503Applied Macroeconomics

Chapter 3 The Ideal Labor Market

Prof M El-SakkaProf M El-SakkaDept of EconomicsDept of Economics

Kuwait UniversityKuwait University

bull Labor is the most important factor of production Most of us Labor is the most important factor of production Most of us derive our main source of income from labor In this chapter derive our main source of income from labor In this chapter we investigate the labor markets when they are working well we investigate the labor markets when they are working well Some of the questions considered are Some of the questions considered are How much labor do How much labor do firms want to hirefirms want to hire How many people want to workHow many people want to work For how For how long long How do taxes technological progress and immigration How do taxes technological progress and immigration affect real wagesaffect real wages

bull Our analysis has three parts (i) Our analysis has three parts (i) What factors govern the What factors govern the decisions of firms to hire labordecisions of firms to hire labor (ii) (ii) What factors govern the What factors govern the willingness of workers to supply itwillingness of workers to supply it And (iii) And (iii) How do the How do the decisions of decisions of firms and workers firms and workers interact to determine the mount interact to determine the mount of labor used in productionof labor used in production

Labor Demand

bull THE FIRMrsquoS DEMAND FOR LABORTHE FIRMrsquoS DEMAND FOR LABOR

bull Deriving the Firmrsquos Labor-Demand CurveDeriving the Firmrsquos Labor-Demand Curve

bull The labor-demand curve shows The labor-demand curve shows the amount of labor a firm the amount of labor a firm would optimally choose to hire ceteris paribus at each real-wage would optimally choose to hire ceteris paribus at each real-wage raterate

bull Recall the rule for profit maximization Recall the rule for profit maximization a firm hires labor until a firm hires labor until the marginal product of labor is equal to the real wage (mpl = the marginal product of labor is equal to the real wage (mpl = wp)wp) Because of diminishing returns the relationship between Because of diminishing returns the relationship between real-wage rates real-wage rates and the and the marginal product of labor marginal product of labor is inverse a is inverse a firm can profitably firm can profitably hire more labor only if real wage falls hire more labor only if real wage falls enough to enough to match the fall in the marginal productmatch the fall in the marginal product

bull We apply the profit maximization rule to the production We apply the profit maximization rule to the production function to derive a labor-demand curve (see the following function to derive a labor-demand curve (see the following Figure)Figure)

bull Imagine that the firm faces a real wage of (wp)1 The optimal Imagine that the firm faces a real wage of (wp)1 The optimal point is found where the point is found where the MP=(wp)1MP=(wp)1 This point corresponds to This point corresponds to a particular level of labor l1 The combination a particular level of labor l1 The combination (l1 (wp)1)(l1 (wp)1) forms point forms point Arsquo Arsquo which is one point on the labor-demand curve which is one point on the labor-demand curve If the firm paid its workers anything more than If the firm paid its workers anything more than (wp)1 (wp)1 to to produce at produce at A A it would reduce its profitsit would reduce its profits

bull If the firm do if it faced a lower wage say If the firm do if it faced a lower wage say (wp)2(wp)2 the new the new optimal production point will be at optimal production point will be at BB At B the firm demands At B the firm demands l2l2

bull The combination The combination (l2 (wp)2) (l2 (wp)2) shown as point shown as point Brsquo Brsquo in the lower in the lower panel is another point on the firmrsquos labor-demand curve The panel is another point on the firmrsquos labor-demand curve The labor-demand curve connects labor-demand curve connects Arsquo Brsquo Arsquo Brsquo and every other profit-and every other profit-maximizing point It is downward sloping because of maximizing point It is downward sloping because of diminishing returns to labordiminishing returns to labor

bull Factors that Shift the Labor-demand curveFactors that Shift the Labor-demand curve

bull The labor-demand curve is not independent of theThe labor-demand curve is not independent of the production production functionfunction As a result anything that shifts the production As a result anything that shifts the production function will in general function will in general shift the labor-demand curveshift the labor-demand curve and the and the labor-demand curve cannot shift unless the production labor-demand curve cannot shift unless the production function also shifts function also shifts Technological progress or an increase in Technological progress or an increase in the capital stock shifts the capital stock shifts the production function upward the production function upward

bull Consider an Consider an increase in the capital stockincrease in the capital stock how does it shift the how does it shift the labor-demand curvelabor-demand curve

bull An increase in capital raises An increase in capital raises MPLMPL at every level of labor at every level of labor demand the higher MP means that the profit-maximizing firm demand the higher MP means that the profit-maximizing firm can afford can afford higher real wage higher real wage at each level of labor The labor-at each level of labor The labor-demand curve shifts vertically upwarddemand curve shifts vertically upward

bull But why would the firm pay workers more for a particular But why would the firm pay workers more for a particular level of labor level of labor when additional capital raises when additional capital raises their marginal their marginal products Why does the firm not just pocket the windfall The products Why does the firm not just pocket the windfall The answer answer competitioncompetition When the marginal product rises each When the marginal product rises each firm tries to hire firm tries to hire more workersmore workers Since we have assumed that Since we have assumed that markets are all in equilibrium all available workers are markets are all in equilibrium all available workers are already employed and it is only by paying higher wages that already employed and it is only by paying higher wages that the firm can attract them the firm can attract them

THE AGGREGATE DEMAND FOR LABOR

bull In macroeconomic analysis we are more concerned with the In macroeconomic analysis we are more concerned with the aggregate demand for laboraggregate demand for labor If all firms produced the If all firms produced the samesame products and if all workers were products and if all workers were alikealike then aggregation from then aggregation from the firm to the economy as a whole would be easy (see the the firm to the economy as a whole would be easy (see the figure) Unfortunately it is not that simplefigure) Unfortunately it is not that simple

bull The first problem is that all firms are The first problem is that all firms are not producing the same not producing the same productproduct When different firms produce different goods we When different firms produce different goods we must find a common unit of measurement must find a common unit of measurement

bull The second problem is that The second problem is that not all workers are alikenot all workers are alike Different Different kinds of workers may face kinds of workers may face different wage rates different wage rates and therefore and therefore have have different marginal products different marginal products at the optimum For our at the optimum For our purposes the wage structure can be summarized in the purposes the wage structure can be summarized in the average average wage ratewage rate Though It provides an imperfect index of the Though It provides an imperfect index of the movements of the wage structure movements of the wage structure

Labor Supply

bull Two measures reflect two aspects of the workerrsquos labor supply Two measures reflect two aspects of the workerrsquos labor supply decision (i) decision (i) participationparticipation ndash that is whether to work or not ndash that is whether to work or not work and (ii) work and (ii) intensityintensity ndash that is how many hours to work It is ndash that is how many hours to work It is easier if we consider intensity first conditional on having easier if we consider intensity first conditional on having decided to work what factors govern the workerrsquos choice of decided to work what factors govern the workerrsquos choice of how many hours of work to supplyhow many hours of work to supply

bull THE WORKER CHOOSING HOURS OF WORKTHE WORKER CHOOSING HOURS OF WORK

bull The Price of LeisureThe Price of Leisure

bull People work for a variety of reasons The most obvious is to People work for a variety of reasons The most obvious is to earn the incomeearn the income Many people ndash though not all ndash find their Many people ndash though not all ndash find their work work fulfilling and interestingfulfilling and interesting Still even those people will Still even those people will generally prefer another generally prefer another hour of leisure hour of leisure to another hour of to another hour of work It is therefore reasonable to assume that work It is therefore reasonable to assume that leisure is a leisure is a goodgood

bull Goods generally have a price Yet there is Goods generally have a price Yet there is nono market for market for leisureleisure Even though there is no explicit price there is an Even though there is no explicit price there is an implicit price or opportunity cost The implicit price or opportunity cost The OPPORTUNITY COST OPPORTUNITY COST of any choice is the value of the best alternative choice that it of any choice is the value of the best alternative choice that it foreclosesforecloses The implicit price of leisure is its opportunity cost The implicit price of leisure is its opportunity cost which is measured by the real wage (which is measured by the real wage (wp) wp)

bull The Labor-Leisure ChoiceThe Labor-Leisure Choice

bull Once we see leisure as a good and the real-wage rate as its Once we see leisure as a good and the real-wage rate as its price it is easier to understand the choices a worker faces price it is easier to understand the choices a worker faces There are 168 hours in a week If a worker chooses There are 168 hours in a week If a worker chooses not to work not to work at allat all he enjoys 168 hours of leisure but forgoes the income he enjoys 168 hours of leisure but forgoes the income needed to buy any other goods If the worker instead takes needed to buy any other goods If the worker instead takes fewer hours of leisure he supplies labor fewer hours of leisure he supplies labor l = 168 ndash hours of l = 168 ndash hours of leisure leisure and he gains the ability to purchase goods worth wp times l and he gains the ability to purchase goods worth wp times l The problem The problem for the worker for the worker is to choose is to choose the hours of labor (the hours of labor (l ) l ) that at the margin makes the psychic value of a small loss that at the margin makes the psychic value of a small loss further loss of leisure time (ie a small increase in labor time) further loss of leisure time (ie a small increase in labor time) exactly equal to the psychic value of the small gain in exactly equal to the psychic value of the small gain in consumption goods that would be purchased by that laborconsumption goods that would be purchased by that labor

bull INCOME EFFECT How would your supply of labor change if you could receive the income that results from the increased wage rate without facing a changed opportunity cost of leisure

bull As a general rule an increase in income ceteris paribus increases the demand for all goods The extra $20 per week would permit you to buy more goods including leisure without reducing your purchases of other goods The reduction in the supply of labor as the result of an increase in income is called the income effect

bull SUBSTITUTION EFFECTSUBSTITUTION EFFECT

bull If the wage rate rose If the wage rate rose would people work more or less As a would people work more or less As a general rule whenever general rule whenever ceteris paribus the price of anything rises ceteris paribus the price of anything rises relative to alternativesrelative to alternatives the demand for it decreases Here the the demand for it decreases Here the price of leisure price of leisure (its opportunity cost) has risen relative to the (its opportunity cost) has risen relative to the price of other goods the supply of price of other goods the supply of labor would riselabor would rise The change The change in the wage rate encourages people to substitute the now in the wage rate encourages people to substitute the now cheaper goods (what you buy using your wage) for the now cheaper goods (what you buy using your wage) for the now more expensive leisure more expensive leisure The increase in the supply of labor as The increase in the supply of labor as the result of an increase in the price (or opportunity cost) of the result of an increase in the price (or opportunity cost) of leisure is called theleisure is called the SUBSTITUTION EFFECT SUBSTITUTION EFFECT

bull The Labor-supply CurveThe Labor-supply Curve

bull The following figure represents the workerrsquos labor-supply The following figure represents the workerrsquos labor-supply decision Look first at panel (A) Suppose that at point A decision Look first at panel (A) Suppose that at point A where the real wage is (where the real wage is (wp)1 the worker decides that providing l wp)1 the worker decides that providing l hours of work balances the advantages of a little more hours of work balances the advantages of a little more consumption against a little more leisure at the margin Now consumption against a little more leisure at the margin Now consider what happens when the real wage rises to (consider what happens when the real wage rises to (wp)2 wp)2 There is a substitution effect shown by the arrow pointing to There is a substitution effect shown by the arrow pointing to the right which encourages the worker to supply more labor the right which encourages the worker to supply more labor The size of the substitution effect is measured by the length of The size of the substitution effect is measured by the length of the arrowthe arrow

bull There is also an income effect shown by the arrow pointing to There is also an income effect shown by the arrow pointing to the left which encourages the worker to supply less laborthe left which encourages the worker to supply less labor

The Slope of the Labor-Supply Curve

bull The net effect The net effect is measured by the difference between the is measured by the difference between the substitution and income effects shown at point B so that an substitution and income effects shown at point B so that an increase in the wage rate increases the workerrsquos supply of labor increase in the wage rate increases the workerrsquos supply of labor to to l2 to the right of l1 If the substitution effect is always stronger l2 to the right of l1 If the substitution effect is always stronger then the labor supply then the labor supply curve slopes upward curve slopes upward

bull Substitution effects are not necessarily stronger than income Substitution effects are not necessarily stronger than income effectseffects Panel (B) shows the construction of the labor-supply Panel (B) shows the construction of the labor-supply curve starting from point C when income effects are stronger curve starting from point C when income effects are stronger than substitution effects When the real-wage rate increases than substitution effects When the real-wage rate increases from (from (wp)1 to (wp)2 the dominant income effect overwhelms wp)1 to (wp)2 the dominant income effect overwhelms the substitution effect and labor the substitution effect and labor supply (point C) falls from supply (point C) falls from l1 to l1 to l2 If income effects are stronger for all wage rates above l2 If income effects are stronger for all wage rates above ((wp)1 wp)1 then the labor-supply curve will slope downward toward point C then the labor-supply curve will slope downward toward point C higher real wage higher real wage rates lower labor supplyrates lower labor supply

bull Although the labor-supply curve can slope downward towards Although the labor-supply curve can slope downward towards a point like A it is not reasonable to believe that it could slope a point like A it is not reasonable to believe that it could slope downward for every possible wage rate At very low wage rates downward for every possible wage rate At very low wage rates it is more reasonable to suppose that with very low incomes it is more reasonable to suppose that with very low incomes the workerrsquos need for food clothing shelter and other the workerrsquos need for food clothing shelter and other ldquoessentialrdquo goods the income effect is weak and the ldquoessentialrdquo goods the income effect is weak and the substitution effect is strong We should therefore expect the substitution effect is strong We should therefore expect the labor-supply curve to be upward sloping when wage rates are labor-supply curve to be upward sloping when wage rates are low Hence labor supply would be backward bending low Hence labor supply would be backward bending

Backward-bending Labor-supply Curve

Adding Realism TaxesAdding Realism Taxes

bull How does the tax affect the income from a little more or a little How does the tax affect the income from a little more or a little less work To answer this question we must know the less work To answer this question we must know the marginal marginal tax ratetax rate ((the fraction of an additional dollar of income that is the fraction of an additional dollar of income that is paid as taxes) paid as taxes) To keep things simple assume that all income is To keep things simple assume that all income is taxed at the same taxed at the same flatflat rate rate ττ In this case the marginal tax rate In this case the marginal tax rate must also be τ which takes a value between zero and one If a must also be τ which takes a value between zero and one If a worker earns worker earns wpwp for an hour of work the government takes for an hour of work the government takes τ(wp) τ(wp) as taxes and leaves the worker as taxes and leaves the worker (1ndashτ)(wp) (1ndashτ)(wp) as the after-as the after-tax real wagetax real wage

bull Since the worker actually receives the Since the worker actually receives the after-tax real wageafter-tax real wage it is it is the the true opportunity cost of leisure true opportunity cost of leisure Any increase in the Any increase in the marginal tax rate represents a decrease in the opportunity cost marginal tax rate represents a decrease in the opportunity cost of leisure If of leisure If substitution effectssubstitution effects are stronger than income are stronger than income effects then any increase in marginal tax rates effects then any increase in marginal tax rates reducesreduces the the supply of labor supply of labor as shown in the following figureas shown in the following figure

The Effect of a Tax Increase on Labor Supply

bull The labor-supply curve with no taxes is shown on the right of The labor-supply curve with no taxes is shown on the right of the figure At the figure At (wp)1(wp)1 the worker supplies labor the worker supplies labor l1l1 If a tax of If a tax of τ1τ1 is imposed the after-tax real wage is is imposed the after-tax real wage is (1ndashτ1)(wp)1(1ndashτ1)(wp)1 The worker The worker should react exactly as if he paid no taxes but suffered a cut in should react exactly as if he paid no taxes but suffered a cut in his wages This is shown as a movement from point A to point B his wages This is shown as a movement from point A to point B where labor supply has fallen to where labor supply has fallen to l2l2 But of course the wage rate But of course the wage rate did not really falldid not really fall the employer still pays (wp)1 This means the employer still pays (wp)1 This means that (l2 (wp)1) is the labor-supply (point C)that (l2 (wp)1) is the labor-supply (point C)

bull Since this would apply for any real-wage rate every point on Since this would apply for any real-wage rate every point on the original curve shifts to the left Because the the original curve shifts to the left Because the tax rate is tax rate is proportional its absolute effect is greaterproportional its absolute effect is greater as is the shift in the as is the shift in the labor-supply curve at high wage rates resulting in a labor-supply curve at high wage rates resulting in a steepening of the curve Any further increase in the tax rate to steepening of the curve Any further increase in the tax rate to say τ2 would shift the labor-supply curve further to the left say τ2 would shift the labor-supply curve further to the left

bull The length of the line segment BC measures the The length of the line segment BC measures the TAX WEDGETAX WEDGE between the real wage paid by employers and the after-tax real between the real wage paid by employers and the after-tax real wage received by workewage received by workersrs The The largerlarger the tax wedge the the tax wedge the largerlarger the leftward shift of the labor-supply curve and the the leftward shift of the labor-supply curve and the greater the greater the reductionreduction in labor supplied at any real wage in labor supplied at any real wage

bull The idea that tax increases lower labor supply and conversely The idea that tax increases lower labor supply and conversely that tax cuts increase labor supply was a major tenet of the so-that tax cuts increase labor supply was a major tenet of the so-called called supply-side economicssupply-side economics popular in the early 1980s popular in the early 1980s President Ronald Reagan and his advisors used it to argue that President Ronald Reagan and his advisors used it to argue that cuts in marginal tax rates cuts in marginal tax rates would stimulate people would stimulate people to to workwork harder and to harder and to earn larger earn larger incomesincomes

Adding Realism A Standard WorkweekAdding Realism A Standard Workweek

bull Another way in which the simple analysis of labor supply is Another way in which the simple analysis of labor supply is unrealistic is that many unrealistic is that many workers are not given an option about workers are not given an option about the number of hours they workthe number of hours they work Although people work part- Although people work part-time and overtime either may be voluntary or mandatory time and overtime either may be voluntary or mandatory

bull Assuming that workers are Assuming that workers are not permitted to work more than not permitted to work more than 40 hours a week40 hours a week the following figure includes a constraint of the following figure includes a constraint of 40 hours If the worker were permitted to choose freely then 40 hours If the worker were permitted to choose freely then the labor-supply curve would backward bending curve The the labor-supply curve would backward bending curve The overall effect is to of the standard work week is to reshape the overall effect is to of the standard work week is to reshape the labor-supply curve as indicated by the heavy curve with the labor-supply curve as indicated by the heavy curve with the vertical segment that runs through points A F G D and E vertical segment that runs through points A F G D and E Any worker on this vertical segment is constrainedAny worker on this vertical segment is constrained

The Individual Labor-Supply Curve in PracticeThe Individual Labor-Supply Curve in Practice

bull What does the individual labor-supply curve look like in What does the individual labor-supply curve look like in realityreality It is difficult to answer this question because in reality It is difficult to answer this question because in reality we can observe we can observe only one pointonly one point on the labor-supply curve for a on the labor-supply curve for a single worker single worker at a particular timeat a particular time All the other points are All the other points are conjecturesconjectures about what the worker would supply if faced with about what the worker would supply if faced with different wage rates If we imagine that on average workers are different wage rates If we imagine that on average workers are substantially substantially similarsimilar we might nonetheless get some idea of we might nonetheless get some idea of what the individual labor-supply curve might look likewhat the individual labor-supply curve might look like

bull The The National Longitudinal SurveyNational Longitudinal Survey (Youth) has catalogued the (Youth) has catalogued the work histories of a large sample of individuals starting at a work histories of a large sample of individuals starting at a young age The following figure plots the real-wage rates and young age The following figure plots the real-wage rates and average weekly hours of labor for about average weekly hours of labor for about 1000010000 male workers male workers from this survey for a from this survey for a single periodsingle period with the best fitting flexible with the best fitting flexible line through these points serves as our empirical estimate of the line through these points serves as our empirical estimate of the labor-supply curve for these workerslabor-supply curve for these workers

bull The regression line traces out a shape very The regression line traces out a shape very like the backward-like the backward-bendingbending labor-supply curve with a 40-hour constraint What labor-supply curve with a 40-hour constraint What looks like a vertical line above 40 hours is looks like a vertical line above 40 hours is not really a solid line not really a solid line at all but a reflection of the fact that about at all but a reflection of the fact that about 7500 7500 of the 10000 of the 10000 workers in the sample supply 40 hours per week at a variety of workers in the sample supply 40 hours per week at a variety of wage rates The labor-supply curve traces out a segment above wage rates The labor-supply curve traces out a segment above the 40-hour point that corresponds to the constraintthe 40-hour point that corresponds to the constraint

bull There are There are points to the rightpoints to the right of 40 hours This is reasonable of 40 hours This is reasonable since in the real world workers do since in the real world workers do work overtimework overtime ndash either ndash either because they are supervisors or professionals or because because they are supervisors or professionals or because employers offer them the required time-and-half wage rate employers offer them the required time-and-half wage rate The fit of the regression line is far from perfect points lie on The fit of the regression line is far from perfect points lie on both sides of the line We should interpret it as a both sides of the line We should interpret it as a snapshotsnapshot of of the behavior of the typical worker But ofthe behavior of the typical worker But of course the typical course the typical worker is not any actual worker in particularworker is not any actual worker in particular

