Labor Economics

Abebe Mucheye Kassie (M.Sc.
In Development
Economics)
Economics Department
Debre Markose University
Ethiopia
Course Name: Labour Economics

Course Code: Econ-3101
August 1 ,2022
8/1/2022 Abebe Mucheye (M.Sc) 1
CHAPTER ONE
INTRODUCTION
• Labor economics is simply defined as the study of the

workings and outcomes of the labor market.
• The workers offer their services to firms in the labor market
where both the pecuniary and non-pecuniary factors play
significant role in the transactions.
• Labor economics is the study of the workings of the market
for labor, which is primarily concerned with the behavior of
employers and employees in response to the general
incentives of wages, prices, profits, non pecuniary
aspects (working conditions, risk of injury, personalities of
managers and flexibility of working hours).

• Three agents can be identified in the labor market: workers,
firms and the government.
• All these actors of the labor market follow their own
objectives.
• With the objective of achieving utility maximization,
workers need to decide whether to work or not,
 how many hours to work,
 which skills to acquire,
 which occupation to enter, whether to join a labor union or
not, how much effort to allocate to the job and when to quit
a job. Each of these decisions of all the workers in the
economy constitutes the quantity and quality of labor
supplied in the economy - labor supply curve.
• Pursuing the motive of profit maximization, firms need to
decide
 how many and which types of workers to hire and fire,
 how much the working hours to be,
 how much capital to employ, and whether to offer safe
working conditions.
• Each of these decisions of all the firms in the economy
generates the demand for labor in aggregate - labor demand
curve.
• However, the motives of workers and firms are
conflicting in the sense that, when the incentives change,
the two agents react differently for such a change.

• When the wage rate is high, for instance, workers respond
by supplying more of their services while the willingness of
firms to demand labor declines, and vice versa.
• But such a conflict of interests is resolved when the labor
market reaches an equilibrium point, at which the demand
for labor by firms is exactly equal to the supply of labor by
workers.
• The third agent, the government enters into the labor
market so that the re-distributional transaction will be
mandatory.

 In facilitating the mandatory transactions, the government can
exercise a wide range of policies that include
 imposing taxes on workers’ earnings.
 subsidizing the training of workers.
 setting minimum wage legislating.
 levying profit tax on firms and encouraging or restricting
immigration.
• In brief when the economic transactions are mutually
advantageous, both parties participate in the labor market
voluntarily.
• But when the labor market fails to facilitate mutually beneficial
transactions, the compensation of losers must take place through
the intervention of the government.

IMPORTANCE OF LABOUR ECONOMICS:
The study of labour economics is importance for the following
reasons.
1. It helps economists to understand labour related problems
e.g Issues on fair wage or salaries workers, welfare of workers,
labour productivity, workers safety, gender related matters, job
security and Job satisfaction.

2. The study important in providing data for economic
planning and policy
e.g. It helps economists to know the contribution of labour
services to peoples income (wages and salaries). There is
evidence that in most economy, labour input is the most of
economic resources.
3. The study of labour economics helps us to understand the
nature of the market in which labour services are bought and
sold.

 Labour economics is concerned with issues that affect or
concern the labour force.
Issues that concerns labour forces include;
• Labour mobility and migration
• Labour markets
• Supply of labour
• Work leisure decision
• Government and institutions
• Participation rates of Labour
• Wage structure
• Quality of labour
• Labour productivity
• Wages and inflation Abebe Mucheye (M.Sc)
8/1/2022 9
Internal and External Labor Markets
o Employers usually have two options to fill a job vacancy.
• The first option involves hiring a new worker by participating
the labor market, referred to as the external market.
• The second option is by promoting the formerly employed
workers to the vacant position , referred to as the internal
market.
 A good example of external market is secondary markets,
 where jobs are not attractive,
 wages are low,
 on-the –job training is very little.
 turnover of workers is so high.
• The basic reason for the existence of secondary labor markets
is that the job does not require workers with much skill, rather
the job can be learnt with in a few hours.
• On the other hand, there are firms where a good deal of
workers with considerable teamwork is necessary.
• In such firms the product demand, and thus the labor demand
is so relatively stable that the firm can invest considerable
resource in training and motivating its workers.
• In order to gain from investments of this kind, the wage rate
in such labor markets must be high enough to attract and
retain’ highly skilled workers.
• Consequently, the rate of turnover in these firms is very small
and there is hardly any mobility of workers across employers.

• Vacancies in such firms are filled by mobilizing workers
across occupations within the firm through promotions or
lateral transfers.
• There is no need of hiring new entrants, except for a few
entry-level positions, from the external market, rather the
positions are filled from the internal markets.
• Large firms are characterized by very highly developed
internal labor markets and long leaders of promotions.

• Nevertheless, the interaction of demand and supply do not
have any role to determine the wage rate of internal labor
market.
• The wage rate simply set by administrative rules or by
unilateral or collective bargaining’s.
• Once the worker is hired at the entry-level jobs, ports of entry,
from the external market, the worker will be assigned to a
ladder of higher-paying positions through the internal labor
market.
• Sometimes the wage rate increases as the worker masters
additional skills while remaining in the same job
classification.

• As the pay is high,
• The mobility across employees is little and
• The working conditions are better highly developed
internal labor markets can be grouped under the
primary labor market.
• To put in the words of McConnell and Bruce (1992) An
internal labor market is an administrative unit, such as a
manufacturing plant, within which the pricing and
allocation of labor is governed by a set of administrative
rules and procedures rather than by economic variables.

Labour Market Theories:
o Most labour market theory explained how labour is
compensated and what constitute labour.
 Examples of labour market theories include of the
• Neoclassical labour market theory,
• Labour market segmentation theory

Assumptions
o Labour market theory is a model, and a model is a simplification
of reality that we use to try to understand a complex concept.
o A model will make some assumptions to make things simple.
o The labour market theory is no different, and it makes a few
important assumptions:
• The most important motivation in the labour market for people is
a wage or other monetary compensation.
• Workers are pretty much fungible - you can substitute one for
another and it makes little difference.
• Workers are mobile - they can move to where there is a demand
for work.
• Wages are flexible - they can go up or down.

1. Neo classical labour market theory – This is otherwise known as the
orthodox labour market theory States that employers act to maximize
their profit by paying low wages for the workers skill they need as they
can, workers also want to maximize their gain by insisting on the
highest pay for the job for which they have the required essential or
dispensable skill.
2. Labour Market Segmentation Theory –
 This theory state that labour market consist of various subgroup with
little or no capability to cross over from one group to another.
 It describes a situation where different groups or individuals receive
different wages or compensations for the same work.
 The theory explains economic marginalization due to racial, ethnic or
political reason. Segmentation can result in different groups, for
example men and women, receiving different wages.

