Introduction to Labor Markets and Discrimination

Introduction to Labor Markets and Discrimination Spring 2010 Alicia Rosburg (ISU) Labor Markets and Discrimination Spring 2010 1 / 57 Spring 201...
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Introduction to Labor Markets and Discrimination

Spring 2010

Alicia Rosburg (ISU)

Labor Markets and Discrimination

Spring 2010

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Spring 2010

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Relevant Readings

BFW Chapter 1 including Appendix 1A KW Chapter 12

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Labor Markets and Discrimination

Outline 1

Labor Market Basics Labor Demand Labor Supply Labor Market Equilibrium Basic Model Issues

2

Discrimination Definitions

3

Deviation from Market Equilibrium Four Cases Examples

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Labor Market Basics

Factors of Production

Labor is a factor of production Factors of production are bought and sold in “factor markets” at “factor prices”

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Labor Market Basics

Factors of Production

Factors of production differ from goods Derived demand - demand for a factor of production is derived from the firm’s output choice Factor prices and derived demand determine how total income of economy is divided - factor distribution of income Roles are reversed from goods market: Firms determine demand Households determine supply

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Labor Market Basics

Factor Price: Wage

Wage is a common signal to both supply (HH) and demand (firm) side: Demand-side: input price to production Supply-side: income or source of purchasing power Real wage: purchasing power of wage =

wage in current price level

$

Price level is determined by a price index

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Labor Market Basics

Labor Demand

Labor Demand Basics

Firms decide how many workers to employ, given market wages and technology Firms pick the employment level that maximizes profit Assume perfect competition: individual firm cannot influence output price Output price takers

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Labor Market Basics

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Labor Demand

Labor Demand Basics Marginal product of labor (MPL ): additional output from employing one more worker Diminishing marginal returns: MPL is decreasing as labor increases (fixed capital) Value of the marginal product of a factor (VMPL ): the monetary value of the additional output from employing one more worker VMPL = p ∗ MPL where p is the price of the output sold by the employer

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Labor Market Basics

Labor Demand

Graphical Depiction of Total and Marginal Product

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Labor Market Basics

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Labor Demand

Optimal Labor Demand

Profits maximized when marginal benefit equals marginal cost Marginal benefit of labor: VMPL Marginal cost of labor: wage (w )

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Labor Market Basics

Labor Demand

Optimal Labor Demand

Intuition: Profit-maximizing and price-taking producer will hire additional workers only if marginal value is greater than wage rate. Hire until the value of the marginal product of the LAST employee is equal to the wage rate VMPL = w Value of marginal product curve is the firms derived demand curve for labor

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Labor Market Basics

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Labor Demand

Optimal Labor Demand

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Labor Market Basics

Labor Demand

Example

Handout 1: Derive the amount of labor that maximizes profits

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Labor Market Basics

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Labor Demand

Example

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Labor Market Basics

Labor Demand

Mathematical Derivation Profit = π = Revenue - Cost Revenue = price of output * output = p ∗ f (x) p = market price of output f (x) = production function Production function: how much output you can produce for a given level of inputs x

Cost = C = w1 x1 + w2 x2 + ... + wn xn = Σi wi xi xi = factor i wi = factor price for factor i

Suppose only factor is labor (L) then: π = p ∗ f (L) − w ∗ L

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Labor Market Basics

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Labor Demand

Mathematical Derivation cont. Goal: Find quantity of labor that maximizes profits Calculus approach: Take derivative of profit with respect to L and set equal to 0 p∗

∂f (L) −w =0 ∂L p ∗ MPL = w VMPL = w

Hire until wage equals value of marginal product of labor - same as intuition provided earlier

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Labor Market Basics

Labor Supply

Labor Supply Basics

Workers decide how much and where to allocate their time given market wages Choose occupation and number of hours that maximizes utility Workers evaluate marginal value of time Value both consumption and leisure time Work additional hour if marginal utility from consuming goods purchased with hourly wage exceeds marginal utility of an additional hour of leisure