THE WORKER CHOOSING TO PARTICIPATETHE WORKER CHOOSING TO PARTICIPATE

bull So far we have examined only one aspect of the workerrsquos So far we have examined only one aspect of the workerrsquos labor-supply decision labor-supply decision how many hours to work for given real how many hours to work for given real wagewage We now take up the second aspect We now take up the second aspect participationparticipation ndash that ndash that is is whether or not to work at allwhether or not to work at all A labor-supply curve that starts A labor-supply curve that starts at the origin and slopes upwards for at least a portion of its at the origin and slopes upwards for at least a portion of its length suggests that even length suggests that even if the wage were very lowif the wage were very low ndash say 1cent ndash say 1cent per hour ndash the worker would work a little bit That is clearly per hour ndash the worker would work a little bit That is clearly unrealisticunrealistic no one would work at all for 1cent per hour no one would work at all for 1cent per hour What What factors determine how high the wage factors determine how high the wage must be to induce a person must be to induce a person to participate in the labor marketto participate in the labor market

bull The labor force The labor force participationparticipation decision is a question of decision is a question of opportunity costopportunity cost Idleness has its charms Before anyone enters Idleness has its charms Before anyone enters the labor force the wage rate must be high enough to overcome the labor force the wage rate must be high enough to overcome them them The opportunity cost of participatingThe opportunity cost of participating in the labor force is in the labor force is sum of sum of

1048766 1048766 the implicit valuethe implicit value the worker places on complete idleness the worker places on complete idleness

1048766 1048766 the explicit coststhe explicit costs of working compared to not working such as of working compared to not working such as clothing transport childcare) andclothing transport childcare) and

1048766 1048766 the explicit losses the explicit losses from working (for instance housework not from working (for instance housework not done)done)

bull The opportunity cost is partly psychological and partly material The opportunity cost is partly psychological and partly material If people were completely If people were completely independentindependent of each other the worker of each other the worker might place a lower value on the opportunity cost of might place a lower value on the opportunity cost of participation because then the choice might be literally between participation because then the choice might be literally between work and starvationwork and starvation

bull But most people are not But most people are not completely independentcompletely independent Whether or Whether or not to participate in the labor force could be a not to participate in the labor force could be a genuine choicegenuine choice and would depend on the and would depend on the real wagereal wage

bull The The RESERVATION WAGE RESERVATION WAGE is defined to be is defined to be the opportunity the opportunity cost of working compared to not workingcost of working compared to not working ndash ndash that is the real wage that is the real wage that is high enough to make it just worthwhile for a worker to that is high enough to make it just worthwhile for a worker to participate in the labor forceparticipate in the labor force

bull Taking account of the opportunity costs of participation affects Taking account of the opportunity costs of participation affects the shape of the labor-supply curve As long as the the shape of the labor-supply curve As long as the real wage is real wage is below the reservationbelow the reservation wage ((wp)R) the worker supplies no wage ((wp)R) the worker supplies no labor at all Above the reservation wage there is a normal labor at all Above the reservation wage there is a normal labor-supply curvelabor-supply curve

bull The following captures the two stages of the labor supply The following captures the two stages of the labor supply decision decision FirstFirst at low wages the worker will at low wages the worker will notnot supply any supply any labor at all and small increases in wages have no effect But labor at all and small increases in wages have no effect But secondsecond as soon as the wage rises enough for the worker to bite as soon as the wage rises enough for the worker to bite the bullet and join the labor force the minimum labor supplied the bullet and join the labor force the minimum labor supplied will be well will be well above zeroabove zero and the worker will decide how many and the worker will decide how many hours to supply above this minimum through the usual process hours to supply above this minimum through the usual process of balancing the opportunity cost of leisure against the desire of balancing the opportunity cost of leisure against the desire for consumption goodsfor consumption goods

AGGREGATE LABOR SUPPLY

bull How can we moveHow can we move from the microeconomics of the labor supply from the microeconomics of the labor supply back to an aggregate relationship usable in macroeconomic back to an aggregate relationship usable in macroeconomic analysis analysis If workers were essentially alikeIf workers were essentially alike the problem would the problem would be easy be easy

bull As we have seen labor supply has two dimensions ndash As we have seen labor supply has two dimensions ndash participationparticipation in the labor force and in the labor force and choice of hourschoice of hours of labor of labor Take the participation decision first If all workers were alike Take the participation decision first If all workers were alike except for except for differences in their reservation wagedifferences in their reservation wage then we could then we could rank them from lowest to highest reservation wage The rank them from lowest to highest reservation wage The aggregate labor-supply (participation) curve is strictly aggregate labor-supply (participation) curve is strictly upwardslopingupwardsloping

bull Of course this is too easy Just as we observed in deriving the Of course this is too easy Just as we observed in deriving the aggregate labor demand curve workers are aggregate labor demand curve workers are not all alikenot all alike Once Once again we must interpret the vertical axis as measuring the again we must interpret the vertical axis as measuring the average real wageaverage real wage that at best provides a kind of index for the that at best provides a kind of index for the level of the wage structure level of the wage structure

bull The The problemproblem remains the remains the samesame when we turn to the choice of when we turn to the choice of hourshours Workers are all different and face a structure of wages Workers are all different and face a structure of wages For each worker individually there is a jump from supplying For each worker individually there is a jump from supplying zero to supplying some positive number of hours zero to supplying some positive number of hours when his own when his own wage rate surpasses their wage rate surpasses their reservation wagereservation wage But in aggregate But in aggregate we are we are unlikely to see such a jumpunlikely to see such a jump Not only are there a variety Not only are there a variety of wages offered at any time but reservation wages differof wages offered at any time but reservation wages differ

Derivation of the Aggregate Labor-supply Curve

bull A curve like the one in this figure can be used to display either A curve like the one in this figure can be used to display either the the participation participation decision or decision or the hoursthe hours The horizontal axis can The horizontal axis can either be used for workers either be used for workers or worker-hoursor worker-hours as measures of the as measures of the labor supply The two meanings are not completely labor supply The two meanings are not completely independent by definition independent by definition

bull workers equiv aggregate worker ndash hours average hours per worker workers equiv aggregate worker ndash hours average hours per worker

The Participation Rate and Average Hours

bull Let us look first at the aggregate participation decision The Let us look first at the aggregate participation decision The aggregate number of workers who have decided to participate aggregate number of workers who have decided to participate is known as the is known as the labor forcelabor force the the civilian labor force over 16 civilian labor force over 16 years of ageyears of age This number excludes uniformed members of the This number excludes uniformed members of the armed services and the small number of workers under 16 armed services and the small number of workers under 16 years old The labor force of course has grown right along years old The labor force of course has grown right along with population with population

bull The participation rateThe participation rate (PR) measures (PR) measures the labor force as its ratio the labor force as its ratio to the relevant populationto the relevant population

bull participation rate = labor forcerelevant population participation rate = labor forcerelevant population

bull ldquoldquonon-institutionalrdquo non-institutionalrdquo excludes people in prison or in homes for excludes people in prison or in homes for the aged) the aged)

bull The aggregate number of hours The aggregate number of hours worked is worked is not as easy not as easy as the as the participation rate to relate to the individual workerrsquos choices participation rate to relate to the individual workerrsquos choices If every worker had the same labor-supply curve we would If every worker had the same labor-supply curve we would have to know the wage offered to each one in order to calculate have to know the wage offered to each one in order to calculate the total number of labor hours supplied In reality workers the total number of labor hours supplied In reality workers are not all alike are not all alike Labor-supply curves may vary systematically Labor-supply curves may vary systematically according to the sex age ethnic group education experience according to the sex age ethnic group education experience or other social or economic characteristics of the workersor other social or economic characteristics of the workers And And within any group the labor-supply curves of individuals are within any group the labor-supply curves of individuals are likely to varylikely to vary

bull In principle In principle if we had a good statistical estimate of the typical if we had a good statistical estimate of the typical distribution of the wagesdistribution of the wages we could make a reasonable we could make a reasonable calculation But statisticians at the Bureau of Labor Statistics calculation But statisticians at the Bureau of Labor Statistics (BLS) do not try to calculate the labor supply in this way (BLS) do not try to calculate the labor supply in this way Instead they Instead they count the number of hours that workers actually count the number of hours that workers actually workwork and the average and the average wages and salaries they are paid wages and salaries they are paid

bull In USA the total hours of labor in 1998 was In USA the total hours of labor in 1998 was 236882236882 million million The average hours of work is The average hours of work is 17211721 hours per year = hours per year = 344344 hours hours per week (assuming a 50 week year) This number is 14 percent per week (assuming a 50 week year) This number is 14 percent below the full time 40-hour week which makes sense since it below the full time 40-hour week which makes sense since it averages over full-time part-time and overtime workers averages over full-time part-time and overtime workers

Labor Market EquilibriumLabor Market Equilibrium

bull MARKET CLEARINGMARKET CLEARING

bull When both demand and supply curves are plotted on the same When both demand and supply curves are plotted on the same diagram the crossing point defines the diagram the crossing point defines the equilibrium real-wage equilibrium real-wage rate and the rate and the equilibrium level of labor employedequilibrium level of labor employed

bull The real wage The real wage looks different looks different from the point of view of the firm from the point of view of the firm and the worker For the and the worker For the firmfirm the relevant real wage is the the relevant real wage is the product-real wage product-real wage defined as defined as the number of units of the good the number of units of the good the firm produces that the wage will purchase the firm produces that the wage will purchase ((price of price of productproduct = = w) w) For the For the workerworker the relevant real wage is the the relevant real wage is the consumption-consumption-real real wagewage defined as defined as the number of typical consumption baskets the number of typical consumption baskets that the wage will purchase that the wage will purchase ((price of price of consumption basket consumption basket = = w)w)

bull For aggregate analysis we might use the For aggregate analysis we might use the Producer Price IndexProducer Price Index or the GDP deflator to approximate the or the GDP deflator to approximate the product priceproduct price and the and the CPICPI to approximate the to approximate the consumption price consumption price

bull Suppose that the product-real wage and the consumption-real Suppose that the product-real wage and the consumption-real wage in the following figure start out with the identical value wage in the following figure start out with the identical value ((wp) at the market-clearing point Awp) at the market-clearing point A Now suppose that Now suppose that imported Japanese cars are a large portion of the typical imported Japanese cars are a large portion of the typical workerrsquos consumption basket workerrsquos consumption basket and that and that ceteris paribus ceteris paribus the price the price of Japanese cars rises sharply This means that the of Japanese cars rises sharply This means that the real wage real wage from the point of view of the from the point of view of the consumer falls to (consumer falls to (wpwpCPICPI ) )11 at point at point

B B on the labor-supply curve (LS) so that the worker would on the labor-supply curve (LS) so that the worker would want to supply less labor (want to supply less labor (LL11))

bull The rise in the price of Japanese cars has no effect on the price The rise in the price of Japanese cars has no effect on the price of their products Nevertheless they see a reduction of labor of their products Nevertheless they see a reduction of labor supply at the original market clearing wage It is as if the supply at the original market clearing wage It is as if the labor-supply curve labor-supply curve has shifted to the left to has shifted to the left to LSLSrsquo which passes rsquo which passes through ((through ((wp) L1) at point C wp) L1) at point C At the original wage rate labor At the original wage rate labor demand exceeds labor supply so firms raise wages in an effort demand exceeds labor supply so firms raise wages in an effort to attract workers until they reach the new market-clearing to attract workers until they reach the new market-clearing wage at point D where they pay (wage at point D where they pay (wpwpPPIPPI ) for labor of L ) for labor of L The The

rise in the price of Japanese cars has the effect of raising the rise in the price of Japanese cars has the effect of raising the wages that firms must pay and reducing labor employedwages that firms must pay and reducing labor employed Higher wages partly compensate workers for the higher costs Higher wages partly compensate workers for the higher costs of consumption but firms can afford to pay those higher wages of consumption but firms can afford to pay those higher wages only if marginal products rise as a result of their using less only if marginal products rise as a result of their using less labor labor

bull The rise in wage rates is not enough to compensate workers The rise in wage rates is not enough to compensate workers fully so the consumption-real wage in equilibrium is (wpfully so the consumption-real wage in equilibrium is (wpCPI CPI ) )

atat point E We can think of import prices as a tax levied on point E We can think of import prices as a tax levied on consumers and of an increase in import prices as widening the consumers and of an increase in import prices as widening the tax wedge Unless the issue that we want to analyze depends on tax wedge Unless the issue that we want to analyze depends on the difference between product- and consumption-real wages the difference between product- and consumption-real wages we will treat the real wage as the same for both labor supply we will treat the real wage as the same for both labor supply and labor demandand labor demand

An Increase in the Price of Consumption GoodsAn Increase in the Price of Consumption GoodsRelative to the Price of OutputRelative to the Price of Output

ANALYZING IDEAL LABOR MARKETSANALYZING IDEAL LABOR MARKETS

bull The aggregate labor-supplylabor-demand diagram provides us The aggregate labor-supplylabor-demand diagram provides us with a powerful tool We now analyze three important with a powerful tool We now analyze three important macroeconomic issues macroeconomic issues

(1) the effect of tax cuts on employment (1) the effect of tax cuts on employment

(2) the effect of technological progress on the well-being of (2) the effect of technological progress on the well-being of workers and workers and

(3) the effect of immigration on existing workers (3) the effect of immigration on existing workers

bull Issue 1 Tax Cuts Issue 1 Tax Cuts What are the effects of a cut in marginal What are the effects of a cut in marginal income-tax rates on employment and the level of GDP in the income-tax rates on employment and the level of GDP in the economyeconomy Recall from section that a lower marginal income-Recall from section that a lower marginal income-tax rate increases labor supply at each real wage (a rightward tax rate increases labor supply at each real wage (a rightward shift of the labor-supply) shift of the labor-supply)

bull Labor-market equilibrium moves from point A to point B in Labor-market equilibrium moves from point A to point B in the lower panel of the following Notice that the amount of the lower panel of the following Notice that the amount of labor available to firms increases so that firms move labor available to firms increases so that firms move production from Arsquo to Brsquo on the labor production function in production from Arsquo to Brsquo on the labor production function in the upper panel Also notice that the real wage falls from (the upper panel Also notice that the real wage falls from (wp)1 wp)1 to (wp)2 Since the cut in taxes increases the number of to (wp)2 Since the cut in taxes increases the number of workers workers willing to work at each wage Workers care about their take-willing to work at each wage Workers care about their take-home pay ndash that is about their home pay ndash that is about their after-tax real wage after-tax real wage This is This is perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 can be greater than the old after-tax real wage (1ndashcan be greater than the old after-tax real wage (1ndashτ1τ1)(wp)1 so )(wp)1 so long as the rise in the take-home share (1 ndash τ) is long as the rise in the take-home share (1 ndash τ) is proportionately greater than the fall in the before-tax real proportionately greater than the fall in the before-tax real wage (wp)wage (wp)

bull The analysis depends on substitution effects dominating The analysis depends on substitution effects dominating income effects which they probably do in aggregate if not for income effects which they probably do in aggregate if not for every worker So the supply-siders of the Reagan years are every worker So the supply-siders of the Reagan years are correct in principle How much output will increase depends on correct in principle How much output will increase depends on how large the substitution effect is If most people work a how large the substitution effect is If most people work a standard 40-hour week the effect could be quite small and the standard 40-hour week the effect could be quite small and the increase in output might also be very small in practiceincrease in output might also be very small in practice

Issue 1 The Effect of a Cut in Marginal Tax RatesIssue 1 The Effect of a Cut in Marginal Tax Rates

Issue 2 Technological Progress and Worker WelfareIssue 2 Technological Progress and Worker Welfare

bull Is technological progress and increasing use of machinery and Is technological progress and increasing use of machinery and other capital beneficial for workersother capital beneficial for workers

bull Technological change or capital accumulation have been Technological change or capital accumulation have been known as ldquoLudditesrdquo (known as ldquoLudditesrdquo (it negatively affects the demand for it negatively affects the demand for laborlabor) To see why the Luddites are wrong ndash at least for ) To see why the Luddites are wrong ndash at least for clearing labor markets ndash recall that technological progress or clearing labor markets ndash recall that technological progress or increased capital both increased capital both shift the labor-demand curve upwardshift the labor-demand curve upward The lower panel of the following figure shows that the effect of The lower panel of the following figure shows that the effect of the increased demand for labor is to increase total employment the increased demand for labor is to increase total employment and the real wage Firms and the real wage Firms can pay a higher real wage can pay a higher real wage because because the additional capital or technological progress the additional capital or technological progress increases the increases the marginal product of labormarginal product of labor

bull The The Ludditesrsquo mistake Ludditesrsquo mistake is most easily seen in the upper panel is most easily seen in the upper panel The Luddite argument assumes that fewer workers will The Luddite argument assumes that fewer workers will produce the same total output Production starts at Arsquo using produce the same total output Production starts at Arsquo using L1 L1 workers to produce Y1 After the upward shift in the production workers to produce Y1 After the upward shift in the production function the same output could be produced using less labor function the same output could be produced using less labor ((L3) at point Arsquorsquo The L3) at point Arsquorsquo The problem is that Arsquorsquo is not an equilibrium problem is that Arsquorsquo is not an equilibrium At that point the marginal product of labor is higher than the At that point the marginal product of labor is higher than the original real wage so a profit-maximizing firm would want to original real wage so a profit-maximizing firm would want to expand production To do this they must hire more labor than expand production To do this they must hire more labor than L3 and indeed they L3 and indeed they find it find it profitable profitable to hire more labor than to hire more labor than the original the original L1 The only way actually to increase labor L1 The only way actually to increase labor is to is to raise the real-wage raise the real-wage rate above its original level Technological rate above its original level Technological progress therefore favors progress therefore favors workers by increasing employment workers by increasing employment and wagesand wages

bull Early in the 19th century hand-woven cloth was very Early in the 19th century hand-woven cloth was very expensive and a worker was lucky to own the clothes on his expensive and a worker was lucky to own the clothes on his back and a spare set for church on Sunday Textiles were one of back and a spare set for church on Sunday Textiles were one of the first industries to benefit from the Industrial Revolution so the first industries to benefit from the Industrial Revolution so that by the end of the 19th century machine-made fabrics and that by the end of the 19th century machine-made fabrics and mass-production made decent clothing in larger quantities mass-production made decent clothing in larger quantities accessible to most of the population of the more developed accessible to most of the population of the more developed countries Similar progress has been made in most forms of countries Similar progress has been made in most forms of production Agricultural production which at the turn of the production Agricultural production which at the turn of the 20th century absorbed half the labor force now absorbs less 20th century absorbed half the labor force now absorbs less than 3 percent while producing more food more cheaply than than 3 percent while producing more food more cheaply than ever ever

bull We must be careful not to dismiss the Luddites as altogether We must be careful not to dismiss the Luddites as altogether foolish While new technology especially over decades has foolish While new technology especially over decades has proved to be a net gain for workers in general the Luddites proved to be a net gain for workers in general the Luddites were in fact correct that their way of life was threatened were in fact correct that their way of life was threatened Independent weavers became factory hands unskilled Independent weavers became factory hands unskilled workers increasingly women and often children replaced workers increasingly women and often children replaced skilled craftsmen and factory work often involved long hours skilled craftsmen and factory work often involved long hours in brutal conditions The wider society reaps the benefits of in brutal conditions The wider society reaps the benefits of technological change while a narrow group sometimes technological change while a narrow group sometimes disproportionately bears its costs Our analysis also assumes disproportionately bears its costs Our analysis also assumes that markets generally clear The implicit assumption is that that markets generally clear The implicit assumption is that displaced workers move on to new jobs possibly in other forms displaced workers move on to new jobs possibly in other forms of production Markets may have a tendency to clear in the of production Markets may have a tendency to clear in the long run yet workers may find themselves displaced in the long run yet workers may find themselves displaced in the short run say over the course of a business cycleshort run say over the course of a business cycle