Chapter Two
Labor Supply Theory
2.1 Measurement of the Labor force Participation

 Unemployment : refers to a situation where the persons
who are able to work and willing to work, at the current
market wage rate, fail to secure work or activity which
gives them income or a means of livelihood. Thus, for a
person to be categorized as unemployed, two conditions
must be fulfilled:
o That the person is without a job and able to work
o The person wants to have a job and is willing to work at
the current market wage rate.

 The term labor force can further be divided into
• employed and
• unemployed.
 To be employed a worker must have been at job with pay
for at least a hour, or worked at least 15 hours on a non paid
job such as the family farm.
 Otherwise, if a worker is actively searching for a job, or is
temporarily laid off and expecting recall but not employed
for pay, he/she is said to be unemployed and constitutes the
labor force.
 If a person is neither employed for pay nor actively looking
for a job and is permanently laid off, he/she is said to be out
of the labor force.
 It is however, important to note that there are sizeable flows
of workers between groups.
o We can identify four major flows of people between
groups:
• From the employed to unemployed groups: some workers
may be voluntarily quitting or laid off.
• From the unemployed to the employed group: some
unemployed workers may be newly hired or recalled from
temporary laid off.
• From the labor force to out of the labor force: some employed
or unemployed workers may retire or drop out of work.
• From out of the labor force to the labor force (new graduates,
for example) and some of the drop outs may re-enter the
labor force.
• The labor force participation (LF) is measured by adding
up the number of workers being employed (E) and
unemployed (U). If we divide the size of the labor force to
the entire population, we arrive at the fraction of the
population that is in the labor force, the labor force
participation rate.
*100%
• unemployment rate is taken as a fraction of the labor force

being unemployed
• Unemployment rate = *100%

2.2. The Work-Leisure Decision Model
• Out of the 24-hours a day available to us if we allocate 8
hours for biologically and culturally determined activities
like sleeping, eating and others, the remaining 16 hours will
be at our disposal. We can spend them either for work or for
leisure, or some combinations them.
• To analyze the workers’ behavior in allocating the
discretionary hours between work and leisure, economist
employ the neoclassical work-leisure decision model.
• Basic idea: Individuals seek to maximize well-being by
consuming both goods and leisure. Most people have to
work to earn money to buy goods. Therefore, there is a
trade-off between hours worked and leisure.

a. Preferences of a worker
• The framework used to analyze labour supply behavior is the
Neoclassical Model of Labour-Leisure Choice.
• Utility Function ‘U’ – measure of satisfaction that individuals
receive from consumption of goods C and leisure L (a kind of
good). C measured as dollar( $ )value of all goods purchased during
a period. L is the number of leisure hours during the same period.
• U = f(C, L) where U is an index and a higher U means higher
utility/ satisfaction/happiness/well being.
• U is a utility function in general form.
• U higher if C and/or L or both higher. C and L are ‘goods’, not
‘bads’ ’ in the sense that the larger the money income given the
price of commodities and/or the larger the leisure time, the higher
the level of utility will be.

• These two goods, C and L, are to some extent substitutes for
each other.
• This means that various combinations of C and L yield the
same level of satisfaction.
• if a worker were made to forgo some hours of leisure for
work, he/she would enjoy an increment on his money
income so that his/her satisfaction could keep unchanged.
• Indifference Curve: The locus of all points (i.e.
combinations) in C, L space that give the same level of
utility.

• The locus of points that stand for equal utility is termed as
an indifference curve.

 Indifference curves have the following important
characteristics;
o Higher indifference curves represent higher levels of utility:
every point on the Utility level B yields a higher-level
satisfaction than utility level A.
• Indifference curves are downward sloping: as both leisure
and money income are goods, for an individual to keep
utility constant either leisure or money income should
increase as the other decrease.
• Indifference curves do not intersect: If they did, the point of
intersection would represent a combination C and L that
yield different level of satisfaction.

• Indifference curves are convex to the origin : (indicating
that opportunity costs increase). For example, the fewer
leisure hours there are, the more C the person has to gain in
order to give up another hour of leisure and keep U
constant.

o The slope of an indifference curves
• The change in utility resulting from an additional $ spent on
goods, holding constant the number of leisure hours, is the
Marginal Utility of Consumption: MUC
• The change in utility resulting from one more hour of
leisure, holding constant the amount of goods consumed, is
the Marginal Utility of Leisure: MUL
• They are both positive numbers.
• The absolute value of the slope of an indifference curve is the
Marginal Rate of Substitution (MRS) in Consumption:
•

• Going from right to left along a particular indifference
curve (e.g. reduce leisure hours) results in: Utility loss =
ΔL*MUL; Utility gain = ΔC*MUC
• The person remains on the same indifference curve i.e.
utility loss = utility gain:
• (ΔL*MUL) + (ΔC*MUC) = 0

b. The Budget Constraint
o A person’s consumption of C & L is constrained by her time
and income.
 Expenditure on goods C equals labour earning (wage rate ×
hours) plus non labour income (V): C = wh+V. This is the
worker’s budget constraint.
 There are no savings in this simple model. Also assume a
constant wage rate (wage independent of hours worked).
 Total time available (e.g. per week) T equals h + L. Because
of this, rewrite the budget constraint as C = w(T - L)+V or
C = (wT+V)-wL .
 Draw this equation in C, L space to obtain the budget line.

• The budget constraint defines the worker’s
opportunity set, indicating all of the consumption - leisure
combinations the worker can afford.
• Where,
– V= endowment (non-labour income, wealth)
– T= hours in the time endowment
– w = hourly wage
– h= hourly work
– c = consumption (= income (Y), no savings)
Þonly the consumption-leisure combinations satisfying
the following budget constraint can be bought:

• Assume seven days of 24 hours available
• Assume labour is homogeneous and waged
• Assume the wage rate is w

• If no work undertaken then 168 hours of leisure taken and
income is zero (a)
• If worker then decides to work one hour then leisure decline
and income rises to . w
• One more hour gives income of 2 w

 The budget line delineates the frontier of the worker’s
opportunity set of all the consumption baskets he/she can
afford to buy.
• in the above figure: E = Endowment point (all leisure, but
still some C due to nonlabour income);
• slope = -w;
• intercept gives maximum possible consumption of goods
(& no leisure at all).
• Moving to the left along budget line: Each hour of leisure
given up allows the worker to buy more goods.

