Labour market part I

Question 1

Why do we look specially at the labour market?

Answer 1

The labour market is not like other markets: is about work and thus persons whose welfare heavily depends on whether they have work and how much they get paid for it

Question 2

What are the special institutional settings in the labour market?

Answer 2

Minimum wages, employers’ market power, employees’ market power (trade unions), employment protection legislation (EPL) - i.e. substantial deviation from traditional competitive framework

Furthermore, interacts with welfare policies e.g. income taxation, education, unemployment insurance benefits, pension system, disability insurance, etc. - complementarities between different policies

Question 3

Why do we call labour demand derived demand?

Answer 3

Derived demand: labour is an input into the production of other goods, consumers demand the goods from the company, which then demands the labour. Firm’s demand for workers derived from profit maximization

Question 4

Which assumptions do we make when we talk about the labour demand?

Answer 4

There are two production inputs: capital and labour
Capital input is constant (in the short-run), choose level of labour input
Firms take market prices for products as given (competitive output market)

Question 5

What is the marginal product of labour?

Answer 5

Marginal product of labour: MP_L=ΔQ/ΔL - the amount of additional production from a 1-unit increase in labour.
Recall: Diminishing marginal product

Question 6

What is the marginal revenue product?

Answer 6

Marginal revenue product = additional revenue resulting from the sale of output created by the use of one additional unit of an input:

MRP_L=ΔR/ΔL=price·ΔQ/ΔL=price ·MP_L

The MRP_L curve is the labour demand curve - shows the quantity of labour that a firm will hire at any given market wage.

Question 7

What does it mean that we assume the labour market is a competitive factor market?

Answer 7

Firms take wages as given - the cost of hiring that additional unit of labour is the market-given wage

Question 8

What is the profit from an additional worker and how many workers does the firm have to hire to maximize profits?

Answer 8

Profit from an additional worker = contribution to revenue

(MRP_L) - wage

Hire workers up to the point where:
MRP_L=w⟺price*MP_L=w⟺price=w/MP_L

w/MP_L is the marginal cost of producing one more unit of output

Labour inputs chosen so that price (of the output good) = marginal cost (of producing one more unit of output)
At the firm’s optimal hiring level, marginal revenue equals the wage divided by the marginal product of labour.

Firm’s labour demand curve = MRP_L

Question 9

What determines the position of the labour demand curve (shifts)?

Answer 9

Shifts in the labour demand curve:

Output price ↑ then labour demand ↑

Technological change MP_L↑ then labour demand ↑

Supply of other factors:
The quantity available of other production factors affects MP_L
Complementarity of different production factors!
Input of capital (or other inputs) ↑ then MP_L↑ then labour demand ↑

Question 10

What are the two dimensions of labour supply?

Answer 10

Quantitative - the quantity of labour supply. The labour force is defined as the part of the population that has a job, is self-employed or is available for work.

The quantity of labour supply happens along two different margins:
Extensive margin: Whether to work at all? (number of persons in the labour force)
Intensive margin: How much to work? (working hours, full-time, part-time)

Qualitative - the qualifications of the labour force (education, experience etc.

The size of the labour force depends on demographics and the individual labour supply decisions:

Quantitative dimension determined by utility maximization by workers – depends on
net benefits from working: wage, fringe benefits, psychological benefits, minus taxes
net benefits from non-working: unemployment insurance or pension benefits, value of time not working (leisure), transfer income

Question 11

What is the central trade off when a person decides how much labour they want to supply to the market?

Answer 11

The central trade-off is between income and leisure
As the wage increases, income increases
The opportunity cost of leisure: wages - As the wage increases, the “price” of leisure increases

Question 12

Define the labour supply curve:

Answer 12

It is upward sloping: higher wage induce workers to increase the quantity of labour they supply
There is a “Substitution effect”: as w↑, the price of leisure increases i.e. substitute work (income) for leisure
It is possibly backward bending (the upper part):
“Income effect”: as w↑, income increases -> can afford to “buy” more leisure (work less) - this only holds true on the individual level, not the market level
Note:
Many people cannot afford not to work at all, so for them this trade-off mainly governs the intensive margin (how many hours?)
The extensive margin is less affected by labour market conditions (wages), but more by individual characteristics (age, sickness, family) and policies (taxation, retirement, unemployment insurance benefits, child care, etc.)