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Labor Market Basics

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Labor Supply

Labor Supply Basics cont. Maximize utility (U) which is represented by an indifference curve “Map” of consumer preferences All combinations of goods or time allocations that make a person equally better off Time allocation budget line: tradeoff between leisure and income used for consumption of goods Given the time allocation budget line, household will choose leisure and work levels that maximize utility (i.e. highest indifference curve)

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Labor Market Basics

Labor Supply

Time Allocation Example Suppose wage rate is $8 per hour and have 80 hours a week to allocate between work and leisure. If devote all time to work get $640 in income to purchase consumption goods and 0 hours of leisure If devote all time to leisure get no income for consumption Optimal leisure and labor time determined by tangency of time allocation budget line and utility curve.

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Labor Market Basics

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Labor Supply

Time Allocation Budget Line

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Labor Market Basics

Labor Supply

MRS

Marginal rate of substitution (MRS): the rate at which a consumer is willing to give up one good in exchange for another good while maintaining the same level of satisfaction Slope of the indifference curve MRS12 =

MU1 MU2

=

∂U ∂z1 ∂U ∂z2

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Labor Supply

Utility Maximization

From the graph we can see that utility is maximized when the utility curve is tangent to the time allocation line Slope of utility = slope of time allocation line MRS12 =

MU1 MU2

=w

MRS equal to the wage rate

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Labor Market Basics

Labor Supply

Labor Supply and Wage Increase A wage increase does not necessarily increase hours of work Two conflicting effects: Substitution effect: Change in the opportunity cost of leisure in terms of other goods Relative cost of leisure increases when wage increases Decreased leisure time and increased labor time

Income effect: Consumer richer for each hour of work Leisure is a normal good - increased consumption with income Increased leisure and decreased labor

→ Total affect on hours of work indeterminant Alicia Rosburg (ISU)

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Labor Market Basics

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Labor Supply

Labor Supply and Wage Increase to $10

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Labor Market Basics

Labor Supply

Labor Supply Curves

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Labor Market Equilibrium

Market Demand and Supply Market demand for labor is the aggregate of individual firm demands at each wage As price increases for an input, the firm demands less of that input as they substitute to a relatively cheaper input As wage increases, substitute machines for labor Market supply for labor is the aggregate of household labor supplies at each wage As wage increases, more potential workers enter the market and total supply will increase Typically do not have backward-bending market supply curves

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Labor Market Basics

Labor Market Equilibrium

Equilibrium: Supply = Demand

At w*, last worker paid the value of their leisure time, others paid more than reservation wage No unemployment at w* Alicia Rosburg (ISU)

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Labor Market Basics

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Labor Market Equilibrium

Potential Shifters Demand Shifters price of product (↑) price of substitutes (↑) MP of workers (education, experience) (↑) demand for product (↑) price of complementary inputs (↓)

Supply Shifters population (↑) taste for leisure (↓) taste for home time (↓) wages elsewhere (↓) bad non-pecuniary aspects of job (↓)

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Labor Market Basics

Labor Market Equilibrium

Curve Shifts and Equilibrium Effects

Demand shifts out → wage ↑ and labor ↑ Supply shifts out → wage ↓ and labor ↑ Alicia Rosburg (ISU)

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Labor Market Equilibrium

Wage Determination Model

Using the demand and supply shift effects, we can predict how various factors effect wages Wage = f[output price (+), productivity (+), substitute output price (+), complement price (-), good job attributes(-), bad job attributes (+), competition (-), wages in other jobs(+)]

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Labor Market Basics

Labor Market Equilibrium

Stable Equilibrium

All persons willing to work at going rate are able to find employment and all employers willing to hire someone at going rate are able to find workers Since firms who maximize profits set VMPL equal to the wage rate, equally productive individuals should earn the same wage

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Labor Market Equilibrium

Underlying Assumptions

1

People have rational preferences among outcomes that can be identified and associated with a value

2

Individuals maximize utility and firms maximize profits

3

People act independently on the basis of full and relevant information

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Labor Market Basics

Basic Model Issues

Violations of Underlying Assumptions

People do not always behave rationally People do not always make choices that maximize utility or profits Lack of full information Uncertainty

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Labor Market Basics

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Basic Model Issues

Violations of Underlying Assumptions cont.