The optimal choice
• Which is the consumption-leisure combination that
guarantees the highest utility compatibly with a given budget
constraint (BC).
• It is the combination at the tangency point between the BC
constraint and the indifference curves.
– At this point the marginal rate of substitution (MRS)
between consumption and leisure equals the wage.
– Any other consumption – leisure bundle on the budget
constraint would give the individual less utility.

Optimal consumption-leisure choice

• At the optimal (utility-maximising) point P, the slope of the
indifference curve is the same as that of the budget line.
This is the same as saying that the MRS in consumption
equals the wage rate:

Labour Supply Decision
• Once someone is working how do they respond to a change
in the wage rate?
 Two key elements
• Substitution effect – as wages rise, person works more
and substitutes work for leisure as the opportunity cost of
leisure rises
• Income effect – as wages rise, person works less as his/her
income has risen thus allowing him/her to spend more time
in leisure activities

Labor supply curve
• Relationship between hours worked and the wage rate.
• At wages slightly above the reservation wage, the labor
supply curve is positively sloped (the substitution effect
dominates the income effect).
• If the income effect begins to dominate the substitution,
hours of work decline as the wage rate increases (a
negatively sloped labor supply curve).

Fig: The backward bending supply curve

• Reservation wage: the lowest wage rate that would make the
person indifferent between working and not working.
o Some implications of the reservation wage:
• The decision to take a job is made by comparing the
reservation wage and the market wage.
• If the market wage is greater (less) than the marginal value
of leisure time, the worker will (will not) participate in the
labor market.

 Since the reservation wage depends on the person’s taste
for work, as the worker’s non labor income increases,
his/her reservation wage becomes higher and consequently
the person is less likely to enter the labor force
 Suppose the market wage rate increases holding the
reservation wage constant the worker who faces the higher
market wage is more likely to participate in the labor
market.
• Therefore, there is a positive relation between the market
wage and the probability of working.

Elasticity of Labour Supply
• The labor supply elasticity (σ) measures responsiveness in
hours worked to changes in the wage rate.
• σ = Percent change in hours worked divided by the
percent change in wage rate.
• Labor supply elasticity less than 1 is inelastic as hours of work

respond proportionally less than the change in wages.
• Labor supply elasticity greater than 1 is elastic as hours of
work respond proportionally more than the change in wages.

Policy application: welfare programs and work incentives
• Cash grants reduce wage incentives.
• Welfare programs create work disincentives.
• Welfare reduces supply of labor by increasing non labor income,
which raises the reservation wage.
o A take-it-or-leave-it cash grant of $500 per week moves the worker
from point P to point G, and encourages the worker to leave the labor
force.

Policy application: the earned income tax credit
• The earned income tax credit should increase labor force
participation of non workers of targeted groups.
o The earned income tax credit encourages some non-workers
to start working and never encourages a worker to quit
working.
• The earned income tax credit produces an income effect

Chapter three
Labour Demand Theory
• The labor market analysis becomes complete when the agents
that constitute demand side are dealt with.
• The agents are firms who make decisions of hiring and firing
of workers.
• In order to satisfy the consumers demand for goods and
services, firms engage in the production process of those goods
and services.
• The production of such goods and services gives rise to the
demand for labor and other factors of production like
building, capital and machines.
• The demand for labor is therefore, derived from the consumers’
demand for goods and services.
• Consequently, the firm’s labor demand is a derived demand.
The Production Function
• The production function describes the techincal
relationships between inputs and outputs.
• For the sake of simplicity, the inputs are categorized into
two groups: labor and capital.
• The economic variable labor is measured by the number of
hours hired by firms and that of capital includes the other
factors of production except labor.
• Thus the production function can be written as

• Where
• Q is the firm's output,
• L is the amount of employee-hours employed by the employer
and
• K is the physical unit of capital used in the production process.
• It is important to note first, that L is obtained by multiplying the
number of workers hired by the average number of hours worked
per person.
• Second, the workers skill is assumed to be homogeneous so that
different workers are aggregated into the single variable labor.
• The marginal product of labor is the change in output resulting
from hiring an additional worker, holding constant the quantities
of other inputs.

• The marginal product of capital is the change in output
resulting from employing one additional unit of capital,
holding constant the quantities of other inputs.
• Graphically, the marginal product curves are derived from the

total product curve as the firm hires more workers.
• Figure 3.1 (a) illustrates the total product curve, which is
upward sloping.
• Figure 3.1(b) depicts the marginal and average product
curves.
• The marginal product curve is the slope of the total product
curve, i.e. the rate of change in output as more workers are
hired.
• The average product of labor is defined as amount of
output produced per person.
• The relationship between MPL and APL can be stated as
follows.
• When APL is increasing, MPL> APL.
• When APL is at its maximum, MPL= APL.
• When APL is decreasing, MPL< APL.

Marginal Revenue Product
• Usually firms make production decisions by considering what
is prevailing in the output market rather than the
availability of factors of production.
• Employment depends on the revenue generated by producing
and selling extra output in the market.
• The more important concept associated with the production
decision of firms is that of the marginal Revenue Product or
the value of marginal Product.
• It is defined as the money value generated from having an
additional worker.

Where VMPL is the value of marginal product of labor and MR is the
marginal revenue. The marginal revenue that is generated by an extra
output sold depends on the bind of market in which the product is sold.
If the market is a perfectly competitive, then the marginal revenue is
identical to the product price (P) and equation (3.5) can written as

The Short-run demand for labor
• The short-run demand for labor analysis focuses on the firms
behavior towards the labor demand over a short period of time
during which the capital stock is hold constant.
• As a result of this, the law of diminishing marginal returns is
regarded as the critical assumption that lies behind the derivation
of the labor demand curve in the short run.
• For exposition purpose, the firm works under the perfectly
competitive output market and hires labor from a competitive
labor market so that both the product price and the market wage
rate the firm faces will be constant.
• Consider the following example, and suppose that the product

price is Birr 2 And the market wage rate is Birr 22.
 For the
8/1/2022
various level of labor employed
Abebe Mucheye (M.Sc)
the marginal product55
and
the value of marginal product is given as follows:
Value
No. of Outpu Margi Value of of
Average
emplo t nal product Marginal Average
yees product Product produc
t
0 0 - - - -
1 11 11 11 22 22
2 27 16 13.5 32 27
3 47 20 15.7 40 31.4
4 66 19 16.5 38 33
5 83 17 16.6 34 33.2
6 98 15 16.3 30 32.6
7 111 13 15.9 26 31.8
8 122 11 15.3 22 30.6
9 131 9 14.6 18 29.2
Short run hiring decision
• Value of Marginal Product of Employment (VMPL) is the
marginal product of labor times the dollar value of the output.
• VMPL indicates the dollar benefit derived
from hiring an additional worker, holding capital constant.
• Value of Average Product of Employment(VAPL) is
the dollar value of output per worker.
• a profit-maximizing firm has to continue to hire workers until
W=VMPL
 the profit maximizing levels satisfies two conditions;
o first, it is downward sloping, and
o second, it equals to the wage rate. Note that the wage rate
and the value of marginal product of labor equals

Labour Demand Curve
• The demand curve for labor indicates how many workers the
firm hires for each possible wage, holding capital constant.
• The labor demand curve is downward sloping. This reflects
the fact that additional workers are costly and alter average
production due to the Law of Diminishing Returns.