Question 13

What can cause a shift in the labour supply curve?

Answer 13

The labour supply curve shifts whenever people change the amount they want to work at a given wage.
Some of the events that might cause such a shift:
Changes in tastes/norms: e.g. liberation of women -> labour supply ↑
Immigration
Generosity of unemployment insurance benefits or early retirement schemes
Increase the benefit from non-working -> labour supply ↓
Changes in income taxes

Question 14

Describe the labour market equilibrium

Answer 14

Perfectly competitive labour market: Equilibrium wage = W^* and Equilibrium employment = L^*

Question 15

Why do we not consider the labour market to be perfectly competitive?

Answer 15

Reasons for labour market imperfections:
Market power on the side of employers (large firms)
Market power on the side of employees (trade unions)ape.com/

Question 16

Describe the extensive margin: labour force

Answer 16

Population divided into three groups: 
1. Employed      2. Unemployed     3. Out of labour force
Labour force (“active population”) = 1.+ 2.

Question 17

What is the labour force participation rate?

Answer 17

The participation rate measures the number of people who are in the labor force who are working, willing to work, or are actively looking for work.

Question 18

How can we calculate participation rate (also called activity rate)?

Answer 18

Participation rate (1)= Labour force/Population100
Often we do not use the full population to calculate the participation rate, we often use the working age population, so it is expressed as a % of the working-age population (population aged 16 to 64)
Participation rate (2)= Labour force/Working age population100
Note the difference to the employment/population ratio
= Number of employed/Population

Question 19

Why did the labour force participation rate increase up till the 1990’s and why has it declined since then?

Answer 19

More women joined the labour force.
The main reason for the decline is longer education, earlier retirement and change in the age structure of the population.

Question 20

Describe the development of female labour participation in the OECD countries and DK

Answer 20

Increasing over time (at different speeds in different countries)
High participation of females in DK - around 73%
The increase (in DK) is associated with better education, individual taxation, expansion of welfare state required female labour and was further facilities by (child care: push and pull)
Other trends:
Women later exit from the labour market
Men have higher labour force participation rates than women

Question 21

Why has participation been falling over time for young men and women?

Answer 21

Later entry to the labour market, education but also later exit

Question 22

How does the size of the labour market depend on entry and exit?

Answer 22

Labour market entry - when do people commence their careers?
Labour market exit - retirement? (early retirement programs,…)
Breaks due to parental leave, sickness, etc.

Question 23

What are the pros and cons of entering the labour force late?

Answer 23

In Denmark, students tended to:
start studies late

pro: learn useful workplace skills (+), motivated to improve their human capital (+), make better tertiary education choices -> better labour market attachment after graduation (+)
con: labour productivity levels over the full working life are reduced (-), reduced lifetime earnings (-) -> foregone tax revenue (-)

take relatively long to finish
(6.5 years for a 5-year masters programme, 3.5 years for a 3-year bachelor programme, [OECD 2009])
reduced lifetime earnings (-) -> foregone tax revenue (-), direct cost on the government budget (-)

Question 24

Describe the intensive margin

Answer 24

HEQuantity of labour supplied also depends on annual working hoursAnnual working hours depend on two things_Weekly working hours (has been going down)Normal hours_ set as a result of general wage bargainingPart-time vs. full-time employmentOvertimeVacation (has been going up)

Question 25

Describe the qualitative dimension of labour supply

Answer 25

International comparisons - differences in educational systems
ISCED classification (see table): match different degrees or stages of education in each country into nine levels
Problems:
- Apprentice training only common in few countries
- Classifications of non-university post-secondary educations?
- On-the-job training

Question 26

What are the effects of the fact the younger people tend to be more educated on GDP?

