatmaximizes
thepresentvalueoflifetimeearnings.Inparticular,workersquite
schoolingwhenthemarginalrateofreturntoschoolingequalstherate
ofdiscount.
Activity
Discusshow thewage-schoolinglocusisdeterminedinthelabourmarket,
andwhyitisupwardslopngandconcave
1 Explainhoweducationcontributetowagedifferentialinthelabour
market

76. 76
LESSONNINE
LABOURUNIONS
9.0Introduction
Tradeunionmaybeabletosecurehighwages,betterworkingconditions,
protectworkersfrom arbitrarytreatmentbymanagementand other
economicgainsforitsmembers.
9.1LessonObjectives
Bytheendofthelessonthelearnershouldbeableto:
1.Explaincollectivebargaining
2.Explainhowunioninfluenceswagesinthelabourmarket
9.2UnionsandManagement:CollectiveBargaining
Whatisaunion?Itmaybedefinedasanorgani¬zationofworkersthatseeks
togainadegreeofmo¬nopolypowerinthesaleofitsservices.Inthiswayit
maybeabletosecurehigherwages,betterwork¬ingconditions,protection
from arbitrarytreatmentbymanagement,andothereconomicgainsforits
members.

77. 77
Thechiefobjectiveofunionsisthustoenhancethestatusofworkers.That
goalislargelyachievedthroughcollectivebargaining.Thisisaprocessof
negotiationbetweenrepresentativesofacompany'smanagementanda
union.Thepurposeistoarriveatasetofmutuallyacceptablewagesand
workingconditionsforemployees.
9.3UnionsInfluenceoverWages
Alabouruniondoesnottrytomaximizewagesbecausethenonlyafew
workerswouldbehired.Italsodoesnotencouragefirmstohireasmany
workersaspossible,becausethewageratewouldthenbeveryloworzero.
Instead,ageneralobjectiveofalabourunionmaybetoincreasethewageof
unionmembers.
Wagesaredeterminedbyforcesofsupplyanddemand.Thus,foraunionto
modifywages,itmustinsomewaysmodifyorchangethemarketforlabour.
Therearethreegeneralmethodsbywhichthiscanbedone.
1.Increasethedemandforlabour
Thiswillresultinmanyworkersbeinghiredatanincreasedwage.Thisisthe
mostdifficultbecauseingeneralunionshavelittleinfluenceoverthedemand
forfinalproducts.
Unionssupportlawsforprotectivetariffsorquotasonimportsandhave
lobbiedagainstfreetradeagreement.
Increasingtheproductivityoflabourwillalsoincreasethedemandforlabour.
Unionspromoteimprovedworkingconditions,shortenedworkweeks,and
employeeeducation.
DemandExpansionModel:Increasethe
DemandforLabor
Throughfeatherbeddingorothermake-workprac¬tices,anorganizedgroup
ofworkersmaysucceedinshiftingthedemandcurveforitslabortotheright.
TheshiftfromDtoD'increasestheequilibriumquan¬tityoflaborfrom20,000
workersto26,000,andtheequilibriumwageratefrom$10perhourto$13.
Figure9.0
WAGES
(hourly)
$20
S

78. 78
15
10
D’
D 0
10 20 30 40
Workers(thousands)
Themodelillustrateswhathappenswhenaunion,seekstoincreasethe
demandforitsmembers.Thatis,theuniontriestoshiftthedemandcurveto
theright,whichwouldresultinhigherequilibriumwagesandemployment.
Theshiftindemandisbroughtaboutbytheuseoffeatherbeddingtechniques.
Theseare"make-work"rulesorpracticesdesignedbyunionstore¬strict
outputbyartificiallyincreasingtheamountoflabororlabortimeemployedon
aparticularjob.Forexample,atvarioustimsinthepast:-ThePainters'Union
limitedthewidthofbrushesandthesizeofrollers.
2.Reducethesupplyoflabour.
Unionsaremoresuccessfulwiththismethod.Skilledunionscancontrol
supplybycontrollingentryintothetradingorrequiringthattheemployees
haveacertificateorlicensebearingwitnessofsuccessfulcompletionofthe
program.
Supply-LimitationModel:DecreasetheSupplyofLabor
Anorganizedgroupofworkers,suchasacraftunion,maybeabletoreduce
thenumberofpeopleenteringoccupation.Thegroupwilltherebyshiftits
supplycurveoflabortotheleftfrom S toS'.Theequilibrium levelof
employmentwillthus decline from 10,0(30 workers to 7,000,and the
equilibriumwageratewillrisefrom$20perhourto$26.