The Demand for labor in the Long Run
• The short-run labor demand discussion assumes that the
time period is so short that the level of capital stock
remains fixed.
• In this section we will see what happens to the demand
for labor if the time period is long enough that the level
of capital changes- the plant size can expand or
contract.
• Therefore, the long run profit-maximization condition
requires making decisions about the number of workers to
be employed and the amount of plant and equipment to
invest in.
• The explanation of this section starts by emphasizing the
basic microeconomic concepts of cost minimization.
• Isoquant curves describe the possible combinations of labor
and capital that produce the same level of output.

Properties of isoquant curves
• Isoquants must be downwards sloping
• Isoquants do not intersect
• Higher isoquants, Q1 , are associated with higher levels of
output
• Isoquants are convex to the origin

Numerical Example

Find
A. MRTSLK?
B. Interpret the result?

• Isocost lines
• The isocost line indicates all labor–capital bundles that exhaust a
specified budget for the firm.
• Isocost lines indicate equally costly combinations of inputs.
• Higher isocost lines indicate higher costs.

• The slope of an isoquant is given by the negative of the
ratio of marginal products.
The slope of the isocost line is derived from the firm’s cost of
production function given by
C = WL + rK

• the slope of the isocost line, is the negative of the ratio of
input prices, cost- minimization principle dictates that the
firm, in order to maximize profit by producing Q 0 level of
output, should produce this output at the lowest possible cost.
• The firm minimizes costs when it uses the capital labor
combination at which the iscost is tangent to the isoquant
curve. implying that the slope of the cost line equals to
the slope of the isoquant curve .
• At optimal combination of capital and labor the marginal rate
of technical substitution equals the ratio of input prices. Upon
rearranging the equality

Elasticity of Labor Demand
• The responsiveness of labor demand for a change in the
wage rates measures the elasticity of labor demand. It is
possible to measure both the short-run and long run
elasticity.
(i)the short-run elasticity of labor demand (SR):- it is defined
as the percentage change in the short-run demand for labor
(LSR) resulting from A 1 percentage change in wage (w) .

• the long-run elasticity of labor demand (S LR) :- it is defined as the percentage change in
the long-run demand for labor (L LR) resulting from a 1 percentage change in the wage
(w).
• Note that the labor demand curves being downward sloping, the elasticity measures of
both the short-run and long run labor demands bear negative sings.
• The imprison of elasticity between short-run and long run demand for labor
indicates that the long-run elasticity of labor demand is greater than the short-
run labor demand elasticity. This is because of the fact that in the long run the
time period is long enough to adjust capital and labor input combinations in
response to changes in the wage rate. But in the short run the time period is too
short to adjust its size optimally.
The End of Chapter Three
06/14/2024 75
Chapter Four
Wage Determinations And Compensating Wage
Differentials
Perfectly Competitive Labor Market
 The characteristics of perfectly competitive labor market
includes
• A large number of firms competing with one another to hire
a specific type of labor to fill identical jobs.
• Numerous qualified people who have identical skills and
who independently supply their labor services
• Wage-taking behavior-neither workers nor employers exert
control over the market wage i.e price takers.
• Perfect, costless information and labor mobility.
 The analysis centers on three issues, i.e. labor market, the
hiring decision by a firm, and allocative efficiency.
(A) Labor Market
o The labor market has two interacting components, namely
• the demand for labor, which reflects the behavior of
employers, and
• the supply of labor, which represents the workers’ behavior.
Labor demand and supply
• The market demand for labor has been shown to be
obtained by horizontal summation of the quantity of labor
demanded by employers over a varying amount of wage rates,
similarly
• The market supply of labor of a particular type of labor is
found by summary the back ward bending individual labor
supply curve at each various wage rates.
• But observe that the market labor supply curve, unlike the
individual one, is not back-ward bending because in
collective terms workers are willing to offer more labor
hours at higher relative wage rates.
• Put differently, ever though specific people may normally
have back-ward bending labor supply curve, labor supply
curves of specific labor markets generally are positively
sloped over realistic wage ranges.
• Higher relative wages attract workers away from household
production, leisure, or other labor markets and toward the
labor market in which the wage increased.

• The market labor supply curve measures the opportunity
cost of employing the last labor hour in this occupation.
• The upward sloping curve implies that more and more wage
rates are necessary to entice additional hour of labor away
from leisure or from work in different occupation.
• To attract additional labor to a certain labor market, the
opportunity costs must be compensated by a higher wage
rage.

• The shorter the time period and the more specialized the
variety of labor, the less elastic the labor supply curve.
• In the short run, increases in the wage may not result in
significant increases in the number of workers in a market,
but in the long run, human capital investments can be
undertaken which will allow greater responsiveness to the
higher relative wage.

Determinants
 Here are the determinants of labor supply and labor demand
(i) Determinants of labor supply
1. Other wage rates:- wages paid in other occupations
2. Non wage income:- income other than from
employment
3. Preferences for work versus leisure
4. Non wage aspects of the job
5. Number of qualified workers
An increase in either of (1) or (2) leads to a decrease in the
labor supply while an increase in any one of (3), (4) or (5)
leads to an increase in the labor supply.
(ii) Determinants of labor demand
1. Product demand
2. Productivity
3. Prices of other resources:- Depending upon whether a
substitute results in a gross complements (output effect >
substitution effect) or a gross substitutes (out put effect <
substitution effect)
4. Number of employers
 An increase in (1), (2), (4) and gross complement resources
yield on increase in the demand for labor whereas an increase
in the gross substitute resources leads to a decline in the
demand for labor.

B. The Hiring Decision by a firm
• Because an individual firm is just small to affect the labor
market, its decision on how many workers to hire will not
affect the market wage. Rather, this firm is a wage-taker in the
same sense that a perfectly competitive seller is a price taker in
the product market.

