Topic 1 - Introduction to Labour Economics

Professor H.J. Schuetze

Economics 370

What is Labour Economics?

Let’s begin by looking at what economics is in

general
g
Study of interactions between decision makers,
which occur in markets, for goods and services (or
commodities).
Of particular interest are the determinates of
equilibrium prices and quantities of goods
exchanged.

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What is Labour Economics?

In a typical free market economy decision makers

are of two main types:
„ Households

„ Firms

Commodities are of two main types:

„ Product (apples, cars)

„ Service (haircuts)

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What is Labour Economics?

The interaction of decision makers in those markets
are related like this:

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What is Labour Economics?

In product markets households provide income to

firms in exchange for goods and services like cars
and haircuts.
In factor markets firms provide income to
households in exchange for labour and capital
(investments).
Government (G) establishes the environment in
which these interactions occur.

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What is Labour Economics?

So this is economics in general, what about labour
economics?
Labour economics is the study of the market for one
particular commodity in the economy:
Labour Services

The actors in the labour market again include:

„ Households

„ Firms

„ Government

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The Actors in the Labour Market

Households make decisions like:

„ when to enter the labour market

„ how much education or training

„ which occupation or industry

„ number of hours to work

„ whether to quit or retire

Firms choose
„ number
b off workers
k tto hi
hire
„ hours of work

„ when to layoff or close plant

„ pension or retirement policy

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Government in the labour Market

Government establishes the environment by:

„ providing training

„ unemployment insurance

„ workers compensation

„ pensions

„ laws to protect workers and firms

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What is labour Economics?
The interactions between these players in the
labour market determines:
the equilibrium price: which is the wage that
workers receive.
the equilibrium quantity: which is the amount of
work that people do in the economy.
„ this quantity has several dimensions
/
Š hours/weeks ⇒ time
Š effort ⇒ efficiency
Š skill ⇒ productivity

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What is labour Economics?

Note: What has been said so far may seem
incredibly obvious, but there are those who would
take issue with it. Theyy would argue:
g
“labour is not a commodity. A person’s labour is not
just something they sell in return for income.
Rather, a persons job, occupation, career are an
important aspect of:
„ identity

„ self
self-esteem
esteem
„ prestige

„ “Who You Are”

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What is labour Economics?
How to respond?
All these things are probably true
However they do not disprove the fact that labour
However,
is something that is bought and sold in a modern
capitalist economy
Price is set by demand and supply
Example: Increased demand for housing in Victoria
has lead to an increase in demand for trades
The
Th result l is
i an increase
i in
i wages among trades
d
We might wish it wasn’t so but in our society it is a
commodity that is traded in markets.

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Why study economics of labour?

If labour is just another commodity and can be
analyzed just like any other, why do we need a
special course/subfield of economics?
We don’t have a special subfield of economics
for each commodity.
e.g. Banana Economics
Why for labour?
The main reason is the importance of the labour
market.

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The Importance of the Labour Market
For virtually all households in the economy, the
sale of their labour services constitutes, by far,
their major source of income
income.
The price of the goods that they sell is the main
determinant of their economic well being.
Thus, to understand the distribution of income in
society – who earns what and why- we need to
understand labour markets,, how wages g are
determined, etc.

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The Importance of the Labour Market

Secondary reason:
Like every commodity labour has a number of
special features/peculiarities that must be taken
into account in a more in depth analysis.
Each of these features has important implications
for how labour markets work and for prices and
quantities.

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Special Features
For example:
Labour Market Consumer Market
household is seller household is purchaser

firm is purchaser firm is seller

Wage Price

„ reflects investment in education

„ compensation for risk
„ discrimination

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How do we study the economics of labour?

1. We can construct models of behaviour
Use same tools that economists use to study
other goods (e g bananas
(e.g., haircuts GM stock,
bananas, haircuts, stock
metal stamping machinery)
Can use standard tools of economics “micro
theory” (budget constraints, indifference curves,
etc.)
Can represent the interactions between the
factors in markets by supply and demand curves
(get equilibrium price and demand)

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How do we study economics of labour?
2. We can test models of behaviour
Test the ability of our models to explain various
facts about labour markets by testing against real
data from labour markets
Typically use statistical analysis including
regression procedures
If the model doesn’t fit it is rejected or revised.