79. 79
Figure9.1
S’
S
30
10
5
D
D 0 5
10 15
Workers
Thousands
Trade unions have persuaded state legislatures to impose licensing
require¬mentsasaconditionforentry. Thegrantingoflicenses,controlled
bythosealreadyinthefield,maybebasedoneducationalrequirements,test
aspecifiednumberofyearsofsupervisedexperience,andpersonalinterviews.
In addition to such specificlabor-limiting prac¬tices,someunionshave
soughttorestricttheoverallsupplyoflaborintheeconomy. Theyhave
donethisbysupportinglegislationto(1)curbimmigra¬tion,(2)shortenthe
workweek,and(3)assurecom¬pulsoryretirement.
3.Bargainingforhigherwages
Thismethodisgenerallyutilizedbyunskilledorsemi-skilledworkers.Thegoal
istobringallworkersintheindustryintounionmembership.Semiand
unskilledunionsareunabletorestrictthesupplyofworker’sbylicensing.
Theyestablishedclosedshop,wherealltheworkersinthefirm oreventhe
industrymustbelongtotheunion.Theunionthenrepresentsalltheworker’s
andnegotiateswiththemanagement.
SUMMARY

80. 80
Unionshaveemployeddifferentmethodsforenhanc¬ingtheirpositioninthe
labormarket.Themethodsin¬clude:
a.Increasingthedemandforlabor.Thisraisesbothwagesand
employment.
b.Decreasingthesupplyoflabor.Thisraiseswagesanddecreases
employment.
Activity
Explainhow tradeunioninfluencewagesandemploymrntinthelabour
market
LESSONTEN
UNEMPOYMENTANDUNDER-EMPLOYMENT
10.0Introduction
Unemploymentiswherepeoplewhohaveabilityandwillingtoworkcannot
findjob.Workersareunemployedformanyreasons.Atanytimeforexample,
manypersonsareinbetweenjobs.Theyhaveeitherjustquitorbeenlaidoff,
ortheyhavejustenteredthelabourmarket.Ittakestimetolearnaboutand
locateavailablejobopportunities.
10.1LessonObjectives

81. 81
Bytheendofthelessonthelearnershouldbeableto:
1 Explainthevarioustypesofunemployment
2 Definetheaskingwage
3 Explainhowasingwageisdetermined
10.2TypesofUnemployment
Thelabourmarketisinconstantinflux.Someworkersquittheirjobs,other
workersarelaidoff.Somefirmsarecuttingback,othersareexpanding.New
workersenterthemarketaftercompletingtheireducationandotherworkers
re-enterafterspendingsometimeinthenon-marketsector.Atanytime
therefore,manyworkersareinbetweenjobs.Ifworkerslookingforjobsand
firmslookingforworkerscouldfindeachotherimmediately,therewouldbe
nounemployment.Frictionalunemploymentarisesbecausebothworkersand
firmsneedtimetolocateeachotherandtodigesttheinformationaboutthe
valueofthejobmatch.
Policy:providingworkerwithinformationaboutjobopeningsandproviding
firswithinformationaboutunemployedworkers.
Seasonalunemployment
Workersinboththegarmentandtheautoindustriesarelaidoffregularly
becausenewmodelsareintroduced.
Structuralunemployment
Itariseswherepersonslookingforworkcannotfitthejobsavailable.Atany
time,somesectorsoftheeconomyaregrowing and othersectorsare
declining.Ifskills were perfectly transferable across sectors,the laid
off-workerscouldquicklymovetothegrowingsectors.Skills,howevermight
be specific to the workers job orindustry,and laid-offworkers lack
qualificationsneededintheexpandingsector.Asaresult,theunemployment
spellsofthedisplacedworkersmightlastforalongtimebecausetheymust
retooltheirskills.Structuralunemploymentthus arises because ofa
mismatchbetweentheskillsthatfirmsaredemanding.
Theproblem isskills;theunemployedarestuckwithhumancapitalthatisno
longeruseful.Policyto reduce this type ofunemploymentis thatthe
governmentwouldhavetoprovidetrainingprogramsthatwouldinfectthe