• To decide on the number of workers a firm will hire we
need to compare the above two curves.
• The single employers has no incentive to pay more than W 0
because at this equilibrium wage rate the firm is able to
attract as many labor hours as it wants.
• If it lowered the wage rate, no worker would be attracted so
the marginal opportunity cost of workers with this skill must
not be less than W0.
• This indicates that the labor supply curve that faces an
individual firm is perfectly elastic, horizontal at W 0.

• In the short run, a firm’s demand for labor curve is its
marginal revenue product curve.
• Thus, this firm can compare the additional revenue (MRP)
obtained by hiring one more unit of labor with the added
cost (MWC) or in this case, the wage rate (W = MWC).
 If MRP > W, it will employ the particular hour of labor; on
the other hand, if MPR < W, it will not.
• To generalize, the profit-maximizing employer will obtain
its optimal level of employment where MRP = MWC.

• If Figure 4.1.(b) L1 level of employment indicates that MRP
exceeds MWC, indicating that the firm can earn a higher
profit if it employs the next hours of labor.
• At L1 what the firm can earn by selling the additional
product resulting from employing this worker (price)
exceeds what is pays on the employment of it (wages).
• This is true for all level of employment below L 0. Then the
firm continues to employ up to L0.
• Beyond L0 diminishing returns finally reduce marginal
product to the extent that MRP lies below the market wage
W0 (=MWC).
• Thus this firm’s total profit will fall if it hires more than L 0
workers.
C. Allocative Efficiency
• Labor is being allocated efficiently when society obtains the
largest amount of domestic output from the given amount of
labor available.
• Available labor is efficiently allocated when its value of
marginal product (VMP) – the dollar value to society of its
marginal product –is the same in all-alternative
employments.

• Suppose that the same labor A is capable of producing
product X and product Y. Suppose also according to the
current allocation of labor the VMP of labor to produce X and
Y are $12 and $8, having the result that VMPX > VMPY.
Because labor resource in the firm that produces product Y is
inefficiently used, by transferring a worker from the
production of Y to that of X it is possible to raise the
efficiency of this labor. This reallocation will cause a
movement down the VMP curve for X and up the VMP curve
for Y. This means that VMPx will fall and VMPY will rise, and
the reallocation continues until the VMPs across the products
are the same, i.e. VMPx = VMPy.
 Once this equality is achieved, there is no further reallocation
of labor, which will cause a net increase in the domestic
output.
 If we expand the example to include n products, the condition
for efficient allocation of any given type of labor is given by
VMPx =VMPY =.........................=VMPn =PL
• Where PL is the price of labor. This equation tells us that
human resources are efficiently allocated when the value of
the last units of labor in various labor market uses (producing
goods X, Y,.... n) are all equal and these values in turn are
equal to the opportunity cost of labor PL (the marginal value
of alternative work, non-labor market production and leisure).
• Alternatively, an under allocation of a particular type of
labor-to-labor market production occurs when its VMP in any
employment exceeds PL;
• an over allocation occurs when its VMP in any labor market
employment
8/1/2022 is less than P L. Mucheye (M.Sc)
Abebe 90
 Under the perfectly competitive product and labor markets,
the equilibriums for the production of n products occur at a
level of employment where profit is maximized by equating
MRP with MWC.
• In a perfectly competitive market labor is hired at which
PL=MWC and the products are sold at a point where MRP =
VMP for all the products.
• Thus each firm maximizes profits where MWC = MRP.
• But because PL= MWC and MRP = VMP for all competitive
firms using the same labor, allocative efficiency condition is
fulfilled under such a market.
 In short, competitive labor markets do result in an efficient
allocation of labor.
Monopoly in the Product Market
• Unlike a competitive firm, a monopolist firm faces a
downward sloping demand curve in the product market,
meaning that increases in its output will require reductions in
price and that its marginal revenue (MR) will be less than its
price.
• Consequently the MRPL (= MR X MP) will fall because,
firstly, because of diminishing returns MP will decline when
more labor is hired. Secondly, MR will decline faster than
price.
• As shown in Figure 4.2 below a monopolist faces a
downward sloping demand curve and MR curve but a
horizontal labor supply curve, indicating that this firm is a
wage-taker.
• Labor demand curve DC is the MRP curve that would have
occurred had there been competition rather than monopoly
and therefore no decline in marginal revenue as the firm
increased its employment and output.
• This MRP curve would be equal to VMP; the firm’s revenue
gain from hiring one more worker would equal society’s
gain in output.
• On the other hand, demand curve Dm is the monopolist’s
MRP curve. In this case, MRP, the value of the extra output
of each worker to the monopolist, is less than VMP, the
value to society.

• Comparisons of perfectly competitive in both product and
labor markets and monopolistic firm in the product and
competitive in the labor market have the following
outcomes:
• The monopolist’s labor demand curve D m is less elastic than
the competitive labor demand curve DC
• The monopolist behaves in the same way as the competitive
firm in determining the profit-maximizing level of
employment where MRP = MWC.
• Nevertheless, this equality produces a lower level of
employment, Qm, than would occur under competitive
product market conditions, Qc.
• The wage paid by the monopolist is the same as that paid
by the competitive firm,Abebe
8/1/2022
because both are wage-takers 95
Mucheye (M.Sc)
• The last outcome needs further description obviously,
efficient labor allocation requires that VMP = P L.
• In a perfectly competitive market PL (=W) reflects the
marginal opportunity cost to society of using a resource in a
particular employment and VMP reflects the measure of the
added contribution to output of a worker in a specific
employment.
• Under a monopolist, the profit maximizing level of
employment is given at Qm where VMP > PL (W0), implying
that too few labor resources are being allocated to this
employment.

Monopsony
• A monopsony is a market in which there is a single buyer.
• A monopolist faces the Market Supply of Labor
To hire more labour, a higher wage must be
paid: marginal cost of labour (MFC) curve is upward sloping.
• To maximize profit the monopolist hires until the marginal cost of
labour , that is , the marginal factor cost , is equal to the marginal
revenue product.
• In this part the focus is on the conditions in the labor market only.
 A single firm dominates the labor market or two or more employers
are collided to fix below competitive wage. They are respectively
referred to as pure monopsony and joint monopsony.