Issue 3 Immigration Jobs and Real WagesIssue 3 Immigration Jobs and Real Wages

bull How does an increase in the labor force through immigration or How does an increase in the labor force through immigration or natural population growth affect labor and GDP natural population growth affect labor and GDP

bull One of the emotional issues associated with US immigration One of the emotional issues associated with US immigration policy ndash particularly towards low-wage workers from Mexico ndash policy ndash particularly towards low-wage workers from Mexico ndash is the idea that is the idea that immigrants take jobs away from native immigrants take jobs away from native workers workers We might be tempted to dismiss this fear as another We might be tempted to dismiss this fear as another example of the lump-of-labor fallacy Yet there is a sensible example of the lump-of-labor fallacy Yet there is a sensible intuition behind the argument An increase in the labor force ndash intuition behind the argument An increase in the labor force ndash due either to immigration or to higher population growth rates due either to immigration or to higher population growth rates ndash can be represented as an outward shift of the aggregate labor ndash can be represented as an outward shift of the aggregate labor supply curve as shown in the following Figure Employment supply curve as shown in the following Figure Employment increases but real wages fall It is not then that immigrants increases but real wages fall It is not then that immigrants take jobs away from natives take jobs away from natives Rather they compete for jobsRather they compete for jobs putting downward pressure on real wagesputting downward pressure on real wages

bull Again we must exercise care in interpreting the analysis Again we must exercise care in interpreting the analysis Remember that aggregate labor and average wage rates hide Remember that aggregate labor and average wage rates hide many details of the labor process The incomes of the new many details of the labor process The incomes of the new immigrants immigrants creates demand creates demand for the new production that they for the new production that they make possible Immigrant workers (at least those ndash whether make possible Immigrant workers (at least those ndash whether legal or illegal ndash who have become the focus of the most intense legal or illegal ndash who have become the focus of the most intense political debate) political debate) are likely to possess fewer skills than nativesare likely to possess fewer skills than natives The net effect is that the increased demand for goods and The net effect is that the increased demand for goods and services generated by immigrants is likely to increase the services generated by immigrants is likely to increase the demand for skilled (demand for skilled (and largely nativeand largely native) workers relative to ) workers relative to their supply and so to increase real wages of skilled workers their supply and so to increase real wages of skilled workers Low-skilled immigration may lower the real wage for farm Low-skilled immigration may lower the real wage for farm workers but if anything it would raise the real wage for workers but if anything it would raise the real wage for computer programmerscomputer programmers

Next Task Labor Market in Kuwait

Appendix Is Labor Supply Stable Over Time

bull Statistics on participation rates or average hours for a Statistics on participation rates or average hours for a particular month or year are snapshot of the labor market particular month or year are snapshot of the labor market Can we analyze the effects of that increase on the labor market Can we analyze the effects of that increase on the labor market under the assumption that the labor-supply curves of workers under the assumption that the labor-supply curves of workers remain essentially stableremain essentially stable

bull Data on participation rates in the United States appear to Data on participation rates in the United States appear to support this conjecture (see Figure 811) which shows the support this conjecture (see Figure 811) which shows the overall civilian participation rate trending upward ndash at least overall civilian participation rate trending upward ndash at least from the middle of the 1960sfrom the middle of the 1960s

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

bull Labor is the most important factor of production Most of us Labor is the most important factor of production Most of us derive our main source of income from labor In this chapter derive our main source of income from labor In this chapter we investigate the labor markets when they are working well we investigate the labor markets when they are working well Some of the questions considered are Some of the questions considered are How much labor do How much labor do firms want to hirefirms want to hire How many people want to workHow many people want to work For how For how long long How do taxes technological progress and immigration How do taxes technological progress and immigration affect real wagesaffect real wages

bull Our analysis has three parts (i) Our analysis has three parts (i) What factors govern the What factors govern the decisions of firms to hire labordecisions of firms to hire labor (ii) (ii) What factors govern the What factors govern the willingness of workers to supply itwillingness of workers to supply it And (iii) And (iii) How do the How do the decisions of decisions of firms and workers firms and workers interact to determine the mount interact to determine the mount of labor used in productionof labor used in production

Labor Demand

bull THE FIRMrsquoS DEMAND FOR LABORTHE FIRMrsquoS DEMAND FOR LABOR

bull Deriving the Firmrsquos Labor-Demand CurveDeriving the Firmrsquos Labor-Demand Curve

bull The labor-demand curve shows The labor-demand curve shows the amount of labor a firm the amount of labor a firm would optimally choose to hire ceteris paribus at each real-wage would optimally choose to hire ceteris paribus at each real-wage raterate

bull Recall the rule for profit maximization Recall the rule for profit maximization a firm hires labor until a firm hires labor until the marginal product of labor is equal to the real wage (mpl = the marginal product of labor is equal to the real wage (mpl = wp)wp) Because of diminishing returns the relationship between Because of diminishing returns the relationship between real-wage rates real-wage rates and the and the marginal product of labor marginal product of labor is inverse a is inverse a firm can profitably firm can profitably hire more labor only if real wage falls hire more labor only if real wage falls enough to enough to match the fall in the marginal productmatch the fall in the marginal product

bull We apply the profit maximization rule to the production We apply the profit maximization rule to the production function to derive a labor-demand curve (see the following function to derive a labor-demand curve (see the following Figure)Figure)

bull Imagine that the firm faces a real wage of (wp)1 The optimal Imagine that the firm faces a real wage of (wp)1 The optimal point is found where the point is found where the MP=(wp)1MP=(wp)1 This point corresponds to This point corresponds to a particular level of labor l1 The combination a particular level of labor l1 The combination (l1 (wp)1)(l1 (wp)1) forms point forms point Arsquo Arsquo which is one point on the labor-demand curve which is one point on the labor-demand curve If the firm paid its workers anything more than If the firm paid its workers anything more than (wp)1 (wp)1 to to produce at produce at A A it would reduce its profitsit would reduce its profits

bull If the firm do if it faced a lower wage say If the firm do if it faced a lower wage say (wp)2(wp)2 the new the new optimal production point will be at optimal production point will be at BB At B the firm demands At B the firm demands l2l2

bull The combination The combination (l2 (wp)2) (l2 (wp)2) shown as point shown as point Brsquo Brsquo in the lower in the lower panel is another point on the firmrsquos labor-demand curve The panel is another point on the firmrsquos labor-demand curve The labor-demand curve connects labor-demand curve connects Arsquo Brsquo Arsquo Brsquo and every other profit-and every other profit-maximizing point It is downward sloping because of maximizing point It is downward sloping because of diminishing returns to labordiminishing returns to labor

bull Factors that Shift the Labor-demand curveFactors that Shift the Labor-demand curve

bull The labor-demand curve is not independent of theThe labor-demand curve is not independent of the production production functionfunction As a result anything that shifts the production As a result anything that shifts the production function will in general function will in general shift the labor-demand curveshift the labor-demand curve and the and the labor-demand curve cannot shift unless the production labor-demand curve cannot shift unless the production function also shifts function also shifts Technological progress or an increase in Technological progress or an increase in the capital stock shifts the capital stock shifts the production function upward the production function upward

bull Consider an Consider an increase in the capital stockincrease in the capital stock how does it shift the how does it shift the labor-demand curvelabor-demand curve

bull An increase in capital raises An increase in capital raises MPLMPL at every level of labor at every level of labor demand the higher MP means that the profit-maximizing firm demand the higher MP means that the profit-maximizing firm can afford can afford higher real wage higher real wage at each level of labor The labor-at each level of labor The labor-demand curve shifts vertically upwarddemand curve shifts vertically upward

bull But why would the firm pay workers more for a particular But why would the firm pay workers more for a particular level of labor level of labor when additional capital raises when additional capital raises their marginal their marginal products Why does the firm not just pocket the windfall The products Why does the firm not just pocket the windfall The answer answer competitioncompetition When the marginal product rises each When the marginal product rises each firm tries to hire firm tries to hire more workersmore workers Since we have assumed that Since we have assumed that markets are all in equilibrium all available workers are markets are all in equilibrium all available workers are already employed and it is only by paying higher wages that already employed and it is only by paying higher wages that the firm can attract them the firm can attract them

THE AGGREGATE DEMAND FOR LABOR

bull In macroeconomic analysis we are more concerned with the In macroeconomic analysis we are more concerned with the aggregate demand for laboraggregate demand for labor If all firms produced the If all firms produced the samesame products and if all workers were products and if all workers were alikealike then aggregation from then aggregation from the firm to the economy as a whole would be easy (see the the firm to the economy as a whole would be easy (see the figure) Unfortunately it is not that simplefigure) Unfortunately it is not that simple

bull The first problem is that all firms are The first problem is that all firms are not producing the same not producing the same productproduct When different firms produce different goods we When different firms produce different goods we must find a common unit of measurement must find a common unit of measurement

bull The second problem is that The second problem is that not all workers are alikenot all workers are alike Different Different kinds of workers may face kinds of workers may face different wage rates different wage rates and therefore and therefore have have different marginal products different marginal products at the optimum For our at the optimum For our purposes the wage structure can be summarized in the purposes the wage structure can be summarized in the average average wage ratewage rate Though It provides an imperfect index of the Though It provides an imperfect index of the movements of the wage structure movements of the wage structure

Labor Supply

bull Two measures reflect two aspects of the workerrsquos labor supply Two measures reflect two aspects of the workerrsquos labor supply decision (i) decision (i) participationparticipation ndash that is whether to work or not ndash that is whether to work or not work and (ii) work and (ii) intensityintensity ndash that is how many hours to work It is ndash that is how many hours to work It is easier if we consider intensity first conditional on having easier if we consider intensity first conditional on having decided to work what factors govern the workerrsquos choice of decided to work what factors govern the workerrsquos choice of how many hours of work to supplyhow many hours of work to supply

bull THE WORKER CHOOSING HOURS OF WORKTHE WORKER CHOOSING HOURS OF WORK

bull The Price of LeisureThe Price of Leisure

bull People work for a variety of reasons The most obvious is to People work for a variety of reasons The most obvious is to earn the incomeearn the income Many people ndash though not all ndash find their Many people ndash though not all ndash find their work work fulfilling and interestingfulfilling and interesting Still even those people will Still even those people will generally prefer another generally prefer another hour of leisure hour of leisure to another hour of to another hour of work It is therefore reasonable to assume that work It is therefore reasonable to assume that leisure is a leisure is a goodgood

bull Goods generally have a price Yet there is Goods generally have a price Yet there is nono market for market for leisureleisure Even though there is no explicit price there is an Even though there is no explicit price there is an implicit price or opportunity cost The implicit price or opportunity cost The OPPORTUNITY COST OPPORTUNITY COST of any choice is the value of the best alternative choice that it of any choice is the value of the best alternative choice that it foreclosesforecloses The implicit price of leisure is its opportunity cost The implicit price of leisure is its opportunity cost which is measured by the real wage (which is measured by the real wage (wp) wp)

bull The Labor-Leisure ChoiceThe Labor-Leisure Choice

bull Once we see leisure as a good and the real-wage rate as its Once we see leisure as a good and the real-wage rate as its price it is easier to understand the choices a worker faces price it is easier to understand the choices a worker faces There are 168 hours in a week If a worker chooses There are 168 hours in a week If a worker chooses not to work not to work at allat all he enjoys 168 hours of leisure but forgoes the income he enjoys 168 hours of leisure but forgoes the income needed to buy any other goods If the worker instead takes needed to buy any other goods If the worker instead takes fewer hours of leisure he supplies labor fewer hours of leisure he supplies labor l = 168 ndash hours of l = 168 ndash hours of leisure leisure and he gains the ability to purchase goods worth wp times l and he gains the ability to purchase goods worth wp times l The problem The problem for the worker for the worker is to choose is to choose the hours of labor (the hours of labor (l ) l ) that at the margin makes the psychic value of a small loss that at the margin makes the psychic value of a small loss further loss of leisure time (ie a small increase in labor time) further loss of leisure time (ie a small increase in labor time) exactly equal to the psychic value of the small gain in exactly equal to the psychic value of the small gain in consumption goods that would be purchased by that laborconsumption goods that would be purchased by that labor

bull INCOME EFFECT How would your supply of labor change if you could receive the income that results from the increased wage rate without facing a changed opportunity cost of leisure

bull As a general rule an increase in income ceteris paribus increases the demand for all goods The extra $20 per week would permit you to buy more goods including leisure without reducing your purchases of other goods The reduction in the supply of labor as the result of an increase in income is called the income effect

bull SUBSTITUTION EFFECTSUBSTITUTION EFFECT

bull If the wage rate rose If the wage rate rose would people work more or less As a would people work more or less As a general rule whenever general rule whenever ceteris paribus the price of anything rises ceteris paribus the price of anything rises relative to alternativesrelative to alternatives the demand for it decreases Here the the demand for it decreases Here the price of leisure price of leisure (its opportunity cost) has risen relative to the (its opportunity cost) has risen relative to the price of other goods the supply of price of other goods the supply of labor would riselabor would rise The change The change in the wage rate encourages people to substitute the now in the wage rate encourages people to substitute the now cheaper goods (what you buy using your wage) for the now cheaper goods (what you buy using your wage) for the now more expensive leisure more expensive leisure The increase in the supply of labor as The increase in the supply of labor as the result of an increase in the price (or opportunity cost) of the result of an increase in the price (or opportunity cost) of leisure is called theleisure is called the SUBSTITUTION EFFECT SUBSTITUTION EFFECT

bull The Labor-supply CurveThe Labor-supply Curve

bull The following figure represents the workerrsquos labor-supply The following figure represents the workerrsquos labor-supply decision Look first at panel (A) Suppose that at point A decision Look first at panel (A) Suppose that at point A where the real wage is (where the real wage is (wp)1 the worker decides that providing l wp)1 the worker decides that providing l hours of work balances the advantages of a little more hours of work balances the advantages of a little more consumption against a little more leisure at the margin Now consumption against a little more leisure at the margin Now consider what happens when the real wage rises to (consider what happens when the real wage rises to (wp)2 wp)2 There is a substitution effect shown by the arrow pointing to There is a substitution effect shown by the arrow pointing to the right which encourages the worker to supply more labor the right which encourages the worker to supply more labor The size of the substitution effect is measured by the length of The size of the substitution effect is measured by the length of the arrowthe arrow

bull There is also an income effect shown by the arrow pointing to There is also an income effect shown by the arrow pointing to the left which encourages the worker to supply less laborthe left which encourages the worker to supply less labor

The Slope of the Labor-Supply Curve

bull The net effect The net effect is measured by the difference between the is measured by the difference between the substitution and income effects shown at point B so that an substitution and income effects shown at point B so that an increase in the wage rate increases the workerrsquos supply of labor increase in the wage rate increases the workerrsquos supply of labor to to l2 to the right of l1 If the substitution effect is always stronger l2 to the right of l1 If the substitution effect is always stronger then the labor supply then the labor supply curve slopes upward curve slopes upward

bull Substitution effects are not necessarily stronger than income Substitution effects are not necessarily stronger than income effectseffects Panel (B) shows the construction of the labor-supply Panel (B) shows the construction of the labor-supply curve starting from point C when income effects are stronger curve starting from point C when income effects are stronger than substitution effects When the real-wage rate increases than substitution effects When the real-wage rate increases from (from (wp)1 to (wp)2 the dominant income effect overwhelms wp)1 to (wp)2 the dominant income effect overwhelms the substitution effect and labor the substitution effect and labor supply (point C) falls from supply (point C) falls from l1 to l1 to l2 If income effects are stronger for all wage rates above l2 If income effects are stronger for all wage rates above ((wp)1 wp)1 then the labor-supply curve will slope downward toward point C then the labor-supply curve will slope downward toward point C higher real wage higher real wage rates lower labor supplyrates lower labor supply

bull Although the labor-supply curve can slope downward towards Although the labor-supply curve can slope downward towards a point like A it is not reasonable to believe that it could slope a point like A it is not reasonable to believe that it could slope downward for every possible wage rate At very low wage rates downward for every possible wage rate At very low wage rates it is more reasonable to suppose that with very low incomes it is more reasonable to suppose that with very low incomes the workerrsquos need for food clothing shelter and other the workerrsquos need for food clothing shelter and other ldquoessentialrdquo goods the income effect is weak and the ldquoessentialrdquo goods the income effect is weak and the substitution effect is strong We should therefore expect the substitution effect is strong We should therefore expect the labor-supply curve to be upward sloping when wage rates are labor-supply curve to be upward sloping when wage rates are low Hence labor supply would be backward bending low Hence labor supply would be backward bending

Backward-bending Labor-supply Curve

Adding Realism TaxesAdding Realism Taxes

bull How does the tax affect the income from a little more or a little How does the tax affect the income from a little more or a little less work To answer this question we must know the less work To answer this question we must know the marginal marginal tax ratetax rate ((the fraction of an additional dollar of income that is the fraction of an additional dollar of income that is paid as taxes) paid as taxes) To keep things simple assume that all income is To keep things simple assume that all income is taxed at the same taxed at the same flatflat rate rate ττ In this case the marginal tax rate In this case the marginal tax rate must also be τ which takes a value between zero and one If a must also be τ which takes a value between zero and one If a worker earns worker earns wpwp for an hour of work the government takes for an hour of work the government takes τ(wp) τ(wp) as taxes and leaves the worker as taxes and leaves the worker (1ndashτ)(wp) (1ndashτ)(wp) as the after-as the after-tax real wagetax real wage

bull Since the worker actually receives the Since the worker actually receives the after-tax real wageafter-tax real wage it is it is the the true opportunity cost of leisure true opportunity cost of leisure Any increase in the Any increase in the marginal tax rate represents a decrease in the opportunity cost marginal tax rate represents a decrease in the opportunity cost of leisure If of leisure If substitution effectssubstitution effects are stronger than income are stronger than income effects then any increase in marginal tax rates effects then any increase in marginal tax rates reducesreduces the the supply of labor supply of labor as shown in the following figureas shown in the following figure

The Effect of a Tax Increase on Labor Supply

bull The labor-supply curve with no taxes is shown on the right of The labor-supply curve with no taxes is shown on the right of the figure At the figure At (wp)1(wp)1 the worker supplies labor the worker supplies labor l1l1 If a tax of If a tax of τ1τ1 is imposed the after-tax real wage is is imposed the after-tax real wage is (1ndashτ1)(wp)1(1ndashτ1)(wp)1 The worker The worker should react exactly as if he paid no taxes but suffered a cut in should react exactly as if he paid no taxes but suffered a cut in his wages This is shown as a movement from point A to point B his wages This is shown as a movement from point A to point B where labor supply has fallen to where labor supply has fallen to l2l2 But of course the wage rate But of course the wage rate did not really falldid not really fall the employer still pays (wp)1 This means the employer still pays (wp)1 This means that (l2 (wp)1) is the labor-supply (point C)that (l2 (wp)1) is the labor-supply (point C)

bull Since this would apply for any real-wage rate every point on Since this would apply for any real-wage rate every point on the original curve shifts to the left Because the the original curve shifts to the left Because the tax rate is tax rate is proportional its absolute effect is greaterproportional its absolute effect is greater as is the shift in the as is the shift in the labor-supply curve at high wage rates resulting in a labor-supply curve at high wage rates resulting in a steepening of the curve Any further increase in the tax rate to steepening of the curve Any further increase in the tax rate to say τ2 would shift the labor-supply curve further to the left say τ2 would shift the labor-supply curve further to the left

bull The length of the line segment BC measures the The length of the line segment BC measures the TAX WEDGETAX WEDGE between the real wage paid by employers and the after-tax real between the real wage paid by employers and the after-tax real wage received by workewage received by workersrs The The largerlarger the tax wedge the the tax wedge the largerlarger the leftward shift of the labor-supply curve and the the leftward shift of the labor-supply curve and the greater the greater the reductionreduction in labor supplied at any real wage in labor supplied at any real wage

bull The idea that tax increases lower labor supply and conversely The idea that tax increases lower labor supply and conversely that tax cuts increase labor supply was a major tenet of the so-that tax cuts increase labor supply was a major tenet of the so-called called supply-side economicssupply-side economics popular in the early 1980s popular in the early 1980s President Ronald Reagan and his advisors used it to argue that President Ronald Reagan and his advisors used it to argue that cuts in marginal tax rates cuts in marginal tax rates would stimulate people would stimulate people to to workwork harder and to harder and to earn larger earn larger incomesincomes

Adding Realism A Standard WorkweekAdding Realism A Standard Workweek

bull Another way in which the simple analysis of labor supply is Another way in which the simple analysis of labor supply is unrealistic is that many unrealistic is that many workers are not given an option about workers are not given an option about the number of hours they workthe number of hours they work Although people work part- Although people work part-time and overtime either may be voluntary or mandatory time and overtime either may be voluntary or mandatory

bull Assuming that workers are Assuming that workers are not permitted to work more than not permitted to work more than 40 hours a week40 hours a week the following figure includes a constraint of the following figure includes a constraint of 40 hours If the worker were permitted to choose freely then 40 hours If the worker were permitted to choose freely then the labor-supply curve would backward bending curve The the labor-supply curve would backward bending curve The overall effect is to of the standard work week is to reshape the overall effect is to of the standard work week is to reshape the labor-supply curve as indicated by the heavy curve with the labor-supply curve as indicated by the heavy curve with the vertical segment that runs through points A F G D and E vertical segment that runs through points A F G D and E Any worker on this vertical segment is constrainedAny worker on this vertical segment is constrained