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Basics – The Supply and Demand Model

Labour is just applied microeconomics so we can
simply apply knowledge from Introductory Economics.
Neoclassical Supply and Demand Analysis:
P (w) S Don’t usually look at all
workers and firms because they
are not homogeneous.
w* Instead look at the market for
burger flippers (for example).
D
Assumes competition
Results in the familiar
equilibrium
ilib i (w*,
( * q*)
*)
q* q
Allows economists to predict what will happen to wages
and employment when:
Labour market policy or market conditions change
Or even when our underlying assumptions change
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Basics
Recall that we need to distinguish between shifts
and movements along the curves.
Demand Shifters?
technology
capital prices
demand for output
Supply Shifters?
population
unearned income
wages in other markets
job conditions
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Subject Matter of Labour Economics

With this model in mind, what do labour
economists study?
Simply, factors that influence labour supply,
demand and their interaction
Labour Supply includes population growth,
participation and education decisions
Labour Demand includes factors that influence
labour costs like minimum wages and output prices
like free trade
Market Outcomes are also studied
This includes the degree of competition,
unemployment and unions
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Empirical Work
We will encounter many applications of econometrics.
The basic goal is to uncover relationships in the
data
Labour market examples:
1. Minimum wages and jobs
2. Immigration and native employment
3. Years of education and earnings
Problem:

Labour economists deal with this in many ways

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Data – the starting point

Labour economists use a wide variety of data sets
1. Aggregate or time-series data
Economy wide
Usually reported over time
Examples:

Cross-section micro-data
Looking across individuals at a point in time
Examples:
- Survey of Consumer Finances (SCF)
- Labour Force Survey – monthly (LFS)
- Census data

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Data – the starting point
3. Panel or longitudinal data
Follow individuals over time
i.e. cross-section
cross section over multiple periods

- Labour Market Activity Survey (LMAS)

- Survey of Labour and Income Dynamics (SLID)

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Regression Analysis
Regression analysis allows researchers to uncover
relationships in the data with some ability to hold
other factors fixed
Example: How much do earnings increase with another
year of education?

earnings

education

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Regression Analysis

earnings

education

Looks positive but we want to quantify it in some way.

The slope tells us the information we are interested in.

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Regression Analysis
Earnings = a + b*years education
• If this relationship was exactly true all of the data
points would lie on the line
• Of course it isn’t exactly true as many other factors
also influence earnings
• Could lump all of these factors together
Earnings = a + b*years education + e
•

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Controlling for “other” factors
We don’t get the ceteris paribus effect of education
on earnings by lumping all of the other factors into
the error term

We can think of some of these things as being

shifters of this line
Example: suppose we think gender has an impact on
earnings (reasonable assumption)
We
W could ld include
i l d a “dummy
“d variable”
i bl ” (0-1)
(0 1) in
i the
th
equation
= 0 if male
=1 if female
Earnings = a + b*years education + d*female + e
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Non-Linear Relationships
What if you don’t think the relationship is linear?
„

Example: 1 additional year of education may raise earnings by

10%
Adding additional years of education will increase earnings
exponentially (just like interest that is compounding)
Thus, a plot of earnings against years of education will be non-
linear

Note: this changes the interpretation of b

b=

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Statistical Significance
The estimate of b (or any coefficient) we obtain from
OLS are estimates with a margin of error
Thus most articles will report coefficients and either
Thus,
standard errors or t-statistics
We could use this information to formulate a p-value.

i.e.
i e What is the probability of estimating the coefficient
b when there really is no relationship between
earnings and education

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Statistical Significance

If this probability is “LOW”:

Usually willing to live with a 5% chance of

getting b if it is actually 0.
Rule of thumb:
1.

2.

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Problems in Estimation

Impossible to hold everything else equal.

„

How important are omitted variables?

Earnings-Education example:
„ suppose there is something we can’t observe that is
related to earnings.
If unrelated to education: no problem
Shift Variable:
•
•

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Problems in Estimation

If related to education: problem

e.g. Ability
High Ability = High Earnings
High Ability = High Education

We observe high ability, high educated workers and

low ability, low educated workers.
Not knowing that there should be two parallel lines
for high ability and low ability workers.

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