Free markets operate in a frictionless market and have have no discrimination

→ Discrimination is a market failure

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Discrimination

Discrimination Discrimination is a departure from a freely functioning labor market equilibrium Wage no longer equals marginal productivity Wage differentials does not imply discrimination Compensating differentials (cover later) Human capital differences (education, experience, etc.) Discrimination can function on either side of the market: Demand side: depressed output price or restricted marginal productivity Supply side: job rationing

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Discrimination

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Definitions

Discrimination Definitions Websters Dictionary: To make a distinction; to use good judgment To make a difference in treatment or favor on a basis other than individual merit Discrimination, in this definition, can be viewed as positive or negative Positive connotation - A discriminating person is someone who has more information and uses this information to make their decision Negative connotation - A discriminating person is someone who knows less about the ability of individuals and uses information on group characteristics to make decision

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Discrimination

Definitions

Discrimination Definitions

Dictionary.com: Treatment or consideration of, or making a distinction in favor of or against, a person or thing based on the group, class, or category to which that person or thing belongs rather than on individual merit

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Discrimination

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Definitions

Discrimination Definitions Economic Definitions To offer different transaction terms to individuals based on Group membership or attribute (antagonism, BFW pg 203) Accurate knowledge of group differences (statistical) Subjectively held opinions regarding relevant criteria (institutional or unconscious)

When two equally qualified individuals are treated differently solely on their group identity (gender, race, age, disability, etc.) When two individuals with identical observed characteristics besides group membership have systematically different outcomes

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Discrimination

Definitions

Sources of Discrimination Access to skills and training Segregation in schools Barriers to entry (ex: cost)

Output price Access to inputs USDA withheld extension services to black farmers

Restriction of job entry Unions Occupational licensing restrictions

Quality of equipment Alicia Rosburg (ISU)

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Discrimination

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Definitions

Circumstance can be unfair, but NOT discrimination unless it has a group dimension Undervaluing a group, NOT an individual Examples?

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Discrimination

Definitions

Discrimination versus Prejudice Discrimination - Treating people differently based on innate characteristics (discriminatory outcomes) Prejudice - Dislike, distaste, or misperception based on innate characteristics (discriminatory attitudes/feelings) Prejudice may or may not cause discrimination Discrimination may not be a result of prejudice Examples?

Contrary to many legal matters, it is not the intent that matters, it is the outcome that matters

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Discrimination

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Definitions

Profiling

Profiling - the use of specific characteristics, as race or age, to make generalizations about a person, as whether he or she may be engaged in illegal activity Type of discrimination Blacks more likely to be stopped, questioned or searched – racial profiling Profiling can occur without prejudice

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Discrimination

Definitions

Segregation

Segregation - separation of people on the basis of race Discrimination can occur without segregation Segregation can occur without discrimination

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Discrimination

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Definitions

Labor Market Discrimination

Wage discrimination - prices paid by employers for given productive characteristics are systematically different for different demographic groups Occupational discrimination - members of specific group with the same education and productive potential are forced in lower-paying occupations or levels of responsibilities by employers who reserve the higher-paying jobs for members of a different group Occupational segregation does not imply occupational discrimination

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Deviation from Market Equilibrium

Deviation from Market Equilibrium What factors would lead to wage differences across markets, groups, or jobs? Are wage differences evidence of discrimination? When market is away from equilibrium, discriminatory job rationing is possible. Cases: 1

Wage setting union

2

Cyclical downturns

3

Compensating Differentials

4

Skill Differences

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Deviation from Market Equilibrium

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Four Cases

1. Wage Setting Union Union sets w > w ∗ H’ = notional demand H” = notional supply Demand side is constraining the equilibrium 00

Unemployment rate = (H H−H 00 = fraction wanting to supply labor at market wage but do not have a job

0)

Only discrimination if access to rationed jobs is preferential for or against a group