The Individual Labor-Supply Curve in PracticeThe Individual Labor-Supply Curve in Practice

bull What does the individual labor-supply curve look like in What does the individual labor-supply curve look like in realityreality It is difficult to answer this question because in reality It is difficult to answer this question because in reality we can observe we can observe only one pointonly one point on the labor-supply curve for a on the labor-supply curve for a single worker single worker at a particular timeat a particular time All the other points are All the other points are conjecturesconjectures about what the worker would supply if faced with about what the worker would supply if faced with different wage rates If we imagine that on average workers are different wage rates If we imagine that on average workers are substantially substantially similarsimilar we might nonetheless get some idea of we might nonetheless get some idea of what the individual labor-supply curve might look likewhat the individual labor-supply curve might look like

bull The The National Longitudinal SurveyNational Longitudinal Survey (Youth) has catalogued the (Youth) has catalogued the work histories of a large sample of individuals starting at a work histories of a large sample of individuals starting at a young age The following figure plots the real-wage rates and young age The following figure plots the real-wage rates and average weekly hours of labor for about average weekly hours of labor for about 1000010000 male workers male workers from this survey for a from this survey for a single periodsingle period with the best fitting flexible with the best fitting flexible line through these points serves as our empirical estimate of the line through these points serves as our empirical estimate of the labor-supply curve for these workerslabor-supply curve for these workers

bull The regression line traces out a shape very The regression line traces out a shape very like the backward-like the backward-bendingbending labor-supply curve with a 40-hour constraint What labor-supply curve with a 40-hour constraint What looks like a vertical line above 40 hours is looks like a vertical line above 40 hours is not really a solid line not really a solid line at all but a reflection of the fact that about at all but a reflection of the fact that about 7500 7500 of the 10000 of the 10000 workers in the sample supply 40 hours per week at a variety of workers in the sample supply 40 hours per week at a variety of wage rates The labor-supply curve traces out a segment above wage rates The labor-supply curve traces out a segment above the 40-hour point that corresponds to the constraintthe 40-hour point that corresponds to the constraint

bull There are There are points to the rightpoints to the right of 40 hours This is reasonable of 40 hours This is reasonable since in the real world workers do since in the real world workers do work overtimework overtime ndash either ndash either because they are supervisors or professionals or because because they are supervisors or professionals or because employers offer them the required time-and-half wage rate employers offer them the required time-and-half wage rate The fit of the regression line is far from perfect points lie on The fit of the regression line is far from perfect points lie on both sides of the line We should interpret it as a both sides of the line We should interpret it as a snapshotsnapshot of of the behavior of the typical worker But ofthe behavior of the typical worker But of course the typical course the typical worker is not any actual worker in particularworker is not any actual worker in particular

THE WORKER CHOOSING TO PARTICIPATETHE WORKER CHOOSING TO PARTICIPATE

bull So far we have examined only one aspect of the workerrsquos So far we have examined only one aspect of the workerrsquos labor-supply decision labor-supply decision how many hours to work for given real how many hours to work for given real wagewage We now take up the second aspect We now take up the second aspect participationparticipation ndash that ndash that is is whether or not to work at allwhether or not to work at all A labor-supply curve that starts A labor-supply curve that starts at the origin and slopes upwards for at least a portion of its at the origin and slopes upwards for at least a portion of its length suggests that even length suggests that even if the wage were very lowif the wage were very low ndash say 1cent ndash say 1cent per hour ndash the worker would work a little bit That is clearly per hour ndash the worker would work a little bit That is clearly unrealisticunrealistic no one would work at all for 1cent per hour no one would work at all for 1cent per hour What What factors determine how high the wage factors determine how high the wage must be to induce a person must be to induce a person to participate in the labor marketto participate in the labor market

bull The labor force The labor force participationparticipation decision is a question of decision is a question of opportunity costopportunity cost Idleness has its charms Before anyone enters Idleness has its charms Before anyone enters the labor force the wage rate must be high enough to overcome the labor force the wage rate must be high enough to overcome them them The opportunity cost of participatingThe opportunity cost of participating in the labor force is in the labor force is sum of sum of

1048766 1048766 the implicit valuethe implicit value the worker places on complete idleness the worker places on complete idleness

1048766 1048766 the explicit coststhe explicit costs of working compared to not working such as of working compared to not working such as clothing transport childcare) andclothing transport childcare) and

1048766 1048766 the explicit losses the explicit losses from working (for instance housework not from working (for instance housework not done)done)

bull The opportunity cost is partly psychological and partly material The opportunity cost is partly psychological and partly material If people were completely If people were completely independentindependent of each other the worker of each other the worker might place a lower value on the opportunity cost of might place a lower value on the opportunity cost of participation because then the choice might be literally between participation because then the choice might be literally between work and starvationwork and starvation

bull But most people are not But most people are not completely independentcompletely independent Whether or Whether or not to participate in the labor force could be a not to participate in the labor force could be a genuine choicegenuine choice and would depend on the and would depend on the real wagereal wage

bull The The RESERVATION WAGE RESERVATION WAGE is defined to be is defined to be the opportunity the opportunity cost of working compared to not workingcost of working compared to not working ndash ndash that is the real wage that is the real wage that is high enough to make it just worthwhile for a worker to that is high enough to make it just worthwhile for a worker to participate in the labor forceparticipate in the labor force

bull Taking account of the opportunity costs of participation affects Taking account of the opportunity costs of participation affects the shape of the labor-supply curve As long as the the shape of the labor-supply curve As long as the real wage is real wage is below the reservationbelow the reservation wage ((wp)R) the worker supplies no wage ((wp)R) the worker supplies no labor at all Above the reservation wage there is a normal labor at all Above the reservation wage there is a normal labor-supply curvelabor-supply curve

bull The following captures the two stages of the labor supply The following captures the two stages of the labor supply decision decision FirstFirst at low wages the worker will at low wages the worker will notnot supply any supply any labor at all and small increases in wages have no effect But labor at all and small increases in wages have no effect But secondsecond as soon as the wage rises enough for the worker to bite as soon as the wage rises enough for the worker to bite the bullet and join the labor force the minimum labor supplied the bullet and join the labor force the minimum labor supplied will be well will be well above zeroabove zero and the worker will decide how many and the worker will decide how many hours to supply above this minimum through the usual process hours to supply above this minimum through the usual process of balancing the opportunity cost of leisure against the desire of balancing the opportunity cost of leisure against the desire for consumption goodsfor consumption goods

AGGREGATE LABOR SUPPLY

bull How can we moveHow can we move from the microeconomics of the labor supply from the microeconomics of the labor supply back to an aggregate relationship usable in macroeconomic back to an aggregate relationship usable in macroeconomic analysis analysis If workers were essentially alikeIf workers were essentially alike the problem would the problem would be easy be easy

bull As we have seen labor supply has two dimensions ndash As we have seen labor supply has two dimensions ndash participationparticipation in the labor force and in the labor force and choice of hourschoice of hours of labor of labor Take the participation decision first If all workers were alike Take the participation decision first If all workers were alike except for except for differences in their reservation wagedifferences in their reservation wage then we could then we could rank them from lowest to highest reservation wage The rank them from lowest to highest reservation wage The aggregate labor-supply (participation) curve is strictly aggregate labor-supply (participation) curve is strictly upwardslopingupwardsloping

bull Of course this is too easy Just as we observed in deriving the Of course this is too easy Just as we observed in deriving the aggregate labor demand curve workers are aggregate labor demand curve workers are not all alikenot all alike Once Once again we must interpret the vertical axis as measuring the again we must interpret the vertical axis as measuring the average real wageaverage real wage that at best provides a kind of index for the that at best provides a kind of index for the level of the wage structure level of the wage structure

bull The The problemproblem remains the remains the samesame when we turn to the choice of when we turn to the choice of hourshours Workers are all different and face a structure of wages Workers are all different and face a structure of wages For each worker individually there is a jump from supplying For each worker individually there is a jump from supplying zero to supplying some positive number of hours zero to supplying some positive number of hours when his own when his own wage rate surpasses their wage rate surpasses their reservation wagereservation wage But in aggregate But in aggregate we are we are unlikely to see such a jumpunlikely to see such a jump Not only are there a variety Not only are there a variety of wages offered at any time but reservation wages differof wages offered at any time but reservation wages differ

Derivation of the Aggregate Labor-supply Curve

bull A curve like the one in this figure can be used to display either A curve like the one in this figure can be used to display either the the participation participation decision or decision or the hoursthe hours The horizontal axis can The horizontal axis can either be used for workers either be used for workers or worker-hoursor worker-hours as measures of the as measures of the labor supply The two meanings are not completely labor supply The two meanings are not completely independent by definition independent by definition

bull workers equiv aggregate worker ndash hours average hours per worker workers equiv aggregate worker ndash hours average hours per worker

The Participation Rate and Average Hours

bull Let us look first at the aggregate participation decision The Let us look first at the aggregate participation decision The aggregate number of workers who have decided to participate aggregate number of workers who have decided to participate is known as the is known as the labor forcelabor force the the civilian labor force over 16 civilian labor force over 16 years of ageyears of age This number excludes uniformed members of the This number excludes uniformed members of the armed services and the small number of workers under 16 armed services and the small number of workers under 16 years old The labor force of course has grown right along years old The labor force of course has grown right along with population with population

bull The participation rateThe participation rate (PR) measures (PR) measures the labor force as its ratio the labor force as its ratio to the relevant populationto the relevant population

bull participation rate = labor forcerelevant population participation rate = labor forcerelevant population

bull ldquoldquonon-institutionalrdquo non-institutionalrdquo excludes people in prison or in homes for excludes people in prison or in homes for the aged) the aged)

bull The aggregate number of hours The aggregate number of hours worked is worked is not as easy not as easy as the as the participation rate to relate to the individual workerrsquos choices participation rate to relate to the individual workerrsquos choices If every worker had the same labor-supply curve we would If every worker had the same labor-supply curve we would have to know the wage offered to each one in order to calculate have to know the wage offered to each one in order to calculate the total number of labor hours supplied In reality workers the total number of labor hours supplied In reality workers are not all alike are not all alike Labor-supply curves may vary systematically Labor-supply curves may vary systematically according to the sex age ethnic group education experience according to the sex age ethnic group education experience or other social or economic characteristics of the workersor other social or economic characteristics of the workers And And within any group the labor-supply curves of individuals are within any group the labor-supply curves of individuals are likely to varylikely to vary

bull In principle In principle if we had a good statistical estimate of the typical if we had a good statistical estimate of the typical distribution of the wagesdistribution of the wages we could make a reasonable we could make a reasonable calculation But statisticians at the Bureau of Labor Statistics calculation But statisticians at the Bureau of Labor Statistics (BLS) do not try to calculate the labor supply in this way (BLS) do not try to calculate the labor supply in this way Instead they Instead they count the number of hours that workers actually count the number of hours that workers actually workwork and the average and the average wages and salaries they are paid wages and salaries they are paid

bull In USA the total hours of labor in 1998 was In USA the total hours of labor in 1998 was 236882236882 million million The average hours of work is The average hours of work is 17211721 hours per year = hours per year = 344344 hours hours per week (assuming a 50 week year) This number is 14 percent per week (assuming a 50 week year) This number is 14 percent below the full time 40-hour week which makes sense since it below the full time 40-hour week which makes sense since it averages over full-time part-time and overtime workers averages over full-time part-time and overtime workers

Labor Market EquilibriumLabor Market Equilibrium

bull MARKET CLEARINGMARKET CLEARING

bull When both demand and supply curves are plotted on the same When both demand and supply curves are plotted on the same diagram the crossing point defines the diagram the crossing point defines the equilibrium real-wage equilibrium real-wage rate and the rate and the equilibrium level of labor employedequilibrium level of labor employed

bull The real wage The real wage looks different looks different from the point of view of the firm from the point of view of the firm and the worker For the and the worker For the firmfirm the relevant real wage is the the relevant real wage is the product-real wage product-real wage defined as defined as the number of units of the good the number of units of the good the firm produces that the wage will purchase the firm produces that the wage will purchase ((price of price of productproduct = = w) w) For the For the workerworker the relevant real wage is the the relevant real wage is the consumption-consumption-real real wagewage defined as defined as the number of typical consumption baskets the number of typical consumption baskets that the wage will purchase that the wage will purchase ((price of price of consumption basket consumption basket = = w)w)

bull For aggregate analysis we might use the For aggregate analysis we might use the Producer Price IndexProducer Price Index or the GDP deflator to approximate the or the GDP deflator to approximate the product priceproduct price and the and the CPICPI to approximate the to approximate the consumption price consumption price

bull Suppose that the product-real wage and the consumption-real Suppose that the product-real wage and the consumption-real wage in the following figure start out with the identical value wage in the following figure start out with the identical value ((wp) at the market-clearing point Awp) at the market-clearing point A Now suppose that Now suppose that imported Japanese cars are a large portion of the typical imported Japanese cars are a large portion of the typical workerrsquos consumption basket workerrsquos consumption basket and that and that ceteris paribus ceteris paribus the price the price of Japanese cars rises sharply This means that the of Japanese cars rises sharply This means that the real wage real wage from the point of view of the from the point of view of the consumer falls to (consumer falls to (wpwpCPICPI ) )11 at point at point

B B on the labor-supply curve (LS) so that the worker would on the labor-supply curve (LS) so that the worker would want to supply less labor (want to supply less labor (LL11))

bull The rise in the price of Japanese cars has no effect on the price The rise in the price of Japanese cars has no effect on the price of their products Nevertheless they see a reduction of labor of their products Nevertheless they see a reduction of labor supply at the original market clearing wage It is as if the supply at the original market clearing wage It is as if the labor-supply curve labor-supply curve has shifted to the left to has shifted to the left to LSLSrsquo which passes rsquo which passes through ((through ((wp) L1) at point C wp) L1) at point C At the original wage rate labor At the original wage rate labor demand exceeds labor supply so firms raise wages in an effort demand exceeds labor supply so firms raise wages in an effort to attract workers until they reach the new market-clearing to attract workers until they reach the new market-clearing wage at point D where they pay (wage at point D where they pay (wpwpPPIPPI ) for labor of L ) for labor of L The The

rise in the price of Japanese cars has the effect of raising the rise in the price of Japanese cars has the effect of raising the wages that firms must pay and reducing labor employedwages that firms must pay and reducing labor employed Higher wages partly compensate workers for the higher costs Higher wages partly compensate workers for the higher costs of consumption but firms can afford to pay those higher wages of consumption but firms can afford to pay those higher wages only if marginal products rise as a result of their using less only if marginal products rise as a result of their using less labor labor

bull The rise in wage rates is not enough to compensate workers The rise in wage rates is not enough to compensate workers fully so the consumption-real wage in equilibrium is (wpfully so the consumption-real wage in equilibrium is (wpCPI CPI ) )

atat point E We can think of import prices as a tax levied on point E We can think of import prices as a tax levied on consumers and of an increase in import prices as widening the consumers and of an increase in import prices as widening the tax wedge Unless the issue that we want to analyze depends on tax wedge Unless the issue that we want to analyze depends on the difference between product- and consumption-real wages the difference between product- and consumption-real wages we will treat the real wage as the same for both labor supply we will treat the real wage as the same for both labor supply and labor demandand labor demand

An Increase in the Price of Consumption GoodsAn Increase in the Price of Consumption GoodsRelative to the Price of OutputRelative to the Price of Output

ANALYZING IDEAL LABOR MARKETSANALYZING IDEAL LABOR MARKETS

bull The aggregate labor-supplylabor-demand diagram provides us The aggregate labor-supplylabor-demand diagram provides us with a powerful tool We now analyze three important with a powerful tool We now analyze three important macroeconomic issues macroeconomic issues

(1) the effect of tax cuts on employment (1) the effect of tax cuts on employment

(2) the effect of technological progress on the well-being of (2) the effect of technological progress on the well-being of workers and workers and

(3) the effect of immigration on existing workers (3) the effect of immigration on existing workers

bull Issue 1 Tax Cuts Issue 1 Tax Cuts What are the effects of a cut in marginal What are the effects of a cut in marginal income-tax rates on employment and the level of GDP in the income-tax rates on employment and the level of GDP in the economyeconomy Recall from section that a lower marginal income-Recall from section that a lower marginal income-tax rate increases labor supply at each real wage (a rightward tax rate increases labor supply at each real wage (a rightward shift of the labor-supply) shift of the labor-supply)

bull Labor-market equilibrium moves from point A to point B in Labor-market equilibrium moves from point A to point B in the lower panel of the following Notice that the amount of the lower panel of the following Notice that the amount of labor available to firms increases so that firms move labor available to firms increases so that firms move production from Arsquo to Brsquo on the labor production function in production from Arsquo to Brsquo on the labor production function in the upper panel Also notice that the real wage falls from (the upper panel Also notice that the real wage falls from (wp)1 wp)1 to (wp)2 Since the cut in taxes increases the number of to (wp)2 Since the cut in taxes increases the number of workers workers willing to work at each wage Workers care about their take-willing to work at each wage Workers care about their take-home pay ndash that is about their home pay ndash that is about their after-tax real wage after-tax real wage This is This is perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 can be greater than the old after-tax real wage (1ndashcan be greater than the old after-tax real wage (1ndashτ1τ1)(wp)1 so )(wp)1 so long as the rise in the take-home share (1 ndash τ) is long as the rise in the take-home share (1 ndash τ) is proportionately greater than the fall in the before-tax real proportionately greater than the fall in the before-tax real wage (wp)wage (wp)

bull The analysis depends on substitution effects dominating The analysis depends on substitution effects dominating income effects which they probably do in aggregate if not for income effects which they probably do in aggregate if not for every worker So the supply-siders of the Reagan years are every worker So the supply-siders of the Reagan years are correct in principle How much output will increase depends on correct in principle How much output will increase depends on how large the substitution effect is If most people work a how large the substitution effect is If most people work a standard 40-hour week the effect could be quite small and the standard 40-hour week the effect could be quite small and the increase in output might also be very small in practiceincrease in output might also be very small in practice

Issue 1 The Effect of a Cut in Marginal Tax RatesIssue 1 The Effect of a Cut in Marginal Tax Rates

Issue 2 Technological Progress and Worker WelfareIssue 2 Technological Progress and Worker Welfare

bull Is technological progress and increasing use of machinery and Is technological progress and increasing use of machinery and other capital beneficial for workersother capital beneficial for workers

bull Technological change or capital accumulation have been Technological change or capital accumulation have been known as ldquoLudditesrdquo (known as ldquoLudditesrdquo (it negatively affects the demand for it negatively affects the demand for laborlabor) To see why the Luddites are wrong ndash at least for ) To see why the Luddites are wrong ndash at least for clearing labor markets ndash recall that technological progress or clearing labor markets ndash recall that technological progress or increased capital both increased capital both shift the labor-demand curve upwardshift the labor-demand curve upward The lower panel of the following figure shows that the effect of The lower panel of the following figure shows that the effect of the increased demand for labor is to increase total employment the increased demand for labor is to increase total employment and the real wage Firms and the real wage Firms can pay a higher real wage can pay a higher real wage because because the additional capital or technological progress the additional capital or technological progress increases the increases the marginal product of labormarginal product of labor

bull The The Ludditesrsquo mistake Ludditesrsquo mistake is most easily seen in the upper panel is most easily seen in the upper panel The Luddite argument assumes that fewer workers will The Luddite argument assumes that fewer workers will produce the same total output Production starts at Arsquo using produce the same total output Production starts at Arsquo using L1 L1 workers to produce Y1 After the upward shift in the production workers to produce Y1 After the upward shift in the production function the same output could be produced using less labor function the same output could be produced using less labor ((L3) at point Arsquorsquo The L3) at point Arsquorsquo The problem is that Arsquorsquo is not an equilibrium problem is that Arsquorsquo is not an equilibrium At that point the marginal product of labor is higher than the At that point the marginal product of labor is higher than the original real wage so a profit-maximizing firm would want to original real wage so a profit-maximizing firm would want to expand production To do this they must hire more labor than expand production To do this they must hire more labor than L3 and indeed they L3 and indeed they find it find it profitable profitable to hire more labor than to hire more labor than the original the original L1 The only way actually to increase labor L1 The only way actually to increase labor is to is to raise the real-wage raise the real-wage rate above its original level Technological rate above its original level Technological progress therefore favors progress therefore favors workers by increasing employment workers by increasing employment and wagesand wages

bull Early in the 19th century hand-woven cloth was very Early in the 19th century hand-woven cloth was very expensive and a worker was lucky to own the clothes on his expensive and a worker was lucky to own the clothes on his back and a spare set for church on Sunday Textiles were one of back and a spare set for church on Sunday Textiles were one of the first industries to benefit from the Industrial Revolution so the first industries to benefit from the Industrial Revolution so that by the end of the 19th century machine-made fabrics and that by the end of the 19th century machine-made fabrics and mass-production made decent clothing in larger quantities mass-production made decent clothing in larger quantities accessible to most of the population of the more developed accessible to most of the population of the more developed countries Similar progress has been made in most forms of countries Similar progress has been made in most forms of production Agricultural production which at the turn of the production Agricultural production which at the turn of the 20th century absorbed half the labor force now absorbs less 20th century absorbed half the labor force now absorbs less than 3 percent while producing more food more cheaply than than 3 percent while producing more food more cheaply than ever ever

bull We must be careful not to dismiss the Luddites as altogether We must be careful not to dismiss the Luddites as altogether foolish While new technology especially over decades has foolish While new technology especially over decades has proved to be a net gain for workers in general the Luddites proved to be a net gain for workers in general the Luddites were in fact correct that their way of life was threatened were in fact correct that their way of life was threatened Independent weavers became factory hands unskilled Independent weavers became factory hands unskilled workers increasingly women and often children replaced workers increasingly women and often children replaced skilled craftsmen and factory work often involved long hours skilled craftsmen and factory work often involved long hours in brutal conditions The wider society reaps the benefits of in brutal conditions The wider society reaps the benefits of technological change while a narrow group sometimes technological change while a narrow group sometimes disproportionately bears its costs Our analysis also assumes disproportionately bears its costs Our analysis also assumes that markets generally clear The implicit assumption is that that markets generally clear The implicit assumption is that displaced workers move on to new jobs possibly in other forms displaced workers move on to new jobs possibly in other forms of production Markets may have a tendency to clear in the of production Markets may have a tendency to clear in the long run yet workers may find themselves displaced in the long run yet workers may find themselves displaced in the short run say over the course of a business cycleshort run say over the course of a business cycle

