Session 8 - Labor Markets (complete)

Question 1

What are the 5 grand challenges in labor economics?

Answer 1

1. The gig economy and remote work
2. Women’s labor force participation
3. Automation and AI
4. Skill gaps and reselling
5. Aging workforce and declining births

Question 2

The gender pay gap - one big challenge of labor economics

1. What part of the gender earnings gap closed over the 20th century?
2. What is the remaining gap due to? (2 reasons)

Answer 2

1. Gender earnings gap from differences in productive characteristics like education and work experience largely closed
2. remaining gap largely due to

disproportional penalty on flexible and shorter work hours
-e.g. 40hrs per week often get paid much more than double compared to 20hrs week

child penalty

Question 3

Child penalty : what possible explanations are there?

Answer 3

1. Biology: assumption that biologically preferences change once a women gives birth; evidence based on adoption/ lesbian couples suggest that this plays a very limited roles
2. More importantly - Gender norms and culture:
   child penalties correlate on survey responses on whether women with children should work
3. Government policies: taxes, transfers, family policies (parental leave, child care provision)

Question 4

Automation - one grand challenge in labor economics

What effects (3) did automation have in the past (+ example)?

Answer 4

Automation in the past:
- plenty of historical examples

Displacement effect: automation directly replaces labor
e.g.: automation of spinning and weaving tasks in the early Industrial Revolution

Productivity effect: as automation increases productivity, economy expands and increases the demand for labor in non-automated tasks
e.g. Introduction of ATMs reduced the costs of banking and encouraged banks to open more branches and hire more bank tellers

Reinstatement effect: creation of new tasks in which labor has a comparative advantage
e.g. the mechanization of agriculture in the 20th century US coincided with a lot of new jobs burgeoning industries of farm equipment

Question 5

What does SBTC stand for and what does it entail?

Answer 5

SBTC = Skill-Biased Technological Change

> The hypothesis that new technologies increase the productivity of skilled workers more than those of less skilled workers
technological changes will lead to higher wage inequality -> SBTC associated with computer technologies is often cited to explain the growing wage inequality since 1980s

Question 6

What are the reasons for the historical decrease in working hours?

Answer 6

1. Production in several industries has become less labor-intensive and more capital-intensive (e.g. automation)
   - at the core of how firms optimize their production, given the technologies available and the costs of production inputs
2. As people escaped poverty and became richer, their demand for leisure time increased
   - this concerns the individual choice of (potential) workers

Question 7

Utility functions - how can we understand how the potential workers decide their work hours?

Answer 7

1. Need to understand their preferences
2. We can quantify preferences using a utility function, with consumption (C) and leisure (free time) time (L)

                          U(C,L)

3. Utility is a measure of the value that one places on an outcome (think of the payoffs in game theory)

Question 8

Indifference curve

1. What is it?
2. What can be said about indifference curves

-shape?
-what does it mean if it is flatter/more curvature?
- can they cross?

Answer 8

1. Indifference curves plot out all the consumption combinations that provide a consumer with the
   same level of utility or satisfaction.

2.1 The typical (convex) shape of an indifference curve implies that individuals prefer balanced consumption baskets - extreme baskets are less preferred

2.2 The more curvature the more preference for variety; the flatter the less preference for variety

2.3 Indifference curves cannot cross because they are isocurves: each curve represents a distinct and constant level of utility; if they cross, it would mean that the same combination of goods corresponds to two different utility levels, which cannot be true

Question 9

What is the budget constraint? (Definition + formula)

Answer 9

The budget constraint defines the most expensive combinations of goods that a person can afford

worker’s budget constraint is:

C=wH=w(24-L)

Question 10

How is the unemployment rate calculated?

Answer 10

The unemployment rate is calculated as the percentage of the total labor force that is unemployed but actively seeking employment. The labor force includes individuals who are either employed or unemployed and actively looking for work.

unemployment rate = unemployed/ labor force x 100

Question 11

What helps to counter wage stickiness and ameliorate (=abbauen) structural unemployment?

Answer 11

Reducing union power: policies that limit the bargaining power of unions can help in bringing wages closer to market equilibrium
* Inflation: because wage stickiness often applies only to nominal wages, reduction
in real wages due to inflation softens the ”price floor”
* Payroll tax cuts: this lowers the overall cost of hiring, making it more financially
feasible for employers to hire or retain worker

Question 12

The historical decrease in working hours: reasons?

Answer 12

“We are richer and work less today.” -> US during the 20th century: annual work time decreased by more than one third; hourly earnings increased by more then six-fold.

Some reasons:
1. Production in several industries has become less labor-intensive and more capital-intensive (e.g. automation)
2. As people escaped poverty and became richer, their demand for leisure time increased

Question 13

Notes on indifference curves

Shape?
Can they cross?

Answer 13

Individuals prefer balanced consumption baskets -> implied by the typical convex shape of an indifference curve
-> the more curvature the more preference for variety. // The flatter the less preference for variety.

Indifference curves cannot cross because they are isovcurves: each curve presents a distinct and constant level of utility.
-> if they cross, it would mean that the same combiantion of goods corresponds to two different utility levels, which cannot be true

Question 14

What is the budget constraint in an indifference curve?

Answer 14

The budget constraint defines the most expensive combinations of goods that a person can afford

A worker’s budget constraint is:

C = wH = w(24-L)

The feasible set is all combinations of goods that a person can afford -> if you look at the linear graph, this would be represented by the triangle area underneath the budget constraint

Question 15

Utility maximization: When is utility maximized?

Answer 15

• whenever an indifference curve crosses the budget constraint in two places, there will be a better attainable indifference curve above it
• So only one indifference curve touches the budget constraint exactly once, and this unique curve identifies the point that maximizes utility

Question 16

Rise in real wage

1. What is the difference in nominal & real wage?
2. How can this come about (2)?

Answer 16

Nominal wages: wages measured in money
Real wages: wages adjusted for price changes (inflation)

Increase in real wages could be due to either increases in nominal wages or decreases in price

-> real wages matter for workers

-> utility function changes with an increase of real wage increase since budget constraint becomes steeper

Question 17

Two effects that govern whether people want to work more or less - which are they? Explain

Answer 17

Income Effect: the effect that the additional income would have if there were no change in the prices (in this case wages);
-> induces workers to work less as leisure is a normal good

( Remember Normal good = )

Substitution Effect: the effect that is only due to changes in prices, holding utility level constant
-> induces workers to work more as working becomes more valuable

The overall effect depends on the sum of the income and substitution effects
Historically, income effect dominated -> with higher wages, people worked less

Question 18

Labor force participation (LFP) - What does it capture?

Answer 18

the share of population that is interested in working; can be affected by various socio-economic and cultural factors

Question 19

How do you calculate the LFP?

Answer 19

LFP = Labor force participation

LFP rate = Labor force/ working-age population
= employed + unemployed / working-age population

[ Working-age population: those aged 15 or older (who are not in the military or institutionalized)

Employed: working-age people who are working

Unemployed: working-age people without jobs but looking for jobs

Labor force: the employed plus the unemployed ]

Question 20

Unemployment rate

1. How is it calculated?

Answer 20

Unemployment rate = unemployed / labor force x 100

Question 21

1. For what is the unemployment rate a key indicator?
2. What does low/high unemployment indicate?

Answer 21

The unemployment rate is a key indicator of population satisfaction with the economy.

Low unemployment rate: People who want to have a job have a job they like

High unemployment:
problematic, can lead to
- reduced consumer spending
- increased government debt
- erosion of skills and work experience
- social unrest

Question 22

Frictional unemployment

Answer 22

Frictional unemployment occurs due to the time it takes for employers to search for workers and for workers to search for jobs

Some sources of frictional unemployment:
- Job searching: it takes time for workers and employers to find positions that match their skills, preferences, and salary expectations
- skills mismatch: if the workers’ skills do not align well with available job openings, they take additional time to realize this and seek retraining
- unemployment insurance: while it provides a safety net, unemployment insurance can incentivize workers to take longer in their job search

Question 23

Structural unemployment

Answer 23

Structural employment occurs when wages don’t fall to bring labor demand and supply into equilibrium

Example: wage-price bargained is higher than the equilibrium

-> effectively serves as a price floor -> labor supply is persistently higher than the labor demand
-> this gap (surplus of supply) is structural unemployment

Question 24

Sources of structural unemployment

Answer 24

Effieciency wages: employers might pay wages higher than the equilibrium level to boost worker productivity, morale or loyalty

wage stickiness: often, wages do not adjust downwards to changes in labor market conditions (e.g. decreases in demand for firm’s products). This can be due to long-term employment contracts or employment contracts or employee resistance to wage cuts

Unions: labor unions often bargain for higher wages for their members

Question 25

Tackling unemployment - policies affecting frictional unemployment

Answer 25

Job search assistance: helps the workers reduce the time spent to find a job

Retraining programs: mitigates issues due to the skills mismatch

Transportation subsidies: helping workers reach potential job locations can help them consider more job options

Question 26

Tackling unemployment - Policies affecting structural unemployment

Answer 26

Reducing union power: policies that limit the bargaining power of unions can help in bringing wages closer to market equilibrium

Inflation: because wage stickiness often applies only to nominal wages due to inflation softens the “price floor”

Payroll tax cuts: this lowers the overall cost of hiring, making it more financially feasible for employers to hire or retain workers

Question 27

Given the utility function of person X, over consumption and hours of free time. Which of the following statements is false about her indifference curves?

a. Indifference curves that are further from the origin represent higher levels of utility.

b. Indifference curves are downward sloping because as consumption increases, hours of free time have to decrease to maintain the same level of utility, assuming no change in other factors.

c.Utility is maximized when two indifference curves intersect.

d. Indifference curves that never intersect the budget constraint represent levels of utility that are not attainable.

Answer 27

Correct: C,

Option C is the correct answer. Intersection would imply that at the point of intersection, Person X has the same level of utility, which is not possible given that each indifference curve represents a different level of utility. Indifference curves representing higher levels of utility are indeed further away from the origin (Option A). Indifference curves are typically downward sloping, representing the trade-off between consumption and leisure (Option B). Option D is also true because if an indifference curve never intersects the budget constraint, it means that the combination of goods on that indifference curve is not affordable given the consumer’s budget.

Question 28

Which of the following definitions of the unemployment rate is actually correct?

a. The unemployment rate is the percentage of the total labor force that is unemployed but actively seeking employment.

b. The unemployment rate is the percentage of the total population that is unemployed and actively seeking employment.

c. The unemployment rate is the percentage of the total labor force that is unemployed.

d. The unemployment rate is the percentage of the total population that is unemployed, whether or not they are actively seeking employment.

Answer 28

Correct: A

The unemployment rate is calculated as the percentage of the total labor force that is unemployed but actively seeking employment. The labor force includes individuals who are either employed or unemployed and actively looking for work. Options B and D are incorrect because they consider the total population, not just the labor force. Option C is also incorrect as it includes all unemployed individuals in the labor force, regardless of whether they are actively seeking employment or not.

Question 29

Which of the following scenarios does not capture a determinant of frictional unemployment?

a. A recently graduated software engineer taking three months to find a job because she is looking for a position that best matches her specific skills and interests.

b. A factory worker losing his job after the factory’s machinery gets upgraded, and he doesn’t have the skills to operate the new machines.

c. A graphic designer deciding to quit her current job and take some time to find a better position because her unemployment benefits allow her to maintain her standard of living for a while.

d. A sudden economic recession causing decreased consumer demand and leading companies to lay off workers.

Answer 29

Correct: D

Option D is the correct answer. A sudden economic recession causing decreased consumer demand and firms laying off workers is more indicative of cyclical unemployment, which is a form of structural unemployment related to the economic cycle. Options A, B, and C, on the other hand, are scenarios representing frictional unemployment due to job search, skill mismatch, and unemployment insurance, respectively.

Question 30

Which of the following is considered in Claudia Goldin’s influential research a key driver of the gender gap in earnings within the same occupations, after accounting for education and work experience?

a. Women choosing lower-paying professions.

b. Gender discrimination in the workplace within the same occupation.

c.Differences in negotiation strategies between men and women within the same occupation.

d. Differences in pay due to differences in the hours that men and women work outside of the 9-to-5 schedule within the same occupation.

Answer 30

Option D is the correct answer. Goldin’s research indicates that, within the same occupations, a significant portion of the gender pay gap can be attributed to differences in the rewards for working longer and nonstandard hours. Occupations with a higher emphasis on working long and irregular hours tend to have larger gender disparities in earnings. This is because women, more often than men, opt for flexibility in working hours due to family or childcare responsibilities, which tend to reduce their earnings relative to men within the same occupations. Options A compares different occupations, which is not what the question is after. B and C, while relevant in broader discussions on the gender pay gap, are not the primary focus of Goldin’s research when examining earnings disparities within the same occupations and after accounting for education and work experience.

Question 31

Which of the following scenarios capture the phenomenon of job polarization?

a. A country where employment in high-wage and low-wage occupations is increasing, while employment in middle-wage occupations is decreasing due to automation and offshoring.

b. A country experiencing a uniform increase in employment opportunities across low-wage, middle-wage, and high-wage occupations due to overall economic growth.

c. A country where only high-wage occupations are seeing an increase in employment, while low-wage and middle-wage occupations are seeing a decrease due to advancements in technology.

d. A country where employment in all sectors is decreasing due to economic recession and high unemployment rates.

Answer 31

Option A is the correct choice, as it best describes job polarization. Job polarization refers to the phenomenon where employment in middle-wage, often routine jobs is declining, while employment in both high-wage, high-skilled jobs and low-wage, low-skilled jobs is increasing. This is largely due to factors like automation, which can easily replace routine jobs, and offshoring, where middle-wage jobs are outsourced to countries with lower labor costs. The other options don’t accurately represent job polarization. Option B represents a uniform employment increase across all sectors, Option C shows only high-wage occupations increasing, and Option D indicates a general employment decline due to economic downturn, none of which capture the essence of job polarization.

Question 32

Which of the following helps counter wage stickiness and ameliorate structural unemployment?

a. Education and training programs.

b.Strong labor unions.

c. Inflation.

d. Increasing the minimum wage.

Answer 32

Option C, inflation, is correct because it reduces real wages, helping to adjust the labor market and possibly reducing structural unemployment caused by wage stickiness. Education and training programs (Option A) are crucial for reducing structural unemployment by improving workforce skills but don’t directly address wage stickiness. Strong labor unions (Option B) and increasing the minimum wage (Option D) can actually contribute to wage stickiness by resisting wage adjustments in response to economic conditions, hence they don’t aid in ameliorating the issue.

Question 33

What is utility?

Answer 33

Utility is a measure of the amount of satisfaction a person gets from something that allows
individuals to compare choices.