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Deviation from Market Equilibrium

Four Cases

2. Cyclical Downturn In recession, labor demand falls to H’ at current wages Reluctance to reduce nominal wages (unions, contracts) Who loses jobs? Discrimination if layoffs are based on favoritism or preferential treatment of a group Discrimination more prevalent in downturns and less in upturns

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Deviation from Market Equilibrium

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Four Cases

3. Compensating Wage Differentials

Compensating differential: wage required to compensate a worker for accepting a bad job attribute or the wage reduction a worker would accept to get a good job attribute Dangerous jobs Undesirable jobs

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Deviation from Market Equilibrium

117 99 79 75 70 62 62 55 54

Four Cases

Nonfatal work related injuries Most Injurious Production Assistants 0.7 Data/sales workers 0.7 Structural metalworkers 0.7 Non-construction Laborers 0.6 Public transportation 0.6 attendants Machine feeders and 0.5 off-bearers Construction and extractive 0.4 trades helpers Punching and stamping 0.4 machine operators Construction laborers 0.4

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per 1000 workers Least Injurious Typists Education administrators Economist Library clerks Data processing equipment repairers Management analysts Child care workers Correctional institution officers Securities and financial services salespeople

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Deviation from Market Equilibrium

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Four Cases

3. Compensating Differentials

2 occupations where one has preferable attributes Workers in risky job need compensation → supply curve shifts S = initial supply (wages equal) S’ = supply with risk rating Displaced workers from risky job obtain non-risky job at lower wage Wage difference: w 00 − w 0 → does not necessarily imply discrimination Alicia Rosburg (ISU)

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Deviation from Market Equilibrium

Four Cases

4. Skill Differences Human Capital: Skills embodied in the worker that improves labor Examples: education, on-the-job training, knowledge Suppose there are 2 jobs, one of which requires more schooling (ex: business versus construction) Worker will need to be compensated for additional schooling Supply of business workers falls (shifts left) Some workers shift to construction → supply shifts right Additional skills raises workers’ marginal productivity so demand for skilled workers also increases

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Deviation from Market Equilibrium

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Four Cases

4. Skill Differences

Wage differential = w 00 − w 0 Reflects differences in cost of skill acquisition and productivity Discrimination only if unequal access to education or training Alicia Rosburg (ISU)

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Deviation from Market Equilibrium

Examples

Taxi Cab Situation Consider a taxi driver driving down a one-way street late at night in a dangerous part of town. Two people hail the cab at the same time but on different sides of the street. Since it is a one-way street, their is no difference to the cab-driver which side of the street a person in on. On the left-hand side a little old lady hails the cab driver. On the right-hand side a tall African American teenage boy wearing a hood hails the cab driver. The taxi driver unhesitatingly picks up the little old lady. Did the cab driver discriminate? Did the cab driver engage in racial profiling? Does it make a difference if the cab driver was a women or a man? What if the cab driver had more information (neighborhood, recent crime, knew one of the potential customers, etc.)? What would you do? Alicia Rosburg (ISU)

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Deviation from Market Equilibrium

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Examples

Video Game Store Suppose you are a cop in a large metropolitan area. You get a report that a a video game store has been robbed. Witnesses saw someone leaving the scene wearing a black baseball cap and heading towards the local grocery store. You are in the immediate area and the grocery store agrees to lock down the doors. You find four people wearing a black baseball cap: Teenage girl Teenage boy Middle-aged man Middle-aged woman Suppose the optimal interrogation technique is to interview from least innocent to most guilty. What order would you interview the four people and why? Alicia Rosburg (ISU)

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Deviation from Market Equilibrium

Examples

Video Game Store cont.

Did you make your decision based on age or sex? Would you consider it profiling if the police used age or sex as a determinant of interview order?

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Deviation from Market Equilibrium

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Examples

Sells Representative

Handout 2 - Sales Representative Example

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Deviation from Market Equilibrium

Examples

Readings for Next Lecture

Regression Analysis: BFW Appendix 7A (pgs 250-255)

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