Issue 3 Immigration Jobs and Real WagesIssue 3 Immigration Jobs and Real Wages

bull How does an increase in the labor force through immigration or How does an increase in the labor force through immigration or natural population growth affect labor and GDP natural population growth affect labor and GDP

bull One of the emotional issues associated with US immigration One of the emotional issues associated with US immigration policy ndash particularly towards low-wage workers from Mexico ndash policy ndash particularly towards low-wage workers from Mexico ndash is the idea that is the idea that immigrants take jobs away from native immigrants take jobs away from native workers workers We might be tempted to dismiss this fear as another We might be tempted to dismiss this fear as another example of the lump-of-labor fallacy Yet there is a sensible example of the lump-of-labor fallacy Yet there is a sensible intuition behind the argument An increase in the labor force ndash intuition behind the argument An increase in the labor force ndash due either to immigration or to higher population growth rates due either to immigration or to higher population growth rates ndash can be represented as an outward shift of the aggregate labor ndash can be represented as an outward shift of the aggregate labor supply curve as shown in the following Figure Employment supply curve as shown in the following Figure Employment increases but real wages fall It is not then that immigrants increases but real wages fall It is not then that immigrants take jobs away from natives take jobs away from natives Rather they compete for jobsRather they compete for jobs putting downward pressure on real wagesputting downward pressure on real wages

bull Again we must exercise care in interpreting the analysis Again we must exercise care in interpreting the analysis Remember that aggregate labor and average wage rates hide Remember that aggregate labor and average wage rates hide many details of the labor process The incomes of the new many details of the labor process The incomes of the new immigrants immigrants creates demand creates demand for the new production that they for the new production that they make possible Immigrant workers (at least those ndash whether make possible Immigrant workers (at least those ndash whether legal or illegal ndash who have become the focus of the most intense legal or illegal ndash who have become the focus of the most intense political debate) political debate) are likely to possess fewer skills than nativesare likely to possess fewer skills than natives The net effect is that the increased demand for goods and The net effect is that the increased demand for goods and services generated by immigrants is likely to increase the services generated by immigrants is likely to increase the demand for skilled (demand for skilled (and largely nativeand largely native) workers relative to ) workers relative to their supply and so to increase real wages of skilled workers their supply and so to increase real wages of skilled workers Low-skilled immigration may lower the real wage for farm Low-skilled immigration may lower the real wage for farm workers but if anything it would raise the real wage for workers but if anything it would raise the real wage for computer programmerscomputer programmers

Next Task Labor Market in Kuwait

Appendix Is Labor Supply Stable Over Time

bull Statistics on participation rates or average hours for a Statistics on participation rates or average hours for a particular month or year are snapshot of the labor market particular month or year are snapshot of the labor market Can we analyze the effects of that increase on the labor market Can we analyze the effects of that increase on the labor market under the assumption that the labor-supply curves of workers under the assumption that the labor-supply curves of workers remain essentially stableremain essentially stable

bull Data on participation rates in the United States appear to Data on participation rates in the United States appear to support this conjecture (see Figure 811) which shows the support this conjecture (see Figure 811) which shows the overall civilian participation rate trending upward ndash at least overall civilian participation rate trending upward ndash at least from the middle of the 1960sfrom the middle of the 1960s

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

Labor Demand

bull THE FIRMrsquoS DEMAND FOR LABORTHE FIRMrsquoS DEMAND FOR LABOR

bull Deriving the Firmrsquos Labor-Demand CurveDeriving the Firmrsquos Labor-Demand Curve

bull The labor-demand curve shows The labor-demand curve shows the amount of labor a firm the amount of labor a firm would optimally choose to hire ceteris paribus at each real-wage would optimally choose to hire ceteris paribus at each real-wage raterate

bull Recall the rule for profit maximization Recall the rule for profit maximization a firm hires labor until a firm hires labor until the marginal product of labor is equal to the real wage (mpl = the marginal product of labor is equal to the real wage (mpl = wp)wp) Because of diminishing returns the relationship between Because of diminishing returns the relationship between real-wage rates real-wage rates and the and the marginal product of labor marginal product of labor is inverse a is inverse a firm can profitably firm can profitably hire more labor only if real wage falls hire more labor only if real wage falls enough to enough to match the fall in the marginal productmatch the fall in the marginal product

bull We apply the profit maximization rule to the production We apply the profit maximization rule to the production function to derive a labor-demand curve (see the following function to derive a labor-demand curve (see the following Figure)Figure)

bull Imagine that the firm faces a real wage of (wp)1 The optimal Imagine that the firm faces a real wage of (wp)1 The optimal point is found where the point is found where the MP=(wp)1MP=(wp)1 This point corresponds to This point corresponds to a particular level of labor l1 The combination a particular level of labor l1 The combination (l1 (wp)1)(l1 (wp)1) forms point forms point Arsquo Arsquo which is one point on the labor-demand curve which is one point on the labor-demand curve If the firm paid its workers anything more than If the firm paid its workers anything more than (wp)1 (wp)1 to to produce at produce at A A it would reduce its profitsit would reduce its profits

bull If the firm do if it faced a lower wage say If the firm do if it faced a lower wage say (wp)2(wp)2 the new the new optimal production point will be at optimal production point will be at BB At B the firm demands At B the firm demands l2l2

bull The combination The combination (l2 (wp)2) (l2 (wp)2) shown as point shown as point Brsquo Brsquo in the lower in the lower panel is another point on the firmrsquos labor-demand curve The panel is another point on the firmrsquos labor-demand curve The labor-demand curve connects labor-demand curve connects Arsquo Brsquo Arsquo Brsquo and every other profit-and every other profit-maximizing point It is downward sloping because of maximizing point It is downward sloping because of diminishing returns to labordiminishing returns to labor

bull Factors that Shift the Labor-demand curveFactors that Shift the Labor-demand curve

bull The labor-demand curve is not independent of theThe labor-demand curve is not independent of the production production functionfunction As a result anything that shifts the production As a result anything that shifts the production function will in general function will in general shift the labor-demand curveshift the labor-demand curve and the and the labor-demand curve cannot shift unless the production labor-demand curve cannot shift unless the production function also shifts function also shifts Technological progress or an increase in Technological progress or an increase in the capital stock shifts the capital stock shifts the production function upward the production function upward

bull Consider an Consider an increase in the capital stockincrease in the capital stock how does it shift the how does it shift the labor-demand curvelabor-demand curve

bull An increase in capital raises An increase in capital raises MPLMPL at every level of labor at every level of labor demand the higher MP means that the profit-maximizing firm demand the higher MP means that the profit-maximizing firm can afford can afford higher real wage higher real wage at each level of labor The labor-at each level of labor The labor-demand curve shifts vertically upwarddemand curve shifts vertically upward

bull But why would the firm pay workers more for a particular But why would the firm pay workers more for a particular level of labor level of labor when additional capital raises when additional capital raises their marginal their marginal products Why does the firm not just pocket the windfall The products Why does the firm not just pocket the windfall The answer answer competitioncompetition When the marginal product rises each When the marginal product rises each firm tries to hire firm tries to hire more workersmore workers Since we have assumed that Since we have assumed that markets are all in equilibrium all available workers are markets are all in equilibrium all available workers are already employed and it is only by paying higher wages that already employed and it is only by paying higher wages that the firm can attract them the firm can attract them

THE AGGREGATE DEMAND FOR LABOR

bull In macroeconomic analysis we are more concerned with the In macroeconomic analysis we are more concerned with the aggregate demand for laboraggregate demand for labor If all firms produced the If all firms produced the samesame products and if all workers were products and if all workers were alikealike then aggregation from then aggregation from the firm to the economy as a whole would be easy (see the the firm to the economy as a whole would be easy (see the figure) Unfortunately it is not that simplefigure) Unfortunately it is not that simple

bull The first problem is that all firms are The first problem is that all firms are not producing the same not producing the same productproduct When different firms produce different goods we When different firms produce different goods we must find a common unit of measurement must find a common unit of measurement

bull The second problem is that The second problem is that not all workers are alikenot all workers are alike Different Different kinds of workers may face kinds of workers may face different wage rates different wage rates and therefore and therefore have have different marginal products different marginal products at the optimum For our at the optimum For our purposes the wage structure can be summarized in the purposes the wage structure can be summarized in the average average wage ratewage rate Though It provides an imperfect index of the Though It provides an imperfect index of the movements of the wage structure movements of the wage structure

Labor Supply

bull Two measures reflect two aspects of the workerrsquos labor supply Two measures reflect two aspects of the workerrsquos labor supply decision (i) decision (i) participationparticipation ndash that is whether to work or not ndash that is whether to work or not work and (ii) work and (ii) intensityintensity ndash that is how many hours to work It is ndash that is how many hours to work It is easier if we consider intensity first conditional on having easier if we consider intensity first conditional on having decided to work what factors govern the workerrsquos choice of decided to work what factors govern the workerrsquos choice of how many hours of work to supplyhow many hours of work to supply

bull THE WORKER CHOOSING HOURS OF WORKTHE WORKER CHOOSING HOURS OF WORK

bull The Price of LeisureThe Price of Leisure

bull People work for a variety of reasons The most obvious is to People work for a variety of reasons The most obvious is to earn the incomeearn the income Many people ndash though not all ndash find their Many people ndash though not all ndash find their work work fulfilling and interestingfulfilling and interesting Still even those people will Still even those people will generally prefer another generally prefer another hour of leisure hour of leisure to another hour of to another hour of work It is therefore reasonable to assume that work It is therefore reasonable to assume that leisure is a leisure is a goodgood

bull Goods generally have a price Yet there is Goods generally have a price Yet there is nono market for market for leisureleisure Even though there is no explicit price there is an Even though there is no explicit price there is an implicit price or opportunity cost The implicit price or opportunity cost The OPPORTUNITY COST OPPORTUNITY COST of any choice is the value of the best alternative choice that it of any choice is the value of the best alternative choice that it foreclosesforecloses The implicit price of leisure is its opportunity cost The implicit price of leisure is its opportunity cost which is measured by the real wage (which is measured by the real wage (wp) wp)

bull The Labor-Leisure ChoiceThe Labor-Leisure Choice

bull Once we see leisure as a good and the real-wage rate as its Once we see leisure as a good and the real-wage rate as its price it is easier to understand the choices a worker faces price it is easier to understand the choices a worker faces There are 168 hours in a week If a worker chooses There are 168 hours in a week If a worker chooses not to work not to work at allat all he enjoys 168 hours of leisure but forgoes the income he enjoys 168 hours of leisure but forgoes the income needed to buy any other goods If the worker instead takes needed to buy any other goods If the worker instead takes fewer hours of leisure he supplies labor fewer hours of leisure he supplies labor l = 168 ndash hours of l = 168 ndash hours of leisure leisure and he gains the ability to purchase goods worth wp times l and he gains the ability to purchase goods worth wp times l The problem The problem for the worker for the worker is to choose is to choose the hours of labor (the hours of labor (l ) l ) that at the margin makes the psychic value of a small loss that at the margin makes the psychic value of a small loss further loss of leisure time (ie a small increase in labor time) further loss of leisure time (ie a small increase in labor time) exactly equal to the psychic value of the small gain in exactly equal to the psychic value of the small gain in consumption goods that would be purchased by that laborconsumption goods that would be purchased by that labor

bull INCOME EFFECT How would your supply of labor change if you could receive the income that results from the increased wage rate without facing a changed opportunity cost of leisure

bull As a general rule an increase in income ceteris paribus increases the demand for all goods The extra $20 per week would permit you to buy more goods including leisure without reducing your purchases of other goods The reduction in the supply of labor as the result of an increase in income is called the income effect

bull SUBSTITUTION EFFECTSUBSTITUTION EFFECT

bull If the wage rate rose If the wage rate rose would people work more or less As a would people work more or less As a general rule whenever general rule whenever ceteris paribus the price of anything rises ceteris paribus the price of anything rises relative to alternativesrelative to alternatives the demand for it decreases Here the the demand for it decreases Here the price of leisure price of leisure (its opportunity cost) has risen relative to the (its opportunity cost) has risen relative to the price of other goods the supply of price of other goods the supply of labor would riselabor would rise The change The change in the wage rate encourages people to substitute the now in the wage rate encourages people to substitute the now cheaper goods (what you buy using your wage) for the now cheaper goods (what you buy using your wage) for the now more expensive leisure more expensive leisure The increase in the supply of labor as The increase in the supply of labor as the result of an increase in the price (or opportunity cost) of the result of an increase in the price (or opportunity cost) of leisure is called theleisure is called the SUBSTITUTION EFFECT SUBSTITUTION EFFECT

bull The Labor-supply CurveThe Labor-supply Curve

bull The following figure represents the workerrsquos labor-supply The following figure represents the workerrsquos labor-supply decision Look first at panel (A) Suppose that at point A decision Look first at panel (A) Suppose that at point A where the real wage is (where the real wage is (wp)1 the worker decides that providing l wp)1 the worker decides that providing l hours of work balances the advantages of a little more hours of work balances the advantages of a little more consumption against a little more leisure at the margin Now consumption against a little more leisure at the margin Now consider what happens when the real wage rises to (consider what happens when the real wage rises to (wp)2 wp)2 There is a substitution effect shown by the arrow pointing to There is a substitution effect shown by the arrow pointing to the right which encourages the worker to supply more labor the right which encourages the worker to supply more labor The size of the substitution effect is measured by the length of The size of the substitution effect is measured by the length of the arrowthe arrow

bull There is also an income effect shown by the arrow pointing to There is also an income effect shown by the arrow pointing to the left which encourages the worker to supply less laborthe left which encourages the worker to supply less labor

The Slope of the Labor-Supply Curve

bull The net effect The net effect is measured by the difference between the is measured by the difference between the substitution and income effects shown at point B so that an substitution and income effects shown at point B so that an increase in the wage rate increases the workerrsquos supply of labor increase in the wage rate increases the workerrsquos supply of labor to to l2 to the right of l1 If the substitution effect is always stronger l2 to the right of l1 If the substitution effect is always stronger then the labor supply then the labor supply curve slopes upward curve slopes upward

bull Substitution effects are not necessarily stronger than income Substitution effects are not necessarily stronger than income effectseffects Panel (B) shows the construction of the labor-supply Panel (B) shows the construction of the labor-supply curve starting from point C when income effects are stronger curve starting from point C when income effects are stronger than substitution effects When the real-wage rate increases than substitution effects When the real-wage rate increases from (from (wp)1 to (wp)2 the dominant income effect overwhelms wp)1 to (wp)2 the dominant income effect overwhelms the substitution effect and labor the substitution effect and labor supply (point C) falls from supply (point C) falls from l1 to l1 to l2 If income effects are stronger for all wage rates above l2 If income effects are stronger for all wage rates above ((wp)1 wp)1 then the labor-supply curve will slope downward toward point C then the labor-supply curve will slope downward toward point C higher real wage higher real wage rates lower labor supplyrates lower labor supply

bull Although the labor-supply curve can slope downward towards Although the labor-supply curve can slope downward towards a point like A it is not reasonable to believe that it could slope a point like A it is not reasonable to believe that it could slope downward for every possible wage rate At very low wage rates downward for every possible wage rate At very low wage rates it is more reasonable to suppose that with very low incomes it is more reasonable to suppose that with very low incomes the workerrsquos need for food clothing shelter and other the workerrsquos need for food clothing shelter and other ldquoessentialrdquo goods the income effect is weak and the ldquoessentialrdquo goods the income effect is weak and the substitution effect is strong We should therefore expect the substitution effect is strong We should therefore expect the labor-supply curve to be upward sloping when wage rates are labor-supply curve to be upward sloping when wage rates are low Hence labor supply would be backward bending low Hence labor supply would be backward bending

Backward-bending Labor-supply Curve

Adding Realism TaxesAdding Realism Taxes

bull How does the tax affect the income from a little more or a little How does the tax affect the income from a little more or a little less work To answer this question we must know the less work To answer this question we must know the marginal marginal tax ratetax rate ((the fraction of an additional dollar of income that is the fraction of an additional dollar of income that is paid as taxes) paid as taxes) To keep things simple assume that all income is To keep things simple assume that all income is taxed at the same taxed at the same flatflat rate rate ττ In this case the marginal tax rate In this case the marginal tax rate must also be τ which takes a value between zero and one If a must also be τ which takes a value between zero and one If a worker earns worker earns wpwp for an hour of work the government takes for an hour of work the government takes τ(wp) τ(wp) as taxes and leaves the worker as taxes and leaves the worker (1ndashτ)(wp) (1ndashτ)(wp) as the after-as the after-tax real wagetax real wage

bull Since the worker actually receives the Since the worker actually receives the after-tax real wageafter-tax real wage it is it is the the true opportunity cost of leisure true opportunity cost of leisure Any increase in the Any increase in the marginal tax rate represents a decrease in the opportunity cost marginal tax rate represents a decrease in the opportunity cost of leisure If of leisure If substitution effectssubstitution effects are stronger than income are stronger than income effects then any increase in marginal tax rates effects then any increase in marginal tax rates reducesreduces the the supply of labor supply of labor as shown in the following figureas shown in the following figure

The Effect of a Tax Increase on Labor Supply

bull The labor-supply curve with no taxes is shown on the right of The labor-supply curve with no taxes is shown on the right of the figure At the figure At (wp)1(wp)1 the worker supplies labor the worker supplies labor l1l1 If a tax of If a tax of τ1τ1 is imposed the after-tax real wage is is imposed the after-tax real wage is (1ndashτ1)(wp)1(1ndashτ1)(wp)1 The worker The worker should react exactly as if he paid no taxes but suffered a cut in should react exactly as if he paid no taxes but suffered a cut in his wages This is shown as a movement from point A to point B his wages This is shown as a movement from point A to point B where labor supply has fallen to where labor supply has fallen to l2l2 But of course the wage rate But of course the wage rate did not really falldid not really fall the employer still pays (wp)1 This means the employer still pays (wp)1 This means that (l2 (wp)1) is the labor-supply (point C)that (l2 (wp)1) is the labor-supply (point C)

bull Since this would apply for any real-wage rate every point on Since this would apply for any real-wage rate every point on the original curve shifts to the left Because the the original curve shifts to the left Because the tax rate is tax rate is proportional its absolute effect is greaterproportional its absolute effect is greater as is the shift in the as is the shift in the labor-supply curve at high wage rates resulting in a labor-supply curve at high wage rates resulting in a steepening of the curve Any further increase in the tax rate to steepening of the curve Any further increase in the tax rate to say τ2 would shift the labor-supply curve further to the left say τ2 would shift the labor-supply curve further to the left

bull The length of the line segment BC measures the The length of the line segment BC measures the TAX WEDGETAX WEDGE between the real wage paid by employers and the after-tax real between the real wage paid by employers and the after-tax real wage received by workewage received by workersrs The The largerlarger the tax wedge the the tax wedge the largerlarger the leftward shift of the labor-supply curve and the the leftward shift of the labor-supply curve and the greater the greater the reductionreduction in labor supplied at any real wage in labor supplied at any real wage

bull The idea that tax increases lower labor supply and conversely The idea that tax increases lower labor supply and conversely that tax cuts increase labor supply was a major tenet of the so-that tax cuts increase labor supply was a major tenet of the so-called called supply-side economicssupply-side economics popular in the early 1980s popular in the early 1980s President Ronald Reagan and his advisors used it to argue that President Ronald Reagan and his advisors used it to argue that cuts in marginal tax rates cuts in marginal tax rates would stimulate people would stimulate people to to workwork harder and to harder and to earn larger earn larger incomesincomes

