Labor Economics (Econ-3101)

Chapter One:
Introduction
 1.1. Labour economics: basic concepts, evolution and
its role in Economics

• As a distinct discipline, labor Economics today is

not quite a century old.
• Before, it was simply analogical part of the central
tradition of theoretical speculation that began
with Adam smith.
• In his “The Wealth of Nations” (1776), Smith
pointed out the centrality of labor to the
economy and the special characteristics of
labor as a participant in the economy.
• When labor Economics finally did emerge as a
specialized field, the older theories of value and
distribution were destined to occupy a subordinate
place, because the founders of the new discipline were
so strongly oriented to other interests: unions and
unionism, labor history, collective bargaining, social and
protective labor legislation and industrial disputes.
• In consequence, topics such as wage and employment
theory were typically considered to be a part of general
economics, rather than Labor Economics itself.
• The specialized study of wages, labor markets, and
institutions did not begin to occupy a prominent
position in the field until the later 1920’s.
• Labor Economics is now firmly established as an area of
theoretical and empirical inquiry in the main stream of
economics.
• The tools that labor economists use to explain and
investigate economic phenomenon, display the same
theoretical rigor and require application of the same
degree of econometric expertise as other major areas of
the subject.
• In short, the old study of labor was highly descriptive,
emphasizing historical developments, facts, institutions,
and legal considerations.
• But, now, labor Economics increasingly has become
applied micro and macro theory.
 Definition of labor economics
• Labor Economics is the study of the workings and
outcomes of the market for labor.
• More specifically, labor Economics is primarily concerned
with the behavior of employers and employees in
response to the general incentives of wages, prices,
profits, and non-pecuniary aspects of the employment
relationship ( such as work environment, risk of injury,
personality of managers, flexibility of work hours etc. ).
• It examines the organization, functioning and outcomes
of labor markets; the decision of prospective and present
labor market participants and the public policies relating
to employment and payment of labor resources.
• Economics is concerned with the general
question of resource allocation and the
determination of prices and levels of production
in the economy.
• Whereas labor economics focuses on one
particular aspect of this process, the
determination of wages and employment in the
labor market and the resulting distribution of
income among individuals and households.
 Why labor economics is both an interesting and
useful subject matter?
• First, the issues addressed in labor economics are of
direct and immediate relevance to each of us.
• The focuses of labor economics is on the world of work-
who is working, what types of jobs are available, and
why people are being paid what they are.
• Second, labor economics deals with a subject with which
many students have firsthand experience or information.
• Not many of us have been involved with the complexity
of foreign exchange markets, central banking or
government tax and expenditure programs.
• Most students do have some previous experience with
finding employment, the advantages and disadvantages of
particular types of jobs, planning careers, and possibly the
operation of labor unions.
• Third, labor economics has so many applications to
current social issues and public policy debates-
– Should the minimum wage be raised? Should it be
abolished?
– Why unemployment rate for blacks is twice of that of
whites?
– Do unions cause inflation?
– Will technological change leads to greater
unemployment?
 1.2. Labor market and the economy
• A market exists whenever there is a good or services for
which there are buyers (demanders) and sellers (suppliers)
who engage in mutual exchange or trade of the item.
• This exchange or trade is typically consummated when
there is a common agreement to the price per unit that the
buyer must pay to the seller.
• Labor is a factor of production that is owned by individuals
and, in effect, rented to business firms for a period of time
to be combined with other factor inputs such as land and
capital to produce good and services.
• Labor is traded in what economists call a factor market, just
as the other factors of production are, i.e. land and capital.
• How the labor and product markets are
interacted?
• Summary: labor market is the market where labor services
are exchanged.
• The price of labor services is called the wage rate
• Quantity can be measured in various units (hours, weeks,
full-time workers).
How is the labor market different?
 In most product markets that you participate in, you are
the buyer/demander
 In the labor market, you are the seller/supplier of labor
services
 Firms are the demanders in the labor market – demand for
labor is derived from the production
decision
• What else is different?
 Labor services are inseparable from people (buyer doesn't
own it)
– Highly regulated (minimum wages, overtime laws)
– People care about who they work with and for
– Fairness matters
– Incentives (“price structure”)
– People care about working conditions
– Employment relationships last a long time
– Workers and jobs are very diverse
– Information is incomplete (who/where are the good
jobs/workers?)
 “The” labor market is really many specialized markets
1.3. Labor Economics and its evolution