Assumptions
• There are numerous qualified homogeneous workers who
act independently to secure employment in the
monopolized labor market
• Information is perfect and mobility is costless
• The monopolist is a wage-setter, it can control the wage
rate it Pays by adjusting the amount of labor it hires

• the monopolist firm is a single firm that faces the labor supply
curve for a given occupation, this curve must be upward
sloping.
• The monopolist’s MWC exceeds the wage rate (AWC)
because it must pay a higher wage to attract more workers,
and it must pay this higher wage to all workers.
• The labor supply curve and AWC are the same. This being the
case our interest is to determine the equilibrium level of
employment and wage rate.
• Every profit-maximizing firm needs to set MWC
at MRP.
• This equality point is located at point A in Figure 4.3 below,
where the firm employs Q1 units of labor.
Units of labor Wage TWC MWC MRP
(AWC) (VMP)
1 1 1 1 7
2 2 4 3 6
3 3 9 5 5
4 4 16 7 4
5 5 25 9 3
6 6 36 11 2

• If the firm were to employ Q0 units of labor, its MRP would
be at point C and its MWC is at point B. yielding a loss
equal to area ABC.
• So the profit maximizing condition dictates the firm to
employ only Q1 units of labor, where MRP equals MWC.
• The corresponding wage rate for Q1 level of employment is
traced by moving along the labor supply curve not along the
labor demand curve.
• The labor demand curve (MRP schedule) is only used to
select the profit maximizing level of employment.
• Note that at W1 wage rate the firm is willing to hire Q2 units
of labor while workers are willing to offer only Q 1 units of
labor, leaving the monopolist with a job vacancy of EF.
Minimum Wage Theory
• Controversial as it has been, many governments have been
exercising minimum wage law to ensure that workers
receive a “living-wage” the minimum wage level is dot at a
level that enables a full time worker to buy the basic
necessities of life.
• In what follows first we consider the impact of minimum
wage law on both the competitive and monopolistic labor
markets, and next the arguments for and against practicing
the minimum wage law.

The competitive Model
• Here both the product and labor markets are competitive.

• In order to raise wages of workers whose wages are relatively
low, governments around the world have imposed minimum
wages.
• A minimum wage works like other price floors. The impact
of a minimum wage is shown in Panel (a) of Figure above
"Alternative Responses to Low Wages".
• Suppose the current equilibrium wage of unskilled workers is
W1, determined by the intersection of the demand and supply
curves of these workers.
• The government determines that this wage is too low and
orders that it be increased to Wm, a minimum wage.
• This strategy reduces employment from L1 to L2, but it raises
the incomes of those who continue to work.
• The higher wage also increases the quantity of labor
supplied to L3. The gap between the quantity of labor
supplied and the quantity demanded, L 3 − L2, is a surplus - a
surplus that increases unemployment.
 To conclude, first, other things being equal the higher the
minimum wage relative to the equilibrium wage, the greater
the ergative employment and the more elastic the labor
supply and finally the greater the unemployment
consequences of the law.

The Monopsony Model
• Minimum wage and monopsony shows a monopsony employer that
faces a supply curve, S, from which we derive the marginal factor
cost curve, MFC. The firm maximizes profit by employing Lm units
of labor and paying a wage of $4 per hour. The wage is below the
firm’s MRP.

• A monopsony employer faces a supply curve S, a marginal
factor cost curve MFC, and a marginal revenue product
curve MRP.
• It maximizes profit by employing Lm units of labor and
paying a wage of $4 per hour.
 The imposition of a minimum wage of $5 per hour makes
the dashed sections of the supply and MFC curves
irrelevant. The marginal factor cost curve is thus a
horizontal line at $5 up to L1 units of
labor. MRP and MFC now intersect at L2 so that
employment increases.

• Now suppose the government imposes a minimum wage of
$5 per hour; it is illegal for firms to pay less.
• At this minimum wage, L1 units of labor are supplied. To
obtain any smaller quantity of labor, the firm must pay the
minimum wage. That means that the section of the supply
curve showing quantities of labor supplied at wages below
$5 is irrelevant; the firm cannot pay those wages. Notice
that the section of the supply curve below $5 is shown as a
dashed line.
• If the firm wants to hire more than L1 units of labor,
however, it must pay wages given by the supply curve.

• Marginal factor cost is affected by the minimum wage. To
hire additional units of labor up to L1, the firm pays the
minimum wage.
• The additional cost of labor beyond L1 continues to be
given by the original MFC curve. The MFC curve thus has
two segments: a horizontal segment at the minimum wage
for quantities up to L1 and the solid portion of
the MFC curve for quantities beyond that.

Compensating wage differentials
• Some of the tremendous wage differentials observed in
everyday life arise because of differences in the quality of jobs.
• Wage differentials that serve to compensate for the relative
attractiveness, or nonmonetary difference, among jobs are
called compensating wage differentials.
• Jobs that involve hard physical, tedium, low social prestige,
irregular employment, seasonal lay off, and physical risk all
tend to be less attractive.
• The theory of compensating wage differentials provides one
explanation of wage differences across individuals and across
occupations.
• This theory suggests that wage differentials exist, in part, to
compensate workers for non-pecuniary characteristics of
alternative types of employment.
• The labour market is not characterized by a single wage:
Workers differ and jobs differ.
• Adam Smith proposed the idea that job characteristics
influence labour market equilibrium.
• Compensating wage differentials arise to compensate
workers for nonwage characteristics of the job (i.e. how
‘pleasant’ or ‘unpleasant’ a job is).
- If a job is unpleasant, the firm must probably offer a higher
wage to attract workers and vice versa.
- Workers have different preferences and firms have
different working conditions.

Purpose of Compensating Wage Differential:
 It fulfills two basic purposes. These are as follows:
i. It serves a social need by giving people an incentive to do
dirty, dangerous, or unpleasant work conditions.
ii. At an individual level, it serves as a reward to workers who
accept unpleasant jobs by paying them more than comparable
workers in more pleasant jobs.
 Those who choice for more pleasant conditions have to buy
them by accepting lower pay.

The Hedonic Wage Theory
• A hedonic wage function reflect the relationship between
wages and job characteristics.
• It matches workers with different risk preferences with
firms that can provide jobs that match these different risk
preferences.
• Different workers have different preferences for risk.
• Hedonic wage theory (HWT) enables us to analyze the
theory of compensating wage differentials for negative job
characteristics (where the probability of the risk injury is
very high) and draw policy conclusions and/or
implications with respect to government safety regulations.

Chapter Five
Unions and the Labor Market
 Labor Unions: A labor union is an organization of workers
that tries to improve working conditions, wages, and
benefits for its members.
 The nation’s first unions were comprised of skilled workers.
After the Civil War, the labor force became more unified.
• Unions used strikes and boycotts to help members get better
pay, hours, & job security.
• Employers resisted with lockouts, firings, and even setting
up company unions.