Adding Realism A Standard WorkweekAdding Realism A Standard Workweek

bull Another way in which the simple analysis of labor supply is Another way in which the simple analysis of labor supply is unrealistic is that many unrealistic is that many workers are not given an option about workers are not given an option about the number of hours they workthe number of hours they work Although people work part- Although people work part-time and overtime either may be voluntary or mandatory time and overtime either may be voluntary or mandatory

bull Assuming that workers are Assuming that workers are not permitted to work more than not permitted to work more than 40 hours a week40 hours a week the following figure includes a constraint of the following figure includes a constraint of 40 hours If the worker were permitted to choose freely then 40 hours If the worker were permitted to choose freely then the labor-supply curve would backward bending curve The the labor-supply curve would backward bending curve The overall effect is to of the standard work week is to reshape the overall effect is to of the standard work week is to reshape the labor-supply curve as indicated by the heavy curve with the labor-supply curve as indicated by the heavy curve with the vertical segment that runs through points A F G D and E vertical segment that runs through points A F G D and E Any worker on this vertical segment is constrainedAny worker on this vertical segment is constrained

The Individual Labor-Supply Curve in PracticeThe Individual Labor-Supply Curve in Practice

bull What does the individual labor-supply curve look like in What does the individual labor-supply curve look like in realityreality It is difficult to answer this question because in reality It is difficult to answer this question because in reality we can observe we can observe only one pointonly one point on the labor-supply curve for a on the labor-supply curve for a single worker single worker at a particular timeat a particular time All the other points are All the other points are conjecturesconjectures about what the worker would supply if faced with about what the worker would supply if faced with different wage rates If we imagine that on average workers are different wage rates If we imagine that on average workers are substantially substantially similarsimilar we might nonetheless get some idea of we might nonetheless get some idea of what the individual labor-supply curve might look likewhat the individual labor-supply curve might look like

bull The The National Longitudinal SurveyNational Longitudinal Survey (Youth) has catalogued the (Youth) has catalogued the work histories of a large sample of individuals starting at a work histories of a large sample of individuals starting at a young age The following figure plots the real-wage rates and young age The following figure plots the real-wage rates and average weekly hours of labor for about average weekly hours of labor for about 1000010000 male workers male workers from this survey for a from this survey for a single periodsingle period with the best fitting flexible with the best fitting flexible line through these points serves as our empirical estimate of the line through these points serves as our empirical estimate of the labor-supply curve for these workerslabor-supply curve for these workers

bull The regression line traces out a shape very The regression line traces out a shape very like the backward-like the backward-bendingbending labor-supply curve with a 40-hour constraint What labor-supply curve with a 40-hour constraint What looks like a vertical line above 40 hours is looks like a vertical line above 40 hours is not really a solid line not really a solid line at all but a reflection of the fact that about at all but a reflection of the fact that about 7500 7500 of the 10000 of the 10000 workers in the sample supply 40 hours per week at a variety of workers in the sample supply 40 hours per week at a variety of wage rates The labor-supply curve traces out a segment above wage rates The labor-supply curve traces out a segment above the 40-hour point that corresponds to the constraintthe 40-hour point that corresponds to the constraint

bull There are There are points to the rightpoints to the right of 40 hours This is reasonable of 40 hours This is reasonable since in the real world workers do since in the real world workers do work overtimework overtime ndash either ndash either because they are supervisors or professionals or because because they are supervisors or professionals or because employers offer them the required time-and-half wage rate employers offer them the required time-and-half wage rate The fit of the regression line is far from perfect points lie on The fit of the regression line is far from perfect points lie on both sides of the line We should interpret it as a both sides of the line We should interpret it as a snapshotsnapshot of of the behavior of the typical worker But ofthe behavior of the typical worker But of course the typical course the typical worker is not any actual worker in particularworker is not any actual worker in particular

THE WORKER CHOOSING TO PARTICIPATETHE WORKER CHOOSING TO PARTICIPATE

bull So far we have examined only one aspect of the workerrsquos So far we have examined only one aspect of the workerrsquos labor-supply decision labor-supply decision how many hours to work for given real how many hours to work for given real wagewage We now take up the second aspect We now take up the second aspect participationparticipation ndash that ndash that is is whether or not to work at allwhether or not to work at all A labor-supply curve that starts A labor-supply curve that starts at the origin and slopes upwards for at least a portion of its at the origin and slopes upwards for at least a portion of its length suggests that even length suggests that even if the wage were very lowif the wage were very low ndash say 1cent ndash say 1cent per hour ndash the worker would work a little bit That is clearly per hour ndash the worker would work a little bit That is clearly unrealisticunrealistic no one would work at all for 1cent per hour no one would work at all for 1cent per hour What What factors determine how high the wage factors determine how high the wage must be to induce a person must be to induce a person to participate in the labor marketto participate in the labor market

bull The labor force The labor force participationparticipation decision is a question of decision is a question of opportunity costopportunity cost Idleness has its charms Before anyone enters Idleness has its charms Before anyone enters the labor force the wage rate must be high enough to overcome the labor force the wage rate must be high enough to overcome them them The opportunity cost of participatingThe opportunity cost of participating in the labor force is in the labor force is sum of sum of

1048766 1048766 the implicit valuethe implicit value the worker places on complete idleness the worker places on complete idleness

1048766 1048766 the explicit coststhe explicit costs of working compared to not working such as of working compared to not working such as clothing transport childcare) andclothing transport childcare) and

1048766 1048766 the explicit losses the explicit losses from working (for instance housework not from working (for instance housework not done)done)

bull The opportunity cost is partly psychological and partly material The opportunity cost is partly psychological and partly material If people were completely If people were completely independentindependent of each other the worker of each other the worker might place a lower value on the opportunity cost of might place a lower value on the opportunity cost of participation because then the choice might be literally between participation because then the choice might be literally between work and starvationwork and starvation

bull But most people are not But most people are not completely independentcompletely independent Whether or Whether or not to participate in the labor force could be a not to participate in the labor force could be a genuine choicegenuine choice and would depend on the and would depend on the real wagereal wage

bull The The RESERVATION WAGE RESERVATION WAGE is defined to be is defined to be the opportunity the opportunity cost of working compared to not workingcost of working compared to not working ndash ndash that is the real wage that is the real wage that is high enough to make it just worthwhile for a worker to that is high enough to make it just worthwhile for a worker to participate in the labor forceparticipate in the labor force

bull Taking account of the opportunity costs of participation affects Taking account of the opportunity costs of participation affects the shape of the labor-supply curve As long as the the shape of the labor-supply curve As long as the real wage is real wage is below the reservationbelow the reservation wage ((wp)R) the worker supplies no wage ((wp)R) the worker supplies no labor at all Above the reservation wage there is a normal labor at all Above the reservation wage there is a normal labor-supply curvelabor-supply curve

bull The following captures the two stages of the labor supply The following captures the two stages of the labor supply decision decision FirstFirst at low wages the worker will at low wages the worker will notnot supply any supply any labor at all and small increases in wages have no effect But labor at all and small increases in wages have no effect But secondsecond as soon as the wage rises enough for the worker to bite as soon as the wage rises enough for the worker to bite the bullet and join the labor force the minimum labor supplied the bullet and join the labor force the minimum labor supplied will be well will be well above zeroabove zero and the worker will decide how many and the worker will decide how many hours to supply above this minimum through the usual process hours to supply above this minimum through the usual process of balancing the opportunity cost of leisure against the desire of balancing the opportunity cost of leisure against the desire for consumption goodsfor consumption goods

AGGREGATE LABOR SUPPLY

bull How can we moveHow can we move from the microeconomics of the labor supply from the microeconomics of the labor supply back to an aggregate relationship usable in macroeconomic back to an aggregate relationship usable in macroeconomic analysis analysis If workers were essentially alikeIf workers were essentially alike the problem would the problem would be easy be easy

bull As we have seen labor supply has two dimensions ndash As we have seen labor supply has two dimensions ndash participationparticipation in the labor force and in the labor force and choice of hourschoice of hours of labor of labor Take the participation decision first If all workers were alike Take the participation decision first If all workers were alike except for except for differences in their reservation wagedifferences in their reservation wage then we could then we could rank them from lowest to highest reservation wage The rank them from lowest to highest reservation wage The aggregate labor-supply (participation) curve is strictly aggregate labor-supply (participation) curve is strictly upwardslopingupwardsloping

bull Of course this is too easy Just as we observed in deriving the Of course this is too easy Just as we observed in deriving the aggregate labor demand curve workers are aggregate labor demand curve workers are not all alikenot all alike Once Once again we must interpret the vertical axis as measuring the again we must interpret the vertical axis as measuring the average real wageaverage real wage that at best provides a kind of index for the that at best provides a kind of index for the level of the wage structure level of the wage structure

bull The The problemproblem remains the remains the samesame when we turn to the choice of when we turn to the choice of hourshours Workers are all different and face a structure of wages Workers are all different and face a structure of wages For each worker individually there is a jump from supplying For each worker individually there is a jump from supplying zero to supplying some positive number of hours zero to supplying some positive number of hours when his own when his own wage rate surpasses their wage rate surpasses their reservation wagereservation wage But in aggregate But in aggregate we are we are unlikely to see such a jumpunlikely to see such a jump Not only are there a variety Not only are there a variety of wages offered at any time but reservation wages differof wages offered at any time but reservation wages differ

Derivation of the Aggregate Labor-supply Curve

bull A curve like the one in this figure can be used to display either A curve like the one in this figure can be used to display either the the participation participation decision or decision or the hoursthe hours The horizontal axis can The horizontal axis can either be used for workers either be used for workers or worker-hoursor worker-hours as measures of the as measures of the labor supply The two meanings are not completely labor supply The two meanings are not completely independent by definition independent by definition

bull workers equiv aggregate worker ndash hours average hours per worker workers equiv aggregate worker ndash hours average hours per worker

The Participation Rate and Average Hours

bull Let us look first at the aggregate participation decision The Let us look first at the aggregate participation decision The aggregate number of workers who have decided to participate aggregate number of workers who have decided to participate is known as the is known as the labor forcelabor force the the civilian labor force over 16 civilian labor force over 16 years of ageyears of age This number excludes uniformed members of the This number excludes uniformed members of the armed services and the small number of workers under 16 armed services and the small number of workers under 16 years old The labor force of course has grown right along years old The labor force of course has grown right along with population with population

bull The participation rateThe participation rate (PR) measures (PR) measures the labor force as its ratio the labor force as its ratio to the relevant populationto the relevant population

bull participation rate = labor forcerelevant population participation rate = labor forcerelevant population

bull ldquoldquonon-institutionalrdquo non-institutionalrdquo excludes people in prison or in homes for excludes people in prison or in homes for the aged) the aged)

bull The aggregate number of hours The aggregate number of hours worked is worked is not as easy not as easy as the as the participation rate to relate to the individual workerrsquos choices participation rate to relate to the individual workerrsquos choices If every worker had the same labor-supply curve we would If every worker had the same labor-supply curve we would have to know the wage offered to each one in order to calculate have to know the wage offered to each one in order to calculate the total number of labor hours supplied In reality workers the total number of labor hours supplied In reality workers are not all alike are not all alike Labor-supply curves may vary systematically Labor-supply curves may vary systematically according to the sex age ethnic group education experience according to the sex age ethnic group education experience or other social or economic characteristics of the workersor other social or economic characteristics of the workers And And within any group the labor-supply curves of individuals are within any group the labor-supply curves of individuals are likely to varylikely to vary

bull In principle In principle if we had a good statistical estimate of the typical if we had a good statistical estimate of the typical distribution of the wagesdistribution of the wages we could make a reasonable we could make a reasonable calculation But statisticians at the Bureau of Labor Statistics calculation But statisticians at the Bureau of Labor Statistics (BLS) do not try to calculate the labor supply in this way (BLS) do not try to calculate the labor supply in this way Instead they Instead they count the number of hours that workers actually count the number of hours that workers actually workwork and the average and the average wages and salaries they are paid wages and salaries they are paid

bull In USA the total hours of labor in 1998 was In USA the total hours of labor in 1998 was 236882236882 million million The average hours of work is The average hours of work is 17211721 hours per year = hours per year = 344344 hours hours per week (assuming a 50 week year) This number is 14 percent per week (assuming a 50 week year) This number is 14 percent below the full time 40-hour week which makes sense since it below the full time 40-hour week which makes sense since it averages over full-time part-time and overtime workers averages over full-time part-time and overtime workers

Labor Market EquilibriumLabor Market Equilibrium

bull MARKET CLEARINGMARKET CLEARING

bull When both demand and supply curves are plotted on the same When both demand and supply curves are plotted on the same diagram the crossing point defines the diagram the crossing point defines the equilibrium real-wage equilibrium real-wage rate and the rate and the equilibrium level of labor employedequilibrium level of labor employed

bull The real wage The real wage looks different looks different from the point of view of the firm from the point of view of the firm and the worker For the and the worker For the firmfirm the relevant real wage is the the relevant real wage is the product-real wage product-real wage defined as defined as the number of units of the good the number of units of the good the firm produces that the wage will purchase the firm produces that the wage will purchase ((price of price of productproduct = = w) w) For the For the workerworker the relevant real wage is the the relevant real wage is the consumption-consumption-real real wagewage defined as defined as the number of typical consumption baskets the number of typical consumption baskets that the wage will purchase that the wage will purchase ((price of price of consumption basket consumption basket = = w)w)

bull For aggregate analysis we might use the For aggregate analysis we might use the Producer Price IndexProducer Price Index or the GDP deflator to approximate the or the GDP deflator to approximate the product priceproduct price and the and the CPICPI to approximate the to approximate the consumption price consumption price

bull Suppose that the product-real wage and the consumption-real Suppose that the product-real wage and the consumption-real wage in the following figure start out with the identical value wage in the following figure start out with the identical value ((wp) at the market-clearing point Awp) at the market-clearing point A Now suppose that Now suppose that imported Japanese cars are a large portion of the typical imported Japanese cars are a large portion of the typical workerrsquos consumption basket workerrsquos consumption basket and that and that ceteris paribus ceteris paribus the price the price of Japanese cars rises sharply This means that the of Japanese cars rises sharply This means that the real wage real wage from the point of view of the from the point of view of the consumer falls to (consumer falls to (wpwpCPICPI ) )11 at point at point

B B on the labor-supply curve (LS) so that the worker would on the labor-supply curve (LS) so that the worker would want to supply less labor (want to supply less labor (LL11))

bull The rise in the price of Japanese cars has no effect on the price The rise in the price of Japanese cars has no effect on the price of their products Nevertheless they see a reduction of labor of their products Nevertheless they see a reduction of labor supply at the original market clearing wage It is as if the supply at the original market clearing wage It is as if the labor-supply curve labor-supply curve has shifted to the left to has shifted to the left to LSLSrsquo which passes rsquo which passes through ((through ((wp) L1) at point C wp) L1) at point C At the original wage rate labor At the original wage rate labor demand exceeds labor supply so firms raise wages in an effort demand exceeds labor supply so firms raise wages in an effort to attract workers until they reach the new market-clearing to attract workers until they reach the new market-clearing wage at point D where they pay (wage at point D where they pay (wpwpPPIPPI ) for labor of L ) for labor of L The The

rise in the price of Japanese cars has the effect of raising the rise in the price of Japanese cars has the effect of raising the wages that firms must pay and reducing labor employedwages that firms must pay and reducing labor employed Higher wages partly compensate workers for the higher costs Higher wages partly compensate workers for the higher costs of consumption but firms can afford to pay those higher wages of consumption but firms can afford to pay those higher wages only if marginal products rise as a result of their using less only if marginal products rise as a result of their using less labor labor

bull The rise in wage rates is not enough to compensate workers The rise in wage rates is not enough to compensate workers fully so the consumption-real wage in equilibrium is (wpfully so the consumption-real wage in equilibrium is (wpCPI CPI ) )

atat point E We can think of import prices as a tax levied on point E We can think of import prices as a tax levied on consumers and of an increase in import prices as widening the consumers and of an increase in import prices as widening the tax wedge Unless the issue that we want to analyze depends on tax wedge Unless the issue that we want to analyze depends on the difference between product- and consumption-real wages the difference between product- and consumption-real wages we will treat the real wage as the same for both labor supply we will treat the real wage as the same for both labor supply and labor demandand labor demand

An Increase in the Price of Consumption GoodsAn Increase in the Price of Consumption GoodsRelative to the Price of OutputRelative to the Price of Output

ANALYZING IDEAL LABOR MARKETSANALYZING IDEAL LABOR MARKETS

bull The aggregate labor-supplylabor-demand diagram provides us The aggregate labor-supplylabor-demand diagram provides us with a powerful tool We now analyze three important with a powerful tool We now analyze three important macroeconomic issues macroeconomic issues

(1) the effect of tax cuts on employment (1) the effect of tax cuts on employment

(2) the effect of technological progress on the well-being of (2) the effect of technological progress on the well-being of workers and workers and

(3) the effect of immigration on existing workers (3) the effect of immigration on existing workers

bull Issue 1 Tax Cuts Issue 1 Tax Cuts What are the effects of a cut in marginal What are the effects of a cut in marginal income-tax rates on employment and the level of GDP in the income-tax rates on employment and the level of GDP in the economyeconomy Recall from section that a lower marginal income-Recall from section that a lower marginal income-tax rate increases labor supply at each real wage (a rightward tax rate increases labor supply at each real wage (a rightward shift of the labor-supply) shift of the labor-supply)

bull Labor-market equilibrium moves from point A to point B in Labor-market equilibrium moves from point A to point B in the lower panel of the following Notice that the amount of the lower panel of the following Notice that the amount of labor available to firms increases so that firms move labor available to firms increases so that firms move production from Arsquo to Brsquo on the labor production function in production from Arsquo to Brsquo on the labor production function in the upper panel Also notice that the real wage falls from (the upper panel Also notice that the real wage falls from (wp)1 wp)1 to (wp)2 Since the cut in taxes increases the number of to (wp)2 Since the cut in taxes increases the number of workers workers willing to work at each wage Workers care about their take-willing to work at each wage Workers care about their take-home pay ndash that is about their home pay ndash that is about their after-tax real wage after-tax real wage This is This is perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 can be greater than the old after-tax real wage (1ndashcan be greater than the old after-tax real wage (1ndashτ1τ1)(wp)1 so )(wp)1 so long as the rise in the take-home share (1 ndash τ) is long as the rise in the take-home share (1 ndash τ) is proportionately greater than the fall in the before-tax real proportionately greater than the fall in the before-tax real wage (wp)wage (wp)

bull The analysis depends on substitution effects dominating The analysis depends on substitution effects dominating income effects which they probably do in aggregate if not for income effects which they probably do in aggregate if not for every worker So the supply-siders of the Reagan years are every worker So the supply-siders of the Reagan years are correct in principle How much output will increase depends on correct in principle How much output will increase depends on how large the substitution effect is If most people work a how large the substitution effect is If most people work a standard 40-hour week the effect could be quite small and the standard 40-hour week the effect could be quite small and the increase in output might also be very small in practiceincrease in output might also be very small in practice

Issue 1 The Effect of a Cut in Marginal Tax RatesIssue 1 The Effect of a Cut in Marginal Tax Rates