82. 82
displacedworkerswiththetypesofskillsthatarenowindemand.
CyclicalUnemployment.
Theremaybeanimbalancebetweenthenumberofworkerslookingforjobs
andthenumberofjobsavailableevenifskillswereperfectlyportableacross
sectors.Thisimbalancemayarisebecausee.g.theeconomyhasmovedinto
arecession.Firmsnow requireasmallerworkforcetosatisfythesmaller
consumerdemandandemployerslayoffmanyworkersgeneratingcyclical
unemployment.Thereisanexcesssupplyofworkersandthemarketdoesnot
clearbecause the wage is sticky and can notadjustdownward.The
union-mandatedwageincreasesorgovernment-imposedminimum wages
introducerigidwagesintothelabourmarketandpreventthemarketfrom
clearing.
Toreducethistypeofunemployment,thegovernmentwillhavetostimulate
aggregatedemandandre-establishmarketequilibriumatthestickywage.
JobSearch
Manytheoriesclaim toexplainwhyunemploymentexistsandpersistsin
competitivemarket.Wewouldobservefrictionalunemploymentevenifthere
werenofundamentalimbalancebetweenthesupplyanddemandforworkers.
Becausedifferentfirmsofferdifferentjobopportunitiesandbecauseworkers
areunawareofwherethebestjobsarelocated,ittakestimetofindthe
availableopportunities.
Anygivenworkercanchoosefrom amongmanydifferentjoboffers,and
differentfirms make differentoffers to the same worker.These wage
differentialsforthesametypeofworkencourageunemployedworkertoshop
arounduntilhe/shefindsasuperiorjoboffer.Becauseittakestimetolearn
aboutthe opportunities provided bydifferentemployers,such activities
pro-longthedurationoftheunemploymentspell.Theworker,however,is
willingtoendurealongerunemploymentspellbecauseitmightleadtoa
higherpayingjob.Ineffect,suchunemploymentisaform ofhumancapital
investment;theworkerisinvestingininformationaboutthelabourmarket.
Thewageofferdistribution
Tosimplifytheanalysis,weassumethatonlyunemployedworkersconduct
suchactivities,althoughworkersmightkeeponsearchingforabetterjob
evenaftertheyacceptaparticularjoboffer.Thewageofferdistributiongives
the frequency distribution describing the various offers available to a
particularunemployedworkerinthelabourmarket.
Figure10.0
Frequency

83. 83
Asdrawn,theworkercanendupinajobpayinganywherefrom $5to$25per
hour.Assumethatunemployedworkerknowstheshapeofthewageoffer
distribution.Inotherwords,heknowsthatthereisahighprobabilitythathis
searchactivitieswilllocateajobpayingbetween$8and$22perhourandthat
thereisasmallprobabilitythathemightendupwithajobpayinglessthan$8
formorethan$22perhour.
Ifsearchactivitieswerefree,theworkerwouldkeeponknockingfromdoorto
dooruntilhefinallyhitthefirm thatpaidthe$25wage.Searchactivities,
however,arecostly.Hecouldhavebeenworkingatalower-payingjob.The
workerseconomictrade-ofisthatthelongerhesearches,themorelikelyhe
willgetahighwageoffer,thelongerhesearches,howeverthemoreitcosts
tofindthatjob.
Non-sequentialandsequentialsearch
Whenshouldtheworkerstopsearchingandsettleforthejobofferathand?
Therearetwoapproachestoansweringthisquestion.Eachapproachgivesa
stoppingruletellingtheworkerwhentoendhissearchactivity.Theworker