• The union movement took shape over the course of more
than a century.
• The 1935 National Labor Relations Act, also known as the
Wagner Act, gave workers the right to organize and required
companies to bargain in good faith with unions

• Types of Union Workplaces
• A closed shop hires only union members. This type of
workplace is now illegal.
• A union shop will hire nonunion members but requires them
to join the union within a certain period of time.
• An agency shop will hire nonunion workers and does not
require them to join the union in order to keep their jobs.
However, nonunion workers must pay union dues or similar
fees, and they are covered by the union contract.

Collective Bargaining
• Collective bargaining is the process in which union and
company representatives meet to negotiate a new labor
contract
 Wages and Benefits
– The union negotiates on behalf of all members for wage
rates, overtime rates, and benefits.
 Working Conditions
– Safety, comfort, worker responsibilities, and other
workplace issues are negotiated and written into the final
contract.
 Job Security
– One of the union’s primary goals is to secure its
members’ jobs. The contract spells out the conditions
under which a workerAbebe
8/1/2022 may be(M.Sc)
Mucheye fired. 118
Labor Strikes and Settlements
o Strikes
– If no agreement is met between the union and the
company, the union may ask its members to vote on a
strike, an organized work stoppage intended to force an
employer to address union demands. Strikes can be
harmful to both the union members and the firm.
 Mediation
– To avoid the economic losses of a strike, a third party is
sometimes called in to settle the dispute. Mediation is a
settlement technique in which a neutral mediator meets
with both sides to try and find an acceptable solution for
both sides.
 Arbitration
– If mediation fails, talks may go into arbitration, a
settlement technique in which a third party reviews the
case and imposes a decision that is legally binding for
both sides.

Total Compensation:
 Wages and Fringes Union workers enjoy a greater variety
and higher overall level of fringe benefits than nonunion
workers. Why?
• Fringes may be higher for the same reason that wages are,
bargaining power of the union.
• The union may simply provide an institutional structure for
information gathering and dissemination about fringes.
• Unions are often controlled by older workers who have a
general preference for more fringes.

• Unions reduce turnover, so the members may expect to
actually use the benefits such as retirement plans and life
insurance
• Under collective bargaining laws, fringe benefits are a
mandatory bargaining item.

Efficiency and Productivity
• How do unions affect the allocation of resources? Unions
might affect efficiency both negatively and positively.
Negative View
 Unions might exert a negative impact on efficiency in three
basic ways.
• First unions often impose work-rules that reduce efficiency
within the firm.
• Second, strikes can reduce the aggregate output of the
economy.
• Finally, the union wage differential distorts the wage
structure, causing a misallocation of labor between union
and non unions firms and industries.
Positive View
 economists believe that unions make a positive
contribution to productivity and efficiency. Their
arguments include the following:
1. Investment and Technological Progress : Union
wage increases may accelerate the substitution of
capital for labor and hasten the search for cost-
reducing (productivity-increasing) technologies.

2. Unions as a Collective Voice: The collective voice
mechanism of unions contribute of labor productivity by
voicing worker grievances and through their effects on labor
turnover, worker security, and managerial efficiency.
• The collective voice may be effective in correcting job
dissatisfaction that otherwise would result in worker
turnover. In addition, the wage differential will reduce quit
rates.

3. Seniority and Informal Training : The union insistence on
the primacy of seniority enhances worker security, making
workers more willing to participate in informal work job
training, which enhances worker quality and productivity.
4. Managerial Performance : Union wage pressure may
precipitate a shock effect that is favorable to productivity.
• Confronted with a strong union and higher wage demands,
firms may be forced to adopt better personnel and
production methods to meet the union's wage demands and
maintain profitability.

Chapter Six
Investment in Human Capital and Manpower planning
• Human capital constitutes the skills, knowledge,
experiences and personal qualities of people.
• The theory of compensating differentials suggest that wages
will vary among workers because of jobs are different.
• Wage also will vary because workers are different. We each
bring into the labor market a unique set of abilities and
acquired skills, or human capital.
• For instance, some persons train to be research biologists
while others persons train to be musicians

• People acquire most of their human capital in school and in
formal and informal on-the-job training programs.
• The skills we acquire in school make up an increasingly
important component of our stock of knowledge.
• Workers add to their stock of human capital throughout their
lives, especially via work experience and education.

• Investments in schooling, however, involves costs of
sacrificing today fees and other educational expenditures in
exchange for the higher rewards to be collected in the future
time.
• According to the values people place on future returns from
today’s investment in schooling, some keep on attending
schooling while others drop out at some stage.
• Therefore trade-offs b/n today’s long one earnings and the
higher earnings in the future, together with access to
Learning and training opportunities determine the
distribution of educational attainment in the population.

• If some group of the population is constrained by financial
and institutional Clements, their access to education will be
limited and hence remarkable differences in educational
attainment are likely to happen between sex, racial and
ethnic groups.
• Differences in educational status, in turn, are reflected in
o differences in the labor market outcomes-
o labor force participation rates,
o unemployment rates and
o wage rates.
• Usually labor force participation and wage rates are
positively correlated with education

Basic Model of Human Capital
 Calculating Return on Human Capital Investment- Present
Value
• The concept of present value underlies model of human
capital.
• Any investment decision compares costs and benefits of
different time periods, using the widely used technique of
present value.
• This technique helps us compare the amount of money spent
and received in different time period. The formula to
calculate the present value (PV) is given by

 The notion of present value allows us to compare dollar
amounts spent and received in different time periods; and it
is given as:
• Present Value = PV = y/(1+r)t ; where
• r- is the per-period discount rate.
• y- is the future value.
• t -is the number of time periods.

Some Points about the Discount Rate
• The higher the rate of discount, that is when the person
attaches a lower value to future earnings opportunities, the
less likely a worker will invest in education.
• A rate of discount reflects out time preferences between the
consumption given up today and the rewards to be received
in future.
• high discount rate refers to present oriented approach

The Wage-Schooling Locus
• The preceding discussion helps us make a decision of going
to school or entering the labor market on a subjective basis.
• This is because the present value concept employed to select
the skill level that maximizes lifetime earnings depends on
the subjective rate of discount.
• To avoid such subjective evaluation of schooling decision,
the problem can be approached form a “stopping rule”
notation.