Reading Assignment
• The Neoclassical school
• The institutional school
 1.4 Unique characteristics of labor market
• Labor should not be considered as being bought and sold like so
much grain, oil or bonds.
• Labor is somewhat unique.
• Hence, the markets in which labor service are bought and sold
embody special characteristics and peculiarities calling for
separate study.
• On the supply side: inseparability of labor service
• Labor service can only be rented.
• Workers themselves cannot be bought and sold.
• Further, because labor service cannot be separated from
workers, the conditions under which services are rented are
often as important as price.
• Put differently non-pecuniary factors loom larger in
employment transactions than they do in market for
commodities; i.e. beside remunerations, non-monetary
aspects of the job become extremely significant.
• These non-monetary factors include:
– jobs health and safety features
– arduousness (difficulty) of the work
– stability of employment
– opportunity for training and advancement
• Thus the supply decisions of workers are more complex
than the supply concept which applies to
product markets
• On the demand side: indirect/derived demand of
labor service
• While the demand for a product is based on the
satisfaction or utility it yields, labor is demanded
because of its contribution to productivity in
creating goods and service.
• Demand for labor is derived from the demand for
the products it produces.
• Hence, the complexity of labor markets means
that the concept of supply and demand must be
substantially revised and reoriented when applied
to labor markets.
• Heterogeneity of workers and jobs
• A third feature of labor market that distinguishes it from
most product markets is the extreme diversity in the
characteristics of the good being traded.
• Individual workers differ by age, race, gender, education,
experience, skills, and complex personality factors, such as
motivation and congeniality.
Labor market outcomes
• There is a useful distinction between labor market outcomes
and the labor market process.
• Labor market outcomes are the observed events, behavior,
or developments in the labor market we are trying to
understand and explain; the outcomes represent the end-
product or final result of the operation of the labor market.
• To understand the cause of the outcomes, however, it is
necessary to understand the process that gave rise to
them, that is, the mechanics of how the labor market
works.
• There are different types of labor market outcomes like:
The changing level and composition of labor supply
The changing level and composition of labor demand
The structure of earnings (average hourly earnings,
weekly earnings, annual earnings or lifetime earnings etc.)
Labor-management relations and collective bargaining
Changes in the level and composition of unemployment
• Labor market process
• What are the causes for labor market outcomes
discussed in the above?
• The labor market process involves three broad
forces that together determine each of the
outcomes.
• These three forces are, respectively, market
forces, institutional forces, and sociological
forces.
• Market forces –the first process to consider in the
determination of the price and allocation of labor is the
market forces of supply and demand in the labor market.
• While a number of important non-economic factors
influence the pricing and distribution of labor, most
economists would agree that the interaction of the
market forces of supply and demand in the labor market
is the single most important determinants of labor
market outcomes.
Increase in labor demand shifts the labor demand curve
and raise the wage rate
Increase in labor supply shifts the supply curve to the right
and then decline the wage rate
• Institutional forces- institutional forces represent the
influence of various organizations such as unions,
governments, and corporations on the pricing and
distribution of labor.
• Institutions affect labor outcomes in two different ways.
• First, they fragment or” balkanize” the labor market into
a number of segmented, loosely connected submarkets.
• Institutions introduce structure, artificial boundaries,
and rigidities into the labor market. E.g. a firm invites
internal and external labor market.
• This segmentation has a boundary between two types
of labor market, which is not governed by competition,
and free market forces.
• Sociological forces- the third determinants of labor
market outcomes are sociological forces, which
represent the influence of social groups and norms on
the determination of wage and the allocation of labor.
• Important factors include; family background, class,
culture, discrimination and custom.
• All these create non-competing group.
• They also affect the supply of labor, the types of job
that the individual prefers etc.
Some individuals or group may be discriminated
A few types of jobs may be preferred by many
workers
THANK YOU !!!