84. 84
couldfollow astrategyofnon-sequentialsearchwheretheworkerdecides
beforehebeginshissearchthathewillrandomlyvisitsaytwentyfirmsinthe
labourmarketandacceptthejobthatpaysthehighestwage(whichwillnot
necessarilybethejobpaying$25).Thissearchstrategyisnotoptimal.
Supposethatonhisfirsttry,theworkerjusthappenstohitthefirm thatpays
$25.Anon-sequentialsearchstrategywouldforcethisworkertovisitanother
19firmsknowingverywellthathecouldneverdobetter.
Itdoesnotmakesense,therefore,fortheworkertocommithimselftoa
predeterminednumberofsearchesregardlessofwhathappenswhileheis
searching.
Sequentialsearchiswherebeforetheworkersetsoutonthesearchprocess,
hedecideswhichjoboffersheiswillingtoaccept.E.g.hemightdecidethat
heisnotwillingtoworkforlessthan$12.Ifthewageofferexceeds$12,he
willacceptthejob,stopsearchingandendtheunemploymentspell.Ifthe
wageofferislessthan$12,hewillrejectthejobofferandstartthesearch
processoveragain.i.e.visitanewfirm,comparethenewwageoffertohis
designedwageandsoon.Thesequentialsearchstrategyimpliesthatifa
workerisluckyenoughandfindthe$25jobonthefirsttry,hewillimmediately
recognizethatheisluckyandstopthesearchprocess.
10.3Theaskingwage
Theaskingwageisthethresholdwagethatdeterminesiftheunemployed
workeracceptsorrejectstheincomingjoboffers.Thereisaclearlink
betweenaworker’saskingwageandthelengthofunemploymentspellsthe
workerwillexperience.
Workerswhohavelowaskingwagewillfindacceptablejobsveryquicklyand
theunemploymentspellwillbeshort.Workerswithhighaskingwagewilltake
alongertimetofindanacceptablejobandtheunemploymentspellwillbe
verylong.
Theunemploymentspellwilllastlonger;thelargeristheaskingwage.
10.3.1Howworkerdetermineshisaskingwage.
Considerthe wage offerdistribution given above.Suppose unemployed

85. 85
workergoesoutandsamplesaparticularjobatrandom.Bypurechance,he
happenstovisitthefirm thatpaysthelowestwagepossible$5.Hemust
decidewhethertoacceptorrejectthisofferbycomparingtheexpectedgains
from additionalsearch.(byhow muchwouldthewageofferincrease?)with
thecostofthesearch.Iftheofferathandis$5,thegainstosearchingone
moretimeareveryhigh.Ifthenextvisitgiveshim $10,theincentiveto
continuesearchingwillagaindependpartlyonthemarginalgainfrom one
more search.Given the wage offerdistribution,there is stilla good
chance-thatadditionalsearchwillgenerateahigherwageoffer.Themarginal
gaintothisadditionalsearchhoweverisnotashighaswhenthewageoffer
wasonly$5.Afterallthereisachancethatifhesearchesonemoretime,he
mighthitafirmofferinglessthan$10.
Supposetheworkerdecidestotryhisluckonemoretime,thistimehehitsthe
jackpot,gettingawageofferof$25.Atthispoint,themarginalgainfrom
furthersearchiszero.Theworkercannotgetahigherwageoffer.
Themarginalgainsfromsearchareloweriftheworkerhasagoodwageoffer
athand.Asaresult,themarginalrevenuecurve(iemarginalgainfrom one
additionalsearch)isdownwardsloping.
Theaskingwageisalsodeterminedbythemarginalcostofsearching.There
aretwotypesofsearchcost
(a)Directcostsofsearch,includingtransportationcostsandcostsof
preparingresumesandtimetaken
(b)Opportunitycostofrejectingtheoffergiven.Themarginalcostof
searchishighiftheworkerhasagoodwageofferathand.Therefore
theMCisupwardsloping.TheinteractionoftheMCcurveandtheMR
givestheaskingwageorW
Figure10.1
mr
mc