Issue 2 Technological Progress and Worker WelfareIssue 2 Technological Progress and Worker Welfare

bull Is technological progress and increasing use of machinery and Is technological progress and increasing use of machinery and other capital beneficial for workersother capital beneficial for workers

bull Technological change or capital accumulation have been Technological change or capital accumulation have been known as ldquoLudditesrdquo (known as ldquoLudditesrdquo (it negatively affects the demand for it negatively affects the demand for laborlabor) To see why the Luddites are wrong ndash at least for ) To see why the Luddites are wrong ndash at least for clearing labor markets ndash recall that technological progress or clearing labor markets ndash recall that technological progress or increased capital both increased capital both shift the labor-demand curve upwardshift the labor-demand curve upward The lower panel of the following figure shows that the effect of The lower panel of the following figure shows that the effect of the increased demand for labor is to increase total employment the increased demand for labor is to increase total employment and the real wage Firms and the real wage Firms can pay a higher real wage can pay a higher real wage because because the additional capital or technological progress the additional capital or technological progress increases the increases the marginal product of labormarginal product of labor

bull The The Ludditesrsquo mistake Ludditesrsquo mistake is most easily seen in the upper panel is most easily seen in the upper panel The Luddite argument assumes that fewer workers will The Luddite argument assumes that fewer workers will produce the same total output Production starts at Arsquo using produce the same total output Production starts at Arsquo using L1 L1 workers to produce Y1 After the upward shift in the production workers to produce Y1 After the upward shift in the production function the same output could be produced using less labor function the same output could be produced using less labor ((L3) at point Arsquorsquo The L3) at point Arsquorsquo The problem is that Arsquorsquo is not an equilibrium problem is that Arsquorsquo is not an equilibrium At that point the marginal product of labor is higher than the At that point the marginal product of labor is higher than the original real wage so a profit-maximizing firm would want to original real wage so a profit-maximizing firm would want to expand production To do this they must hire more labor than expand production To do this they must hire more labor than L3 and indeed they L3 and indeed they find it find it profitable profitable to hire more labor than to hire more labor than the original the original L1 The only way actually to increase labor L1 The only way actually to increase labor is to is to raise the real-wage raise the real-wage rate above its original level Technological rate above its original level Technological progress therefore favors progress therefore favors workers by increasing employment workers by increasing employment and wagesand wages

bull Early in the 19th century hand-woven cloth was very Early in the 19th century hand-woven cloth was very expensive and a worker was lucky to own the clothes on his expensive and a worker was lucky to own the clothes on his back and a spare set for church on Sunday Textiles were one of back and a spare set for church on Sunday Textiles were one of the first industries to benefit from the Industrial Revolution so the first industries to benefit from the Industrial Revolution so that by the end of the 19th century machine-made fabrics and that by the end of the 19th century machine-made fabrics and mass-production made decent clothing in larger quantities mass-production made decent clothing in larger quantities accessible to most of the population of the more developed accessible to most of the population of the more developed countries Similar progress has been made in most forms of countries Similar progress has been made in most forms of production Agricultural production which at the turn of the production Agricultural production which at the turn of the 20th century absorbed half the labor force now absorbs less 20th century absorbed half the labor force now absorbs less than 3 percent while producing more food more cheaply than than 3 percent while producing more food more cheaply than ever ever

bull We must be careful not to dismiss the Luddites as altogether We must be careful not to dismiss the Luddites as altogether foolish While new technology especially over decades has foolish While new technology especially over decades has proved to be a net gain for workers in general the Luddites proved to be a net gain for workers in general the Luddites were in fact correct that their way of life was threatened were in fact correct that their way of life was threatened Independent weavers became factory hands unskilled Independent weavers became factory hands unskilled workers increasingly women and often children replaced workers increasingly women and often children replaced skilled craftsmen and factory work often involved long hours skilled craftsmen and factory work often involved long hours in brutal conditions The wider society reaps the benefits of in brutal conditions The wider society reaps the benefits of technological change while a narrow group sometimes technological change while a narrow group sometimes disproportionately bears its costs Our analysis also assumes disproportionately bears its costs Our analysis also assumes that markets generally clear The implicit assumption is that that markets generally clear The implicit assumption is that displaced workers move on to new jobs possibly in other forms displaced workers move on to new jobs possibly in other forms of production Markets may have a tendency to clear in the of production Markets may have a tendency to clear in the long run yet workers may find themselves displaced in the long run yet workers may find themselves displaced in the short run say over the course of a business cycleshort run say over the course of a business cycle

Issue 3 Immigration Jobs and Real WagesIssue 3 Immigration Jobs and Real Wages

bull How does an increase in the labor force through immigration or How does an increase in the labor force through immigration or natural population growth affect labor and GDP natural population growth affect labor and GDP

bull One of the emotional issues associated with US immigration One of the emotional issues associated with US immigration policy ndash particularly towards low-wage workers from Mexico ndash policy ndash particularly towards low-wage workers from Mexico ndash is the idea that is the idea that immigrants take jobs away from native immigrants take jobs away from native workers workers We might be tempted to dismiss this fear as another We might be tempted to dismiss this fear as another example of the lump-of-labor fallacy Yet there is a sensible example of the lump-of-labor fallacy Yet there is a sensible intuition behind the argument An increase in the labor force ndash intuition behind the argument An increase in the labor force ndash due either to immigration or to higher population growth rates due either to immigration or to higher population growth rates ndash can be represented as an outward shift of the aggregate labor ndash can be represented as an outward shift of the aggregate labor supply curve as shown in the following Figure Employment supply curve as shown in the following Figure Employment increases but real wages fall It is not then that immigrants increases but real wages fall It is not then that immigrants take jobs away from natives take jobs away from natives Rather they compete for jobsRather they compete for jobs putting downward pressure on real wagesputting downward pressure on real wages

bull Again we must exercise care in interpreting the analysis Again we must exercise care in interpreting the analysis Remember that aggregate labor and average wage rates hide Remember that aggregate labor and average wage rates hide many details of the labor process The incomes of the new many details of the labor process The incomes of the new immigrants immigrants creates demand creates demand for the new production that they for the new production that they make possible Immigrant workers (at least those ndash whether make possible Immigrant workers (at least those ndash whether legal or illegal ndash who have become the focus of the most intense legal or illegal ndash who have become the focus of the most intense political debate) political debate) are likely to possess fewer skills than nativesare likely to possess fewer skills than natives The net effect is that the increased demand for goods and The net effect is that the increased demand for goods and services generated by immigrants is likely to increase the services generated by immigrants is likely to increase the demand for skilled (demand for skilled (and largely nativeand largely native) workers relative to ) workers relative to their supply and so to increase real wages of skilled workers their supply and so to increase real wages of skilled workers Low-skilled immigration may lower the real wage for farm Low-skilled immigration may lower the real wage for farm workers but if anything it would raise the real wage for workers but if anything it would raise the real wage for computer programmerscomputer programmers

Next Task Labor Market in Kuwait

Appendix Is Labor Supply Stable Over Time

bull Statistics on participation rates or average hours for a Statistics on participation rates or average hours for a particular month or year are snapshot of the labor market particular month or year are snapshot of the labor market Can we analyze the effects of that increase on the labor market Can we analyze the effects of that increase on the labor market under the assumption that the labor-supply curves of workers under the assumption that the labor-supply curves of workers remain essentially stableremain essentially stable

bull Data on participation rates in the United States appear to Data on participation rates in the United States appear to support this conjecture (see Figure 811) which shows the support this conjecture (see Figure 811) which shows the overall civilian participation rate trending upward ndash at least overall civilian participation rate trending upward ndash at least from the middle of the 1960sfrom the middle of the 1960s

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

bull Imagine that the firm faces a real wage of (wp)1 The optimal Imagine that the firm faces a real wage of (wp)1 The optimal point is found where the point is found where the MP=(wp)1MP=(wp)1 This point corresponds to This point corresponds to a particular level of labor l1 The combination a particular level of labor l1 The combination (l1 (wp)1)(l1 (wp)1) forms point forms point Arsquo Arsquo which is one point on the labor-demand curve which is one point on the labor-demand curve If the firm paid its workers anything more than If the firm paid its workers anything more than (wp)1 (wp)1 to to produce at produce at A A it would reduce its profitsit would reduce its profits

bull If the firm do if it faced a lower wage say If the firm do if it faced a lower wage say (wp)2(wp)2 the new the new optimal production point will be at optimal production point will be at BB At B the firm demands At B the firm demands l2l2

bull The combination The combination (l2 (wp)2) (l2 (wp)2) shown as point shown as point Brsquo Brsquo in the lower in the lower panel is another point on the firmrsquos labor-demand curve The panel is another point on the firmrsquos labor-demand curve The labor-demand curve connects labor-demand curve connects Arsquo Brsquo Arsquo Brsquo and every other profit-and every other profit-maximizing point It is downward sloping because of maximizing point It is downward sloping because of diminishing returns to labordiminishing returns to labor

bull Factors that Shift the Labor-demand curveFactors that Shift the Labor-demand curve

bull The labor-demand curve is not independent of theThe labor-demand curve is not independent of the production production functionfunction As a result anything that shifts the production As a result anything that shifts the production function will in general function will in general shift the labor-demand curveshift the labor-demand curve and the and the labor-demand curve cannot shift unless the production labor-demand curve cannot shift unless the production function also shifts function also shifts Technological progress or an increase in Technological progress or an increase in the capital stock shifts the capital stock shifts the production function upward the production function upward

bull Consider an Consider an increase in the capital stockincrease in the capital stock how does it shift the how does it shift the labor-demand curvelabor-demand curve

bull An increase in capital raises An increase in capital raises MPLMPL at every level of labor at every level of labor demand the higher MP means that the profit-maximizing firm demand the higher MP means that the profit-maximizing firm can afford can afford higher real wage higher real wage at each level of labor The labor-at each level of labor The labor-demand curve shifts vertically upwarddemand curve shifts vertically upward

bull But why would the firm pay workers more for a particular But why would the firm pay workers more for a particular level of labor level of labor when additional capital raises when additional capital raises their marginal their marginal products Why does the firm not just pocket the windfall The products Why does the firm not just pocket the windfall The answer answer competitioncompetition When the marginal product rises each When the marginal product rises each firm tries to hire firm tries to hire more workersmore workers Since we have assumed that Since we have assumed that markets are all in equilibrium all available workers are markets are all in equilibrium all available workers are already employed and it is only by paying higher wages that already employed and it is only by paying higher wages that the firm can attract them the firm can attract them

THE AGGREGATE DEMAND FOR LABOR

bull In macroeconomic analysis we are more concerned with the In macroeconomic analysis we are more concerned with the aggregate demand for laboraggregate demand for labor If all firms produced the If all firms produced the samesame products and if all workers were products and if all workers were alikealike then aggregation from then aggregation from the firm to the economy as a whole would be easy (see the the firm to the economy as a whole would be easy (see the figure) Unfortunately it is not that simplefigure) Unfortunately it is not that simple

bull The first problem is that all firms are The first problem is that all firms are not producing the same not producing the same productproduct When different firms produce different goods we When different firms produce different goods we must find a common unit of measurement must find a common unit of measurement

bull The second problem is that The second problem is that not all workers are alikenot all workers are alike Different Different kinds of workers may face kinds of workers may face different wage rates different wage rates and therefore and therefore have have different marginal products different marginal products at the optimum For our at the optimum For our purposes the wage structure can be summarized in the purposes the wage structure can be summarized in the average average wage ratewage rate Though It provides an imperfect index of the Though It provides an imperfect index of the movements of the wage structure movements of the wage structure

Labor Supply

bull Two measures reflect two aspects of the workerrsquos labor supply Two measures reflect two aspects of the workerrsquos labor supply decision (i) decision (i) participationparticipation ndash that is whether to work or not ndash that is whether to work or not work and (ii) work and (ii) intensityintensity ndash that is how many hours to work It is ndash that is how many hours to work It is easier if we consider intensity first conditional on having easier if we consider intensity first conditional on having decided to work what factors govern the workerrsquos choice of decided to work what factors govern the workerrsquos choice of how many hours of work to supplyhow many hours of work to supply

bull THE WORKER CHOOSING HOURS OF WORKTHE WORKER CHOOSING HOURS OF WORK

bull The Price of LeisureThe Price of Leisure

bull People work for a variety of reasons The most obvious is to People work for a variety of reasons The most obvious is to earn the incomeearn the income Many people ndash though not all ndash find their Many people ndash though not all ndash find their work work fulfilling and interestingfulfilling and interesting Still even those people will Still even those people will generally prefer another generally prefer another hour of leisure hour of leisure to another hour of to another hour of work It is therefore reasonable to assume that work It is therefore reasonable to assume that leisure is a leisure is a goodgood

bull Goods generally have a price Yet there is Goods generally have a price Yet there is nono market for market for leisureleisure Even though there is no explicit price there is an Even though there is no explicit price there is an implicit price or opportunity cost The implicit price or opportunity cost The OPPORTUNITY COST OPPORTUNITY COST of any choice is the value of the best alternative choice that it of any choice is the value of the best alternative choice that it foreclosesforecloses The implicit price of leisure is its opportunity cost The implicit price of leisure is its opportunity cost which is measured by the real wage (which is measured by the real wage (wp) wp)

bull The Labor-Leisure ChoiceThe Labor-Leisure Choice

bull Once we see leisure as a good and the real-wage rate as its Once we see leisure as a good and the real-wage rate as its price it is easier to understand the choices a worker faces price it is easier to understand the choices a worker faces There are 168 hours in a week If a worker chooses There are 168 hours in a week If a worker chooses not to work not to work at allat all he enjoys 168 hours of leisure but forgoes the income he enjoys 168 hours of leisure but forgoes the income needed to buy any other goods If the worker instead takes needed to buy any other goods If the worker instead takes fewer hours of leisure he supplies labor fewer hours of leisure he supplies labor l = 168 ndash hours of l = 168 ndash hours of leisure leisure and he gains the ability to purchase goods worth wp times l and he gains the ability to purchase goods worth wp times l The problem The problem for the worker for the worker is to choose is to choose the hours of labor (the hours of labor (l ) l ) that at the margin makes the psychic value of a small loss that at the margin makes the psychic value of a small loss further loss of leisure time (ie a small increase in labor time) further loss of leisure time (ie a small increase in labor time) exactly equal to the psychic value of the small gain in exactly equal to the psychic value of the small gain in consumption goods that would be purchased by that laborconsumption goods that would be purchased by that labor

bull INCOME EFFECT How would your supply of labor change if you could receive the income that results from the increased wage rate without facing a changed opportunity cost of leisure

bull As a general rule an increase in income ceteris paribus increases the demand for all goods The extra $20 per week would permit you to buy more goods including leisure without reducing your purchases of other goods The reduction in the supply of labor as the result of an increase in income is called the income effect

bull SUBSTITUTION EFFECTSUBSTITUTION EFFECT

bull If the wage rate rose If the wage rate rose would people work more or less As a would people work more or less As a general rule whenever general rule whenever ceteris paribus the price of anything rises ceteris paribus the price of anything rises relative to alternativesrelative to alternatives the demand for it decreases Here the the demand for it decreases Here the price of leisure price of leisure (its opportunity cost) has risen relative to the (its opportunity cost) has risen relative to the price of other goods the supply of price of other goods the supply of labor would riselabor would rise The change The change in the wage rate encourages people to substitute the now in the wage rate encourages people to substitute the now cheaper goods (what you buy using your wage) for the now cheaper goods (what you buy using your wage) for the now more expensive leisure more expensive leisure The increase in the supply of labor as The increase in the supply of labor as the result of an increase in the price (or opportunity cost) of the result of an increase in the price (or opportunity cost) of leisure is called theleisure is called the SUBSTITUTION EFFECT SUBSTITUTION EFFECT

bull The Labor-supply CurveThe Labor-supply Curve

bull The following figure represents the workerrsquos labor-supply The following figure represents the workerrsquos labor-supply decision Look first at panel (A) Suppose that at point A decision Look first at panel (A) Suppose that at point A where the real wage is (where the real wage is (wp)1 the worker decides that providing l wp)1 the worker decides that providing l hours of work balances the advantages of a little more hours of work balances the advantages of a little more consumption against a little more leisure at the margin Now consumption against a little more leisure at the margin Now consider what happens when the real wage rises to (consider what happens when the real wage rises to (wp)2 wp)2 There is a substitution effect shown by the arrow pointing to There is a substitution effect shown by the arrow pointing to the right which encourages the worker to supply more labor the right which encourages the worker to supply more labor The size of the substitution effect is measured by the length of The size of the substitution effect is measured by the length of the arrowthe arrow

bull There is also an income effect shown by the arrow pointing to There is also an income effect shown by the arrow pointing to the left which encourages the worker to supply less laborthe left which encourages the worker to supply less labor

The Slope of the Labor-Supply Curve

bull The net effect The net effect is measured by the difference between the is measured by the difference between the substitution and income effects shown at point B so that an substitution and income effects shown at point B so that an increase in the wage rate increases the workerrsquos supply of labor increase in the wage rate increases the workerrsquos supply of labor to to l2 to the right of l1 If the substitution effect is always stronger l2 to the right of l1 If the substitution effect is always stronger then the labor supply then the labor supply curve slopes upward curve slopes upward

bull Substitution effects are not necessarily stronger than income Substitution effects are not necessarily stronger than income effectseffects Panel (B) shows the construction of the labor-supply Panel (B) shows the construction of the labor-supply curve starting from point C when income effects are stronger curve starting from point C when income effects are stronger than substitution effects When the real-wage rate increases than substitution effects When the real-wage rate increases from (from (wp)1 to (wp)2 the dominant income effect overwhelms wp)1 to (wp)2 the dominant income effect overwhelms the substitution effect and labor the substitution effect and labor supply (point C) falls from supply (point C) falls from l1 to l1 to l2 If income effects are stronger for all wage rates above l2 If income effects are stronger for all wage rates above ((wp)1 wp)1 then the labor-supply curve will slope downward toward point C then the labor-supply curve will slope downward toward point C higher real wage higher real wage rates lower labor supplyrates lower labor supply

bull Although the labor-supply curve can slope downward towards Although the labor-supply curve can slope downward towards a point like A it is not reasonable to believe that it could slope a point like A it is not reasonable to believe that it could slope downward for every possible wage rate At very low wage rates downward for every possible wage rate At very low wage rates it is more reasonable to suppose that with very low incomes it is more reasonable to suppose that with very low incomes the workerrsquos need for food clothing shelter and other the workerrsquos need for food clothing shelter and other ldquoessentialrdquo goods the income effect is weak and the ldquoessentialrdquo goods the income effect is weak and the substitution effect is strong We should therefore expect the substitution effect is strong We should therefore expect the labor-supply curve to be upward sloping when wage rates are labor-supply curve to be upward sloping when wage rates are low Hence labor supply would be backward bending low Hence labor supply would be backward bending

Backward-bending Labor-supply Curve

Adding Realism TaxesAdding Realism Taxes

bull How does the tax affect the income from a little more or a little How does the tax affect the income from a little more or a little less work To answer this question we must know the less work To answer this question we must know the marginal marginal tax ratetax rate ((the fraction of an additional dollar of income that is the fraction of an additional dollar of income that is paid as taxes) paid as taxes) To keep things simple assume that all income is To keep things simple assume that all income is taxed at the same taxed at the same flatflat rate rate ττ In this case the marginal tax rate In this case the marginal tax rate must also be τ which takes a value between zero and one If a must also be τ which takes a value between zero and one If a worker earns worker earns wpwp for an hour of work the government takes for an hour of work the government takes τ(wp) τ(wp) as taxes and leaves the worker as taxes and leaves the worker (1ndashτ)(wp) (1ndashτ)(wp) as the after-as the after-tax real wagetax real wage

bull Since the worker actually receives the Since the worker actually receives the after-tax real wageafter-tax real wage it is it is the the true opportunity cost of leisure true opportunity cost of leisure Any increase in the Any increase in the marginal tax rate represents a decrease in the opportunity cost marginal tax rate represents a decrease in the opportunity cost of leisure If of leisure If substitution effectssubstitution effects are stronger than income are stronger than income effects then any increase in marginal tax rates effects then any increase in marginal tax rates reducesreduces the the supply of labor supply of labor as shown in the following figureas shown in the following figure

The Effect of a Tax Increase on Labor Supply

bull The labor-supply curve with no taxes is shown on the right of The labor-supply curve with no taxes is shown on the right of the figure At the figure At (wp)1(wp)1 the worker supplies labor the worker supplies labor l1l1 If a tax of If a tax of τ1τ1 is imposed the after-tax real wage is is imposed the after-tax real wage is (1ndashτ1)(wp)1(1ndashτ1)(wp)1 The worker The worker should react exactly as if he paid no taxes but suffered a cut in should react exactly as if he paid no taxes but suffered a cut in his wages This is shown as a movement from point A to point B his wages This is shown as a movement from point A to point B where labor supply has fallen to where labor supply has fallen to l2l2 But of course the wage rate But of course the wage rate did not really falldid not really fall the employer still pays (wp)1 This means the employer still pays (wp)1 This means that (l2 (wp)1) is the labor-supply (point C)that (l2 (wp)1) is the labor-supply (point C)

bull Since this would apply for any real-wage rate every point on Since this would apply for any real-wage rate every point on the original curve shifts to the left Because the the original curve shifts to the left Because the tax rate is tax rate is proportional its absolute effect is greaterproportional its absolute effect is greater as is the shift in the as is the shift in the labor-supply curve at high wage rates resulting in a labor-supply curve at high wage rates resulting in a steepening of the curve Any further increase in the tax rate to steepening of the curve Any further increase in the tax rate to say τ2 would shift the labor-supply curve further to the left say τ2 would shift the labor-supply curve further to the left

bull The length of the line segment BC measures the The length of the line segment BC measures the TAX WEDGETAX WEDGE between the real wage paid by employers and the after-tax real between the real wage paid by employers and the after-tax real wage received by workewage received by workersrs The The largerlarger the tax wedge the the tax wedge the largerlarger the leftward shift of the labor-supply curve and the the leftward shift of the labor-supply curve and the greater the greater the reductionreduction in labor supplied at any real wage in labor supplied at any real wage

bull The idea that tax increases lower labor supply and conversely The idea that tax increases lower labor supply and conversely that tax cuts increase labor supply was a major tenet of the so-that tax cuts increase labor supply was a major tenet of the so-called called supply-side economicssupply-side economics popular in the early 1980s popular in the early 1980s President Ronald Reagan and his advisors used it to argue that President Ronald Reagan and his advisors used it to argue that cuts in marginal tax rates cuts in marginal tax rates would stimulate people would stimulate people to to workwork harder and to harder and to earn larger earn larger incomesincomes