• The alternative concept helps to identify the optimal time at
which the person stops and enter the labor market and
suggests the way for estimating the rate of return to
education.
• The wage-schooling locus, which associates the salary that a
particular worker would earn and the employer would be
willing to pay if he completed a particular level of schooling,
constitutes the analytical tool for stopping rule.
• The salary for each schooling level is determined by the
supply of workers with that particular schooling and the
demand by employers for workers with that schooling level.

Properties of Wage-schooling locus
• It is an upward sloping curve: Financial rewards must tend to
motivate educational decisions so that additional cost
incurred to improve skills must be accompanied by more
compensations.
• The slope of the locus tells us by how much a worker’s
earnings would increase if he were to obtain one more year
of schooling. In short it is closely related with the empirical
measure of “the rate of return”
• The locus has a concave shape: the law of diminishing
marginal returns is applicable to human capital
accumulation, i.e. as schooling level increases by one unit
the extra benefit from each additional year of schooling
decreases.
The Marginal Rate of Return to Schooling
• The marginal rate of return to schooling, which is a more
closely related concept to work- schooling locus, measures
the percentage change in earnings resulting from one more
year of school.
•

• Where is the slope of the wage- schooling locus.
• To see the definition of MRR more closely, suppose that
the cost incurred in attending school is given by the
forgone earnings.
• A high school graduate earns W0 if he joins the labor
force, W1 if he joins the labor force after a year and so on.
• If he avoids labor market entry by a year he will forge W 0
earnings.
• The worker’s one-year investment in education, however,
raises his earnings by So, the marginal rate of
return to schooling compares this additional earnings
resulting from additional investment in education with
the foregone earnings. Abebe Mucheye (M.Sc)
8/1/2022 140
• The concavity of wage-schooling locus implies that the
marginal rate of return schedule is declining as the year of
schooling increases.

The Stopping Rule Determination
• To determine the optimal schooling level, we need to
compare the MRR and the perfectly elastic rate of discount.
• For every given rate of discount, r, there is a corresponding
MRR value. Present-oriented are less likely to go to college
than forward-looking people.
• In other words, the more present-oriented a person is, the
larger the individual’s rate if discount and the higher the
likelihood to quit schooling at lower levels.

• On the other hand, the marginal rate of return schedule gets
lower and lower as the years of schooling increases.
• The intersection point of MRR and the straight-line rate of
discount determine the optimal level of schooling.

• Suppose that the worker has a rate of discount( r) that is
constant, that is, it is independent of how much schooling
he/she gets.
• Which level of schooling should a person choose? It turn
out that the intersection of the MRR curve and the
horizontal rate of discount schedule determines the optimal
level of schooling for the worker, or s* years in the figure.
• In other words, the stopping rule that tells the worker when
he should quit school is: marginal rate of return to schooling
= r. This stopping rule maximizes the worker’s present
value of earrings over the life cycle.

On the Job Training (OJT)
• Until now, we have focused on one particular aspect of
human capital investment-the schooling decision.
• Most workers augment their human capital stock after
completing their education, particularly through on-the-job-
training (OJT) programs.
• Evidences show that OJT is an important component of a
worker’s human capital stock, making up at least half of a
worker’s human capital. There are two types of OJT.
• These are: general training and specific training.

1. General training- is the type of training that, once acquired,
enhances productivity equally in all forms. These general
skills, which include such things as typing learning how to
drive, and learning how to use a calculator, are found
frequently in the labor market.
2. Specific training- is the type of training that enhances
productivity only in the firm where it is acquired and the
productivity gains are lost once the worker leaves the firm.
Example, of specific training also bound in labor market:
learning how to drive a tank in the army or memorizing the
hierarchical nature of a particular organization and the like.

Manpower Planning Techniques
o Manpower planning is largely concerned with labor supply.
Thus, it is interested in such questions as:
• how many people are coming onto the labor market,
• what are their education and training levels,
• what is their age etc.

• Manpower planning arises from the need to relate the
demand for manpower skills to effective supply.
 There are two widely used techniques for such planning,
namely,
o the human capital and
o the manpower requirements approaches.
 the human capital approach focuses on the current
unbalance of demand for and supply of labor the latter does
on the future imbalances.
• The relationship between the demands for manpower skills
to supply particularly relies on the relationship between the
human resource endowments of labor, on the one hand, and
output, on the other hand.
 Three linkages can be generated from this relationship
• the link between total out put produced and work force used
in the production process-labor productivity
• the link between labor’s contribution to total output and the
share of total output in the form of earnings-labor income
• the link between earnings of the work force and a measure of
its human resource endowments used in the production
process-earnings distribution.

The Human Capital Approach
• The human resource endowments, of which relation with
output underlies this approach is measured a proxy variable
of educational status,
• To minimize the impact of other phenomena of the labor
market on wage differentials, like sex discrimination,
experience variation and ability differences, the human
capital approach makes use of the average income.

 Thus changes in income earnings are mere or less ascribed to
differences in educational levels.
• It is worth identifying two basic implications of the positive
correlation between education levels and income earnings.
• Firstly, Employers are willing to compensate the costs
incurred attending schools rather than participating in the
economic activity.
• Secondly, persons with higher schooling level are expected
to demonstrate higher levels of productivity.

• Under the human capital approach human resource
development decisions are comparable with their investment
decisions in which the cost benefit criteria serves as a basis
for investment undertakings.
• Both benefits and costs of human capital investments can be
considered from the social and private perspectives
consequently the benefits include the potential contribution
to total output and the lifetime earnings increment resulting
from additional schooling.
• Where as the costs incorporate direct or indirect costs
incurred by the person and/or society in such investments.

The Manpower Requirements Approach
• One way to link human resource planning with the sac it
economic growth paths is to project the demand for different
labor skills according to the growth largest established far
particular products.
• this method attempts to estimate the demand for skills to fit
determinate output growth largest and derives its importance
from the need to anticipate the labor skill shortages due to
the normally long period required to train qualified
personnel.
• It sacks to anticipate or foresee any excesses of demand or
supply with respect to the specific skills in order to ovoid
costs due to imbalances
• The typical procedure is to project in a first phase, the
demand according to type of occupation (skills) for each
economic sector given a target for the product known
coefficients for the amount of labor per unit of output (i.e.
the inverse of labor productivity), and a certain number of
occupational categories that are supposed to be mutually
exclusive.

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Abebe Mucheye Kassie (M.Sc.

Course Name: Labour Economics

• Labor economics is simply defined as the study of the

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2.1 Measurement of the Labor force Participation

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• unemployment rate is taken as a fraction of the labor force

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• Labor supply elasticity less than 1 is inelastic as hours of work

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• Graphically, the marginal product curves are derived from the

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• Consider the following example, and suppose that the product

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