86. 86
Considerwhathappensiftheworkergetsawageofferofonly$10whichis
lessthantheaskingwageW.TheMRfrom searchexceedstheMC,andthe
workerwouldcontinuesearching.Ifthewageofferathandwas$20(above
theaskingwage),theworkershouldacceptthejobbecausetheexpected
benefitsfrom additionalsearcharelowerthantheMCofsearch.Theasking
wagethereforemakestheworkerindifferentbetweencontinuingandending
hissearchactivities
DeterminantsoftheAskingwage
Workersaskingwagewillrespondtochangesinthebenefitsandcostsof
searchactivities.Thebenefitsfrom searcharecollectedinthefuture,sothey
dependonthe;
1 workersdiscountrates.Workerswithhighdiscountratesarepresent
orientedandhenceperceivethefuturebenefitsfromsearchtobelow.
WorkerswhohavehighdiscountrateshavelowerMRcurves(ShiftingtheMR
curvetotherightandhencewillhaveloweraskingwages.Becausethese
workersdonothavethepatiencetowaituntilabetteroffercomesalong,they
acceptlowerwageoffersandhaveshortunemploymentspells.
2 Theunemploymentinsurance(UI)systemwhichcompensatesworkers
whoareunemployedandwhoareactivelyengaginginsearchactivities.
Supposethattheworkerhasawageofferathandof$400andqualifiesforUI
of$200,theworkerisonlygivenupto$200byrejectingthejoboffer.TheUI
benefitsthereforereducetheMCofsearch.
AreductionintheMCofsearchshiftsthemarginalcostcurvetotheleft
raisingtheaskingwage.TheUIsystem thereforehasthreeimportanteffects
onthelabourmarket:
1Itleadstolongerunemploymentspells
2Itincreasestheunemploymentrate
3Itleadstohigherpostunemploymentwages
Insummarythesearchmodelhastwokeypredictionsaboutthelengthof
unemploymentspell:Unemploymentspellswilllastlongerwhenthecostof
searchingfalls:andunemploymentspellswilllastlongerwhenthebenefits
fromsearchingrise.
10.4Summary

87. 87
 Therearevarioustypesofunemploymentthatcanbefoundinan
economy
 Askingwageisthewagewherethemarginalcostofjobsearchis
equaltothemarginalbenefitofjobsearch
Activity
Distinguishbetweenstructuralandfrictionalunemployment
LESSONELEVEN
LABOURMOBILITY
11.0Introduction

88. 88
Workersarealwaysinmotion.Theymovefrom onejobtoonother,orfrom
onegeographicalregiontoanotherorfromoneemployertoanother
11.1LessonObjectives
Bytheendofthislessonthelearnershouldbeableto:
1 Definethetermlabourmobility
2 Explainthevariousformsoflabourmobility
3 Explainthedeterminantsoflabourmobility
11.2MeaningofLabourMobility
Itmeans"thecapacityandabilityoflabourtomovefromoneplacetoanother
orfrom oneoccupationtoanotherorfrom onejobtoanotherorfrom one
industrytoanother."Itistheextenttowhichtheworkersareableorwillingto
movebetweendifferentjobs,occupations,andgeographicalareas.Itiscalled
horizontalmobilityifitdoesnotresultinachangeintheworker'sgradingor
status,andverticalmobilityifitdoes.Skilledworkershavelowoccupational
mobilitybuthighgeographicalmobility;low-skilledorunskilledworkershave
highdegreesofbothtypesofmobility.Lowlabor-mobilitycausesstructural
unemployment,andgovernmentstrytoavoiditbyworkerretrainingschemes
andbyencouragingestablishmentofnewindustriesintheaffectedareas.
11.3Typesofmobilityoflabour

89. 89
Mobilityoflabourisoffollowingtypes.
1.GeographicalMobility-Whenalabourermovesfrom oneregionto
another,withintheboundariesofanationorfrom onenationto
anotheriscalledgeographicalmobilityoflabour.
2.OccupationalMobility-Movementoflabourersfromonejobtoanother
isoccupationalmobility.ThisisinadditionclassifiedintoHorizontal
and verticalnobilities.Horizontalmobility means movement in
occupationbyalabourerfrom onegradetothedifferentjobinthe
samegrade.Whereasverticalmobilitydenotes,upgradationofjobs
andstatusfrom lowertohigherfrom oneoccupationtoanotheris
calledverticalmobility.
3.Mobilityamidstindustries-Movementoflabourersfrom oneindustry
toanotherwithoutchangingtheoccupationisknownasindustrial
mobility.
11.4FactorsDeterminingmobilityoflabour
1.Education and Training -Themobilityoflabourisbased on the
knowledgeandskill.Themoreofknowledge,thechanceofmovement
amplifies.

