Labour Economics Engl'

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• Labour Economics (Engl.)
• WS0405 Course Code 5,246.1
• Lecture 2
• Lecturer Rosalia Vazquez-Alvarez
• rosalia.vazquez-alvarez_at_unisg.ch

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Lecture 2 Summary

• Summary Lecture 1
• Participation Decision Consumers are utility
  maximizers
• Investment in Human Capital and Education

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1. Summary Lecture 1

• In L.1 we have seen
• (1) Determinants for the DEMAND FOR LABOUR
• ? Derived Demand from Product demand
• ? MPL
• Motivation ? Producers as PROFIT MAXIMZERS
• (2) Determinants for the SUPPLY OF LABOUR
• ? WAGE RATES as incentives to the input labour.
• ? Issues Short run vrs. Long Run supply of
  labour, elastic inelastic supply of labour.
• Motivation for workers? Utility Maximization

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(cont(1) summary L.1)

• .Today we look at a micro-foundation where
  workes decision to participate on paid labour
  market activities (at a given wage, for a given
  amount of non-labour income) is motivated by
  their aim to maximize some level of utility.
• .In the second part of todays lecture we will
  see that workers participation by skill type is
  motivated by long run preferences in terms of
  investment in their productive capacity, for any
  given level of utility.

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(2) Participation Workers as Utility Maximizers

• Who enters the Labour Market?
• Workers decidePARTICIPATE
• NOT TO PARTICIPATE
• Legal Constrains Legal worker, 16
  -65
• Those who decide to participate are the LABOUR
  FORCE if they are active participants in paid
  labour market activities
• Incentives for Participation LABOUR INCOME
• But.SUPPLYING LABOUR ? DEMAND FOR LEISURE DOWN!
• Take LEISURE A GOOD that consumers demand,
  alongside food, housing, clothing,
  etc?

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(cont(2) Workers as Utility Maximizers)

• SUPPLY OF LABOUR ? DEMAND FOR LEISURE
• Then,
• .what affects the DEMAND FOR LEISURE?
• - The opportunity cost of leisure hourly wage
  rate
• - Personal wealth (capital wealth and human
  skills)
• - Personal Preferences (e.g., workaholics)
• Main Concepts
• (a) INCOME EFFECT
• (b) SUBSTITUTION EFFECT

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(cont(2) Workers as Utility Maximizers)
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(cont(2) Workers as Utility Maximizers)

• Remarks
• ? Individuals react to both, the INCOME and
  SUBSTITUTION effect, when making participation
  decisions (leisure decisions). Since both effects
  might work at once, it is only empirically where
  we can decide which effect is the strongest.
• Example
• Inheretance

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(cont(2) Workers as Utility Maximizers)

• How can we represent LABOUR SUPPLY of individuals
  in a DIAGRAM?
• ? BACKWARD BENDING LABOUR SUPPLY CURVE
• from 0,W..SUBSTITUTION effect dominates.
• from W,maxW.INCOME effect dominates.

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(cont(2) Workers as Utility Maximizers)

• in general, why do Workers aim at EARNING LABOUR
  income?
• Main aim is to buy Goods Services, and to be
  able to enjoy leisure time.
• then, we can think of the representative
  worker as consuming a basket of goods services
  (call it G), and leisure time (call it l), so to
  obtain a degree of UTILITY (some hypothetical
  number that represents SATISFACTION by means of
  UTILS).
• we think of G and las been SUBSTITUTES If you
  want to get more G (goods services), you need
  to reduce leisure (l). Let the following function
  represent utility
• this is represented in the form of a UTILITY
  CURVE or INDIFFERENCE CURVE ?