Answer 26

In the short run, labour market non-participation reduces GDP
In the long run, increased productivity stimulates growth
…if the chosen education is useful
So does education actually raise productivity?
Higher productivity should be rewarded with a wage premium

Question 27

What are the private incentives to invest in tertiary education?

Answer 27

Private costs of tertiary education: 
›	direct cost (e.g. tuition) (0 in DK)
›	foregone earnings (= opportunity cost)
›	higher taxes/contributions (the major cost in DK)
Private benefits of tertiary education:
›	higher earnings (“wage premium”)
›	small likelihood of unemployment
›	study grants
-> small net present value in Denmark

Question 28

Historically, the Danish labour market is highly organized: centralized negotiations (”collective bargaining”) between representatives for employers and employees (”social partners”). Describe the functions of these social partners

Answer 28

Social partners (employers’ federations and trade unions)
take responsibility for wage bargaining – though since 2004 only for base pay and lowest wages (”minimum pay system”) - unlike other countries, no minimum wage legislation in Denmark
agree on normal working hours
set rules together with government for labour protection
Example: no minimum wage legislation, but social partners negotiate a minimum wage
In principle, social partners negotiate without political interference but sometimes explicit or implicit public interference
Agreements depend on welfare policies (e.g. social assistance)

Question 29

The main rules of the Danish labour market are based on the General Agreement, originally from 1899, but revised a few times since then. What are the main elements?

Answer 29

› Both firms and workers are free to organize
› Right to use strikes and lock-outs to reach a collective agreement
› For the duration of a collective agreement (usually, 2-3 years), parties are obliged to preserve peaceful relations
› In case of disagreement, there is a prescribed set of rules to follow (eventually Labour Court)
Due to this system, Denmark has few strikes and lock-outs … but major strikes and lock-outs may occur in connection with the bargaining process

Question 30

What influences wages?

Answer 30

Labour demand (competitive labour market): MRP_L=price*MP_L=w
Worker characteristics (observable + unobservable):
“Innate ability” -> higher (marginal) productivity MP_L↑ -> MRP_L ↑
Human capital: productivity + signaling
Effort
Discrimination
Note: individual characteristics account for only around half of wage dispersion
Job characteristics (compensating differential - defined as the additional amount of income that a given worker must be offered in order to motivate them to accept a given undesirable job, relative to other jobs that worker could perform): - ‘bad’ jobs tend to have higher equilibrium wages (compensating wage differentials)
Bargaining power of the two parties negotiating wages
Institutional setting (minimum wages, unions, collective bargaining, …)

Question 31

What are the direct and indirect wage costs?

Answer 31

Total wage costs are relevant for firms (labour demand)
Denmark has high total wage costs, but the main part is wage costs
Other countries have lower wage costs, but higher social contributions

Question 32

Define the gender earnings gap

Answer 32

Gender earnings gap: earnings difference between men and women (usually expressed in % of men’s earnings)
Gender gap in mean earnings in

Question 33

What explains the gap?

Answer 33

› Education cannot explain the gap
› Experience, industry and occupation explain more than 60% of the gap
› Unexplained 38%: often interpreted as discrimination (“unequal pay for equal work”)

Caution:
› unobserved variables
› psychological differences

Question 34

Where do differences in experience, industry and occupation come from?

Answer 34

“Child penalty”: By how many percent do women fall behind relative to men after having their first child? Approx. 20%
No drop in earnings for similarly aged women without kids

Underlying mechanisms:
› mothers do not advance to higher ranks, have lower likelihood of becoming managers
› switch to more family-friendly employers, especially public sector

Unequal pay as result of children explains 80% of gender wage gap (=20%/24%)
Experience, occupation and discrimination operate through the effect of having children