90. 90
2.OutlookorUrge-Theoutlookorurgeofworkersto risein life
determinestheirmobility.Iftheyareoptimistandbroadminded,they
willmovetootherjobsandplaces.Differencesinlanguage,habits,
religion,andcastewillnotbeanobstacleintheirmobility.
3.SocialSet-up-Themobilityoflabouralsodependsuponthesocial
setup.Asocietydominatedcastesystem andjointfamilysystem lacks
inmobilityoflabour.Butinthecaseswheretheconvictionsdonot
existhasmobility.
4.Means of Transport - Sophisticated modes of transport and
communicationencouragemobilityoflabour.Incaseofemergency,
communicationwiththeirfamiliesorthroughaviationfacilitiesonecan
meetoutthesituation.
5.AgriculturalDevelopment-Atthetimesofvacation,intheeventof
agriculturaldevelopment,labourmovesfrom highpopulatedareatoa
lowerpopulace.
6.PeaceandSecurity-Themobilityoflabouralsobasedtoahugeextent
tothelawandorderinthenation.Intheevent,ifthepropertiesofthe
populacearenotsafe,theywillnottendtomovefrom theircurrent
placetoanotherplaceandtoanycorrespondingoccupation.
ObstaclesofMobilityofLabour
Thereareseveralfactorswhich encumbermobilityoflabour.Theyare
changesinweather,religiousconviction,casteandcreed,behaviourand
mannerisms,traditionsandconvictions,mothertongues,likingsandchoices
etc.Theotherfactorsareuneducated,lackofknowledge,indebtedness,

91. 91
affectiontowealthandland,deficiency,economicbackwardness,lackof
modesoftransportation,communicatingskillsandcertainlyredundancy.
MeritsofMobilityofLabour
Toaugmentproductiveefficiency,themobilityoflabourhelpsaton.Whistthe
workersearningcapacityalsoraiseswhentheyarepreparedtoshiftfrom
placestobetterplaces.Theygethighpaidjobsleavinglow paidwork.It
resolvesthecomplexityofredundancywhentheworkersmovefrom placeto
place.Alsofiscaldevelopmenthappenswhenunemployedshiftstopublic
workslikeconstructionofdams,buildingroadsandcanalsetc.Thusit
amplifiesproduction,employmentandearnings.
Determinantsofworkermobility
Workersmoveiftheexpectedpresentvalueofthenetbenefitsispositive
Benefitsandcostsofmobility
 Psychiccostsandbenefitsareincludedaswellasdirectcostsand
benefits.
• costsandbenefitsinclude:
– friendshipswithco-workersandmembersofthecommunity,
– familyties,
– workingenvironment,
– non-pecuniaryjobbenefits,and
– Characteristicsofgeographicallocations.
Factorsaffectingthemobilitydecision
• Individualsaremorelikelytomovewhen:
– thedifferenceinwagesorsalariesislarge,
– theworkerisunhappyinhisorhercurrentjoborlocation,
– thedirectcostassociatedwithmovingislow,and
– Benefitswillberealizedoveralongertimeperiod(T).
Geographicmobility
• Morestronglyaffectedbythe“pull”from thedestinationthanbythe
“push”fromtheoriginallocation.