Adding Realism A Standard WorkweekAdding Realism A Standard Workweek

bull Another way in which the simple analysis of labor supply is Another way in which the simple analysis of labor supply is unrealistic is that many unrealistic is that many workers are not given an option about workers are not given an option about the number of hours they workthe number of hours they work Although people work part- Although people work part-time and overtime either may be voluntary or mandatory time and overtime either may be voluntary or mandatory

bull Assuming that workers are Assuming that workers are not permitted to work more than not permitted to work more than 40 hours a week40 hours a week the following figure includes a constraint of the following figure includes a constraint of 40 hours If the worker were permitted to choose freely then 40 hours If the worker were permitted to choose freely then the labor-supply curve would backward bending curve The the labor-supply curve would backward bending curve The overall effect is to of the standard work week is to reshape the overall effect is to of the standard work week is to reshape the labor-supply curve as indicated by the heavy curve with the labor-supply curve as indicated by the heavy curve with the vertical segment that runs through points A F G D and E vertical segment that runs through points A F G D and E Any worker on this vertical segment is constrainedAny worker on this vertical segment is constrained

The Individual Labor-Supply Curve in PracticeThe Individual Labor-Supply Curve in Practice

bull What does the individual labor-supply curve look like in What does the individual labor-supply curve look like in realityreality It is difficult to answer this question because in reality It is difficult to answer this question because in reality we can observe we can observe only one pointonly one point on the labor-supply curve for a on the labor-supply curve for a single worker single worker at a particular timeat a particular time All the other points are All the other points are conjecturesconjectures about what the worker would supply if faced with about what the worker would supply if faced with different wage rates If we imagine that on average workers are different wage rates If we imagine that on average workers are substantially substantially similarsimilar we might nonetheless get some idea of we might nonetheless get some idea of what the individual labor-supply curve might look likewhat the individual labor-supply curve might look like

bull The The National Longitudinal SurveyNational Longitudinal Survey (Youth) has catalogued the (Youth) has catalogued the work histories of a large sample of individuals starting at a work histories of a large sample of individuals starting at a young age The following figure plots the real-wage rates and young age The following figure plots the real-wage rates and average weekly hours of labor for about average weekly hours of labor for about 1000010000 male workers male workers from this survey for a from this survey for a single periodsingle period with the best fitting flexible with the best fitting flexible line through these points serves as our empirical estimate of the line through these points serves as our empirical estimate of the labor-supply curve for these workerslabor-supply curve for these workers

bull The regression line traces out a shape very The regression line traces out a shape very like the backward-like the backward-bendingbending labor-supply curve with a 40-hour constraint What labor-supply curve with a 40-hour constraint What looks like a vertical line above 40 hours is looks like a vertical line above 40 hours is not really a solid line not really a solid line at all but a reflection of the fact that about at all but a reflection of the fact that about 7500 7500 of the 10000 of the 10000 workers in the sample supply 40 hours per week at a variety of workers in the sample supply 40 hours per week at a variety of wage rates The labor-supply curve traces out a segment above wage rates The labor-supply curve traces out a segment above the 40-hour point that corresponds to the constraintthe 40-hour point that corresponds to the constraint

bull There are There are points to the rightpoints to the right of 40 hours This is reasonable of 40 hours This is reasonable since in the real world workers do since in the real world workers do work overtimework overtime ndash either ndash either because they are supervisors or professionals or because because they are supervisors or professionals or because employers offer them the required time-and-half wage rate employers offer them the required time-and-half wage rate The fit of the regression line is far from perfect points lie on The fit of the regression line is far from perfect points lie on both sides of the line We should interpret it as a both sides of the line We should interpret it as a snapshotsnapshot of of the behavior of the typical worker But ofthe behavior of the typical worker But of course the typical course the typical worker is not any actual worker in particularworker is not any actual worker in particular

THE WORKER CHOOSING TO PARTICIPATETHE WORKER CHOOSING TO PARTICIPATE

bull So far we have examined only one aspect of the workerrsquos So far we have examined only one aspect of the workerrsquos labor-supply decision labor-supply decision how many hours to work for given real how many hours to work for given real wagewage We now take up the second aspect We now take up the second aspect participationparticipation ndash that ndash that is is whether or not to work at allwhether or not to work at all A labor-supply curve that starts A labor-supply curve that starts at the origin and slopes upwards for at least a portion of its at the origin and slopes upwards for at least a portion of its length suggests that even length suggests that even if the wage were very lowif the wage were very low ndash say 1cent ndash say 1cent per hour ndash the worker would work a little bit That is clearly per hour ndash the worker would work a little bit That is clearly unrealisticunrealistic no one would work at all for 1cent per hour no one would work at all for 1cent per hour What What factors determine how high the wage factors determine how high the wage must be to induce a person must be to induce a person to participate in the labor marketto participate in the labor market

bull The labor force The labor force participationparticipation decision is a question of decision is a question of opportunity costopportunity cost Idleness has its charms Before anyone enters Idleness has its charms Before anyone enters the labor force the wage rate must be high enough to overcome the labor force the wage rate must be high enough to overcome them them The opportunity cost of participatingThe opportunity cost of participating in the labor force is in the labor force is sum of sum of

1048766 1048766 the implicit valuethe implicit value the worker places on complete idleness the worker places on complete idleness

1048766 1048766 the explicit coststhe explicit costs of working compared to not working such as of working compared to not working such as clothing transport childcare) andclothing transport childcare) and

1048766 1048766 the explicit losses the explicit losses from working (for instance housework not from working (for instance housework not done)done)

bull The opportunity cost is partly psychological and partly material The opportunity cost is partly psychological and partly material If people were completely If people were completely independentindependent of each other the worker of each other the worker might place a lower value on the opportunity cost of might place a lower value on the opportunity cost of participation because then the choice might be literally between participation because then the choice might be literally between work and starvationwork and starvation

bull But most people are not But most people are not completely independentcompletely independent Whether or Whether or not to participate in the labor force could be a not to participate in the labor force could be a genuine choicegenuine choice and would depend on the and would depend on the real wagereal wage

bull The The RESERVATION WAGE RESERVATION WAGE is defined to be is defined to be the opportunity the opportunity cost of working compared to not workingcost of working compared to not working ndash ndash that is the real wage that is the real wage that is high enough to make it just worthwhile for a worker to that is high enough to make it just worthwhile for a worker to participate in the labor forceparticipate in the labor force

bull Taking account of the opportunity costs of participation affects Taking account of the opportunity costs of participation affects the shape of the labor-supply curve As long as the the shape of the labor-supply curve As long as the real wage is real wage is below the reservationbelow the reservation wage ((wp)R) the worker supplies no wage ((wp)R) the worker supplies no labor at all Above the reservation wage there is a normal labor at all Above the reservation wage there is a normal labor-supply curvelabor-supply curve

bull The following captures the two stages of the labor supply The following captures the two stages of the labor supply decision decision FirstFirst at low wages the worker will at low wages the worker will notnot supply any supply any labor at all and small increases in wages have no effect But labor at all and small increases in wages have no effect But secondsecond as soon as the wage rises enough for the worker to bite as soon as the wage rises enough for the worker to bite the bullet and join the labor force the minimum labor supplied the bullet and join the labor force the minimum labor supplied will be well will be well above zeroabove zero and the worker will decide how many and the worker will decide how many hours to supply above this minimum through the usual process hours to supply above this minimum through the usual process of balancing the opportunity cost of leisure against the desire of balancing the opportunity cost of leisure against the desire for consumption goodsfor consumption goods

AGGREGATE LABOR SUPPLY

bull How can we moveHow can we move from the microeconomics of the labor supply from the microeconomics of the labor supply back to an aggregate relationship usable in macroeconomic back to an aggregate relationship usable in macroeconomic analysis analysis If workers were essentially alikeIf workers were essentially alike the problem would the problem would be easy be easy

bull As we have seen labor supply has two dimensions ndash As we have seen labor supply has two dimensions ndash participationparticipation in the labor force and in the labor force and choice of hourschoice of hours of labor of labor Take the participation decision first If all workers were alike Take the participation decision first If all workers were alike except for except for differences in their reservation wagedifferences in their reservation wage then we could then we could rank them from lowest to highest reservation wage The rank them from lowest to highest reservation wage The aggregate labor-supply (participation) curve is strictly aggregate labor-supply (participation) curve is strictly upwardslopingupwardsloping

bull Of course this is too easy Just as we observed in deriving the Of course this is too easy Just as we observed in deriving the aggregate labor demand curve workers are aggregate labor demand curve workers are not all alikenot all alike Once Once again we must interpret the vertical axis as measuring the again we must interpret the vertical axis as measuring the average real wageaverage real wage that at best provides a kind of index for the that at best provides a kind of index for the level of the wage structure level of the wage structure

bull The The problemproblem remains the remains the samesame when we turn to the choice of when we turn to the choice of hourshours Workers are all different and face a structure of wages Workers are all different and face a structure of wages For each worker individually there is a jump from supplying For each worker individually there is a jump from supplying zero to supplying some positive number of hours zero to supplying some positive number of hours when his own when his own wage rate surpasses their wage rate surpasses their reservation wagereservation wage But in aggregate But in aggregate we are we are unlikely to see such a jumpunlikely to see such a jump Not only are there a variety Not only are there a variety of wages offered at any time but reservation wages differof wages offered at any time but reservation wages differ

Derivation of the Aggregate Labor-supply Curve

bull A curve like the one in this figure can be used to display either A curve like the one in this figure can be used to display either the the participation participation decision or decision or the hoursthe hours The horizontal axis can The horizontal axis can either be used for workers either be used for workers or worker-hoursor worker-hours as measures of the as measures of the labor supply The two meanings are not completely labor supply The two meanings are not completely independent by definition independent by definition

bull workers equiv aggregate worker ndash hours average hours per worker workers equiv aggregate worker ndash hours average hours per worker

The Participation Rate and Average Hours

bull Let us look first at the aggregate participation decision The Let us look first at the aggregate participation decision The aggregate number of workers who have decided to participate aggregate number of workers who have decided to participate is known as the is known as the labor forcelabor force the the civilian labor force over 16 civilian labor force over 16 years of ageyears of age This number excludes uniformed members of the This number excludes uniformed members of the armed services and the small number of workers under 16 armed services and the small number of workers under 16 years old The labor force of course has grown right along years old The labor force of course has grown right along with population with population

bull The participation rateThe participation rate (PR) measures (PR) measures the labor force as its ratio the labor force as its ratio to the relevant populationto the relevant population

bull participation rate = labor forcerelevant population participation rate = labor forcerelevant population

bull ldquoldquonon-institutionalrdquo non-institutionalrdquo excludes people in prison or in homes for excludes people in prison or in homes for the aged) the aged)

bull The aggregate number of hours The aggregate number of hours worked is worked is not as easy not as easy as the as the participation rate to relate to the individual workerrsquos choices participation rate to relate to the individual workerrsquos choices If every worker had the same labor-supply curve we would If every worker had the same labor-supply curve we would have to know the wage offered to each one in order to calculate have to know the wage offered to each one in order to calculate the total number of labor hours supplied In reality workers the total number of labor hours supplied In reality workers are not all alike are not all alike Labor-supply curves may vary systematically Labor-supply curves may vary systematically according to the sex age ethnic group education experience according to the sex age ethnic group education experience or other social or economic characteristics of the workersor other social or economic characteristics of the workers And And within any group the labor-supply curves of individuals are within any group the labor-supply curves of individuals are likely to varylikely to vary

bull In principle In principle if we had a good statistical estimate of the typical if we had a good statistical estimate of the typical distribution of the wagesdistribution of the wages we could make a reasonable we could make a reasonable calculation But statisticians at the Bureau of Labor Statistics calculation But statisticians at the Bureau of Labor Statistics (BLS) do not try to calculate the labor supply in this way (BLS) do not try to calculate the labor supply in this way Instead they Instead they count the number of hours that workers actually count the number of hours that workers actually workwork and the average and the average wages and salaries they are paid wages and salaries they are paid

bull In USA the total hours of labor in 1998 was In USA the total hours of labor in 1998 was 236882236882 million million The average hours of work is The average hours of work is 17211721 hours per year = hours per year = 344344 hours hours per week (assuming a 50 week year) This number is 14 percent per week (assuming a 50 week year) This number is 14 percent below the full time 40-hour week which makes sense since it below the full time 40-hour week which makes sense since it averages over full-time part-time and overtime workers averages over full-time part-time and overtime workers

Labor Market EquilibriumLabor Market Equilibrium

bull MARKET CLEARINGMARKET CLEARING

bull When both demand and supply curves are plotted on the same When both demand and supply curves are plotted on the same diagram the crossing point defines the diagram the crossing point defines the equilibrium real-wage equilibrium real-wage rate and the rate and the equilibrium level of labor employedequilibrium level of labor employed

bull The real wage The real wage looks different looks different from the point of view of the firm from the point of view of the firm and the worker For the and the worker For the firmfirm the relevant real wage is the the relevant real wage is the product-real wage product-real wage defined as defined as the number of units of the good the number of units of the good the firm produces that the wage will purchase the firm produces that the wage will purchase ((price of price of productproduct = = w) w) For the For the workerworker the relevant real wage is the the relevant real wage is the consumption-consumption-real real wagewage defined as defined as the number of typical consumption baskets the number of typical consumption baskets that the wage will purchase that the wage will purchase ((price of price of consumption basket consumption basket = = w)w)

bull For aggregate analysis we might use the For aggregate analysis we might use the Producer Price IndexProducer Price Index or the GDP deflator to approximate the or the GDP deflator to approximate the product priceproduct price and the and the CPICPI to approximate the to approximate the consumption price consumption price

bull Suppose that the product-real wage and the consumption-real Suppose that the product-real wage and the consumption-real wage in the following figure start out with the identical value wage in the following figure start out with the identical value ((wp) at the market-clearing point Awp) at the market-clearing point A Now suppose that Now suppose that imported Japanese cars are a large portion of the typical imported Japanese cars are a large portion of the typical workerrsquos consumption basket workerrsquos consumption basket and that and that ceteris paribus ceteris paribus the price the price of Japanese cars rises sharply This means that the of Japanese cars rises sharply This means that the real wage real wage from the point of view of the from the point of view of the consumer falls to (consumer falls to (wpwpCPICPI ) )11 at point at point

B B on the labor-supply curve (LS) so that the worker would on the labor-supply curve (LS) so that the worker would want to supply less labor (want to supply less labor (LL11))

bull The rise in the price of Japanese cars has no effect on the price The rise in the price of Japanese cars has no effect on the price of their products Nevertheless they see a reduction of labor of their products Nevertheless they see a reduction of labor supply at the original market clearing wage It is as if the supply at the original market clearing wage It is as if the labor-supply curve labor-supply curve has shifted to the left to has shifted to the left to LSLSrsquo which passes rsquo which passes through ((through ((wp) L1) at point C wp) L1) at point C At the original wage rate labor At the original wage rate labor demand exceeds labor supply so firms raise wages in an effort demand exceeds labor supply so firms raise wages in an effort to attract workers until they reach the new market-clearing to attract workers until they reach the new market-clearing wage at point D where they pay (wage at point D where they pay (wpwpPPIPPI ) for labor of L ) for labor of L The The

rise in the price of Japanese cars has the effect of raising the rise in the price of Japanese cars has the effect of raising the wages that firms must pay and reducing labor employedwages that firms must pay and reducing labor employed Higher wages partly compensate workers for the higher costs Higher wages partly compensate workers for the higher costs of consumption but firms can afford to pay those higher wages of consumption but firms can afford to pay those higher wages only if marginal products rise as a result of their using less only if marginal products rise as a result of their using less labor labor

bull The rise in wage rates is not enough to compensate workers The rise in wage rates is not enough to compensate workers fully so the consumption-real wage in equilibrium is (wpfully so the consumption-real wage in equilibrium is (wpCPI CPI ) )

atat point E We can think of import prices as a tax levied on point E We can think of import prices as a tax levied on consumers and of an increase in import prices as widening the consumers and of an increase in import prices as widening the tax wedge Unless the issue that we want to analyze depends on tax wedge Unless the issue that we want to analyze depends on the difference between product- and consumption-real wages the difference between product- and consumption-real wages we will treat the real wage as the same for both labor supply we will treat the real wage as the same for both labor supply and labor demandand labor demand

An Increase in the Price of Consumption GoodsAn Increase in the Price of Consumption GoodsRelative to the Price of OutputRelative to the Price of Output

ANALYZING IDEAL LABOR MARKETSANALYZING IDEAL LABOR MARKETS

bull The aggregate labor-supplylabor-demand diagram provides us The aggregate labor-supplylabor-demand diagram provides us with a powerful tool We now analyze three important with a powerful tool We now analyze three important macroeconomic issues macroeconomic issues

(1) the effect of tax cuts on employment (1) the effect of tax cuts on employment

(2) the effect of technological progress on the well-being of (2) the effect of technological progress on the well-being of workers and workers and

(3) the effect of immigration on existing workers (3) the effect of immigration on existing workers

bull Issue 1 Tax Cuts Issue 1 Tax Cuts What are the effects of a cut in marginal What are the effects of a cut in marginal income-tax rates on employment and the level of GDP in the income-tax rates on employment and the level of GDP in the economyeconomy Recall from section that a lower marginal income-Recall from section that a lower marginal income-tax rate increases labor supply at each real wage (a rightward tax rate increases labor supply at each real wage (a rightward shift of the labor-supply) shift of the labor-supply)

bull Labor-market equilibrium moves from point A to point B in Labor-market equilibrium moves from point A to point B in the lower panel of the following Notice that the amount of the lower panel of the following Notice that the amount of labor available to firms increases so that firms move labor available to firms increases so that firms move production from Arsquo to Brsquo on the labor production function in production from Arsquo to Brsquo on the labor production function in the upper panel Also notice that the real wage falls from (the upper panel Also notice that the real wage falls from (wp)1 wp)1 to (wp)2 Since the cut in taxes increases the number of to (wp)2 Since the cut in taxes increases the number of workers workers willing to work at each wage Workers care about their take-willing to work at each wage Workers care about their take-home pay ndash that is about their home pay ndash that is about their after-tax real wage after-tax real wage This is This is perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 can be greater than the old after-tax real wage (1ndashcan be greater than the old after-tax real wage (1ndashτ1τ1)(wp)1 so )(wp)1 so long as the rise in the take-home share (1 ndash τ) is long as the rise in the take-home share (1 ndash τ) is proportionately greater than the fall in the before-tax real proportionately greater than the fall in the before-tax real wage (wp)wage (wp)

bull The analysis depends on substitution effects dominating The analysis depends on substitution effects dominating income effects which they probably do in aggregate if not for income effects which they probably do in aggregate if not for every worker So the supply-siders of the Reagan years are every worker So the supply-siders of the Reagan years are correct in principle How much output will increase depends on correct in principle How much output will increase depends on how large the substitution effect is If most people work a how large the substitution effect is If most people work a standard 40-hour week the effect could be quite small and the standard 40-hour week the effect could be quite small and the increase in output might also be very small in practiceincrease in output might also be very small in practice

Issue 1 The Effect of a Cut in Marginal Tax RatesIssue 1 The Effect of a Cut in Marginal Tax Rates

Issue 2 Technological Progress and Worker WelfareIssue 2 Technological Progress and Worker Welfare

bull Is technological progress and increasing use of machinery and Is technological progress and increasing use of machinery and other capital beneficial for workersother capital beneficial for workers

bull Technological change or capital accumulation have been Technological change or capital accumulation have been known as ldquoLudditesrdquo (known as ldquoLudditesrdquo (it negatively affects the demand for it negatively affects the demand for laborlabor) To see why the Luddites are wrong ndash at least for ) To see why the Luddites are wrong ndash at least for clearing labor markets ndash recall that technological progress or clearing labor markets ndash recall that technological progress or increased capital both increased capital both shift the labor-demand curve upwardshift the labor-demand curve upward The lower panel of the following figure shows that the effect of The lower panel of the following figure shows that the effect of the increased demand for labor is to increase total employment the increased demand for labor is to increase total employment and the real wage Firms and the real wage Firms can pay a higher real wage can pay a higher real wage because because the additional capital or technological progress the additional capital or technological progress increases the increases the marginal product of labormarginal product of labor

bull The The Ludditesrsquo mistake Ludditesrsquo mistake is most easily seen in the upper panel is most easily seen in the upper panel The Luddite argument assumes that fewer workers will The Luddite argument assumes that fewer workers will produce the same total output Production starts at Arsquo using produce the same total output Production starts at Arsquo using L1 L1 workers to produce Y1 After the upward shift in the production workers to produce Y1 After the upward shift in the production function the same output could be produced using less labor function the same output could be produced using less labor ((L3) at point Arsquorsquo The L3) at point Arsquorsquo The problem is that Arsquorsquo is not an equilibrium problem is that Arsquorsquo is not an equilibrium At that point the marginal product of labor is higher than the At