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(cont(2) Workers as Utility Maximizers)
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(cont(2) Workers as Utility Maximizers)
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(cont(2) Workers as Utility Maximizers)
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(cont(2) Workers as Utility Maximizers)

• Then, the idea is that for a given set of
  preference (combined level of MONEY, and
  LEISURE), a consumer will aim at
• MAXIMISING HIS/HER UTILITY LEVEL
• subject to a
• BUDGET CONSTRAIN (BC)
• BC TOTAL AVAILABLE
• LABOUR NON-LABOUR INCOME
• B.C ?
• (Complement, Fig.1)

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(cont(2) Workers as Utility Maximizers)
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(cont(2) Workers as Utility Maximizers)

• .At point (N) or (P), the indifference curve
  meets the budget constrain and both curves have
  the same gradient.
• .a SHIFT in NON-LABOUR INCOME ? Higher
  Indifference curve
• .an INCREASE in the hourly wage rate ? Rotation
  of B.C therefore higher Indifference
  curveremmember that for each individual we could
  draw an infinite number of INDIFFERENCE curves
  (different degree of inclination given his/her
  taste for laisure), and there will always be one
  that implies the maximum utility acheivable given
  a particular budget constrain.
• ..we will see these effects as either INCOME or
  SUBSTITUTION EFFECTS?

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(cont(2) Workers as Utility Maximizers)

• PURE INCOME EFFECT
• ?
• UPWARD/DOWNWARD SHIFT in the BC
• ?SayUPWARD SHIFT (e.g., inheretance) of BC to
  a new and higher level of autonomous income,
  then AT THE GOING WAGE RATE the workers moves to
  a higher indifference curve, with a higher level
  of UTILITY.
• RESULT Increase LEISURE and reduce HOURS
  worked
• (same graph as before)

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(cont(2) Workers as Utility Maximizers)
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(cont(2) Workers as Utility Maximizers)

• (2) CHANGE IN WAGES ? SUBSTITUTION INCOME
  EFFECTROTATION OF THE BC!!
• ?
• and the SIGN of the TOTAL EFFECT EFFECT given a
  CHANGE IN WAGE depends of which of the two
  (INCOME or SUBSTITUTION) is the strongest,.
• ifindifference curve is FLATTER
• ..? SUBSTITUTION EFFECT dominates
• ifindifference curve is STEEPER
• ..? INCOME EFFECT dominates

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(cont(2) Workers as Utility Maximizers)
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(cont(2) Workers as Utility Maximizers)
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(cont(2) Workers as Utility Maximizers)

• the question isIF THERE IS A CHANGE IN WAGES,
  can we ISOLATE each of the effects?
• ? YES!
• That is,.(1) FIND INCOME EFFECT
• Parallel Movement of BC as if WAGES
  were set constant
• to find new change in l(h) given the
  new indifference curve.
• (2) FIND THE SUBSTITUTION EFFECT
• Rotate the second new BC around the
  INDIFFERENCE CURVE so that you end up at
  the new level of M192.

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(cont(2) Workers as Utility Maximizers)

• Notice that so far we have used UTILITY
  MAXIMIZATION as way to see the SUPPLY of
  PARTICIPANTSbut we can also define the
  NON-PARTICIPANTS as those who supply ZERO HOURS
  OF WORK (16 hours of leisure)how do we use the
  diagrams to show the point at which
  NONPARTICIPATS maximize utility?
• NONPARTICIPANTS ? ZERO HOURS of work AT THE
  GOING WAGE RATE, that is, FOR A GIVEN
  BC.
• ? Do they ever enter the Market?
• ?we could assume that all (able willing)
  non-participants have a RESERVATION WAGE
  that would make working an attractive
  option..? Diagram

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(cont(2) Workers as Utility Maximizers)

• where X RESERVATION WAGE RATE
• at the going wage for ABC UTILITY MAXIMIZED at
  (h0,l16),
• (the diagram assumes zero non-labour income). If
  Wage-rate increases from
• C ? X, the individuals utility is maximized at
  (h6, l10)

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(cont(2) Workers as Utility Maximizers)

• APPLICATIONSOCIAL PROGRAMS aim at MANIPULATING
  individuals BC (total income received).
• e.g., WELFARE programs aimed at reducing the
  price of leisure by income subsidy ( zero
  wage-rate change).
• Saya worker receives a SUBSIDY with the
  CONDITION of a minimum number of hours work
• (see complement Fig.2)

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3. Investment in Human Capital and Education

• So far
• Workers motivated by UTILITY MAXIMIZATION as
  decision TO PARTICIPATE in paid labour market
  activities.
• ButNOT ALL PARTICIPANT are IDENTICAL with
  respect to their LABOUR INPUT!that is, we can
  think that all participants aim at maximizing
  utility, but labour economics is interested not
  just on understanding participation but also
  understanding
• the MOTIVATION for different TYPES of LABAOUR
  SUPPLY ? SKILLUNSKILLLED labour Supply
• ?skill type determined.
• by INVESTMENT in EDUCATION TRAINING

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(cont(3) Investment in Human Capital)

• INVESTMENT ? SKILL Formation
• ? Affects potential Lifetime
  Earnings
• What do we mean by INVESTMENT?
• (1) Education training
• (2) Search (time) for potential work
• (3) Migratory movements
• All contribute towards.HUMAN CAPITAL
  ACCUMULATION
• where.

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(cont(3) Investment in Human Capital)

• What is the COST of HUMAN CAPITAL (INVESTMENT)?
• (1) Direct cost of learning (e.g., tuition
  fees)
• (2) Indirect cost of learning (e.g., forgone
  earnings due to time spent at college)
• What are the RETURNS from HUMAN CAPITAL
  INVESTMENT?
• (1) (expected) higher future lifetime earnings
• (2) Job satisfaction
• (3) Social gains (lower crime, signalling for
  firms)
• .where, the individuals gains over the
  life-cycle can be illustrated as in complementary
  figure 3

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(cont(3) Investment in Human Capital)

• Mathematical valuation of lifetime expected
  returns
• The idea is that we invest in education before
  receiving any potential returns. Then, we need to
  value the benefit of investing on acquiring human
  capital by the NET PRESENT VALUE
• (see Complement Fig.4)

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(cont(3) Investment in Human Capital)

• Clearly, whereas WAGES is the main factor
  determining LABOUR SUPPLY, the difference between
  the supply of different SKILL LEVELS (e.g,
  unskilled, semi-skilled, skilled) depends on the
  determinants of HUMAN CAPITAL INVESTMENT
• .WHAT DETERMINES COLLEGE-EDUCATION DEMAND?
• (1) Preference (more or less impacient)
  Individuals with higher discount factor (r) value
  tomorrow less than those with a lower discount
  factor (and more pacience)
• (2) Age younger cohorts demand higher amounts
  of college education
• (3) Cost of college attendance
• (4) Wage differentials W(College)
  W(HighSchool)
• (5) Other factors generalised as demographics,
  e.g., at individuals level, parents education,
  gender group, ethnicity, etc.

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(cont(3) Investment in Human Capital)

• Previouslyimplications of INVESTMENT on
  education with respect to LABOUR SUPPLY,
• .But, what is the (DEMAND SIDE) MARKET RESPONSE
  to college attendance?
• Example Increase College Attendance
• ? Increase SUPPLY SKILL workers
• ? Reduce WAGES for SKILLED WORKERS
• ? might INCREASE the relative cost of
  unskilled and/or semi-skilled workers, as
  these become more scarce.
• GenerallyEMPLOYERS will demand different SKILL
  TYPES and offer different WAGES by skill class
  Therefore pre-market entering education (basic,
  high-school, college, etc), defines the SKILL
  TYPE, butON-THE-JOB-TRAINING implies further
  contribution to HUMAN CAPITAL FORMATION and,
  therefore, futher LABOUR INCOME implications! ?

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(cont(3) Investment in Human Capital)

• ON-THE-JOB-TRAINING
• Individuals enter the market with a specific
  SKILL TYPE
• Initial SKILL implies a particular (average) wage
  profile
• ON-THE-JOB-TRAINING has IMPLICATIONS FOR THE
  SHAPE OF THE EARNINGS-AGE PROFILE.

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(cont(3) Investment in Human Capital)

• .main characteristics of the AGE-EARNINGS
  PROFILE
• ? Earnings increase if education increases (at
  any age)
• (..due to investment in formal education)
• ? Rapid increase of earnings at early ages
  CONCAVITY
• (due to investment in ON-THE-JOB-TRAINING)
  
• ? Greater Wage Differentials over skill types
  as Age increases.
• ? Gender Gap by skill type.

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(cont(3) Investment in Human Capital)

• MALES EARNINGS PROFILE

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(cont(3) Investment in Human Capital)

• FEMALES EARNINGS PROFILE

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(cont(3) Investment in Human Capital)

• IS EDUCATION A GOOD INVESTMENT?
• ?we could answer YES given that there is a clear
  (empirical) wage gap. In general (and adjusting
  for inflation) the average american college
  graduate finds a 5 to 12 rate of return from
  investing on education. However, these estimates
  might suffer from OVERESTIMATION or
  UNDERESTIMATION
• OVERESTIMATION ifABILITY BIAS (i.e., those who
  go to college might be of higher ability,
  therefore, not all investment gains are
  attributable to college, as some might be there
  even if college education investment had not been
  taken)
• UNDERESTIMATION..e.g., investing on education
  might lead to better HEALTH, better HOUSEHOLD
  CONDITIONS, better chance that own children
  invest on education..all these positive
  esternal effect are not accounted for in the
  return from investment in educaiton that takes
  into account only earning gains.

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(cont(3) Investment in Human Capital)

• futhermore
• HUMAN CAPITAL INVESTMENT
• ? GOOD SOCIAL INVESTMENT
• What is the SOCIAL COST OF HUMAN CAPITAL
  INVESTMENT?
• (1) Direct cost (money cost of education)
• (2) Indirect cost ( negative externalities, if
  any)
• What is the SOCIAL BENEFIT FROM H.C. INVESTMENT?
• (1) Better society
• (2) but also, for employers, education
  achievement acts as a SIGNAL to sort out
  employers in terms of productivity.

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(cont(3) Investment in Human Capital)

• so far, assumed there exists a positve relation
  between WAGES EDUCATION Next, we show a
  theoretical framwork that justifies this
  relation
• Unified Wage Theory
• SUPPLY SIDE Workers expectHigher Pay
• GIVEN
• Higher Ammounts of Education
• ? Wokers conduct a COST-BENEFIT analysis
  to select an ammount of education
• DEMAND SIDE Employers compensate with wage
  differentials for greater levels of education,
  but at a DIMINISHING RATE

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(cont(3) Investment in Human Capital)

• .Supply side Wages as function of Education
• ? Worker A requires higher compensation to
  invest on incremental amounts of education (s/he
  is more impacienthigher discount rate)

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(cont(3) Investment in Human Capital)

• demand side of the market Firms offer higher
  wages for higher levels of education, but at a
  DIMINISHING RATE That is, profit maximizing
  firms disply ISOPROFIT functions where each
  combined point of (education,wages) implies a
  break-even point.
• ? Firm Y pays lower increment in wages for
  further increments in educationdemand for lower
  skill groups.

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(cont(3) Investment in Human Capital)

• WAGEEDUCATION determination
• .There exists a positive relation between Wages
  and Education.

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(cont(3) Investment in Human Capital)

• what if firms demand for labour was not
  sensitive to education? Then, d(W)/d(E)0 Demand
  for workes at a going wage rate is independent of
  the workers educational achievements

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(end(3) Investment in Human Capital)

• We have seen.
• Utility Maximization as motivation for Labour
  Market Participation.
• Welfare program effects on workers utility and
  labour market participation.
• Human Capital investment motivation for wage
  differential and skill formation.
• On-The-Job-Training Age as determinants of
  income profile once workers enter the labour
  market within a particular (pre-market education
  determined) skill type.
• Theoretical framework to determine the positive
  relation between the wages and levels of
  education.
• end Lecture 2.