92. 92
• Youngworkersaremorelikelytomove.
• Marriedworkersarelesslikelytomove.
• Mostmovesarewithincountyandstateboundaries.
• Chainmigrationisacommonphenomenonininternationalmigration.
Skills,incomedistribution,andmigration
• whenforeigncountrieshavealowerdegreeofincomeinequality:
– thereturntohumancapitalislikelytobehigherintheU.S.,
– EncouragingskilledindividualstoemigratetotheU.S.
• Whenthereisahigherdegreeofincomeinequalityinforeigncountries,
lowskilledindividualsaremorelikelytoemigratetotheU.S.
• Inrecentdecades,immigrantstotheU.S.havebeenlessskilledthanin
thepast.
Returnstomigration
• Householdsgenerallyreceiveanincreaseinincomeasaresultof
immigration.
• Wivesoftenexperienceadeclineinincomeasaresultofimmigration.
• Immigrantsgenerallyreceiveaninitialincomethatisbelow thatof
domesticworkers.
• Immigrantsexperienceamorerapidincreaseinearningsthanfor
domesticworkers.
• Rateofgrowthofimmigrantincomehasbeenlowerinrecentdecades.
Returnmigration
• Asubstantialshareofimmigrationinvolvesreturnmigration.
• thismaybeaplannedreturnafteraperiodoftimeworkingina
high-wagearea,or
• Itmaybetheresultofunrealizedexpectations.
Immigrationandemployment
• Immigrationincreaseslaborsupplyinsomelabormarkets.
• Immigrationraiseslabordemandinalllabormarkets.
• Domesticemployment(andwages)willriseinthoselabormarketsin
whichlabordemandrisesbymorethanlaborsupply.
• Domesticemployment(andwages)willfallinthoselabormarketsin
whichlaborsupplyrisesbymorethanlabordemand.
Overalleffectsofimmigrationoneconomy
• Immigrantlaborlowersthecostofgoods,benefitingconsumers.
• Immigrantspaymoreintaxesthantheyconsumeinpublicservices
(thisisespeciallytrueforillegalimmigrants).
• Immigrantsbringtheirhumancapitalwiththemwhentheyimmigrate.
• Empirically,immigrationappearstohavelittle,ifany,effectonthe
wageratesoremploymentprospectsofdomesticworkers.
Employeeturnoverandjobmatching

93. 93
• Employeeturnoveristheresultofjobquitsandlayoffs.
• Workerswillengageinavoluntaryquitonlyiftheexpectedbenefits
outweightheexpectedcosts.
• Economicefficiencymayimproveasaresultofjobquitsandlayoffs.
Determinantsofturnover
• Workerswhoreceivealowerwagearemorelikelytoquit.
• Firmsthatofferlowerwageshavehigherquitrates.
• Womenhavehigherquitrates.
• Jobquitsincreaseduringexpansionsandfallduringrecessions.
• Layoffsriseduringrecessionsandfallduringexpansions.
• Workersarelesslikelytoquitwhenthecostofquittingishigher.
Workermobilityandmonopsony
• Whentherearenocostsofmobility,thelawofonepricewouldapplyin
labormarkets.
• Workers shiftfrom job to job untilthe wage rate is the same
everywhereforworkerswithagivenmixofskillsandabilities.
• Mobilitycosts,however,givefirmssomedegreeofmonopsonypower
inlabormarkets.
11.5Summary
 Labourmobilityisthemovementoflabouracrossthelabourmarkets
 Therearevariuousformsoflabourmobility
 Therearevariousfactorsthatdeterminelabourmobilityinaneconomy
Activity
Explainthefactorsthatdeterminethelabourmobility
FurtherReadings

94. 94
1.Addison,J.TandW.S.Siebert(1979).THEMARKETFORLABOUR.AN
ANALYTICALTREATMENT.SANTAMONICA,CALIFORNIA:GOODYEAR
PUBLISHINGCOMPANY,INC
2.PierreCahuc,StéphaneCarcillo,AndréZylberberg,William McCuaig.
(2014)LABOURECONOMICS2ndEd.MITPress.
2. Smith,S.W(1994).LabourEconomics,Routledge:London
3. McConnell,C.RandS.L.Brue(1995).ContemporaryLabourEconomics,
FourthEdition.Singapore:McGraw-HillInc.
4. Bosworth,D.DawkinsandT.Stromback(1996).TheEconomicsofthe
LabourMarket,England and Singapore:Addison WesleyLongman
Limited.
5. Hardwick,P.B.KhanandJ.Langmead(19996).Anintroductionto
ModernEconomics,FourthEdition.EdinburgeandSingapore:Addison
WesleyLomgmanLimited.
6. J.BorjasLabourEconomics.ThirdEditionMcGraw-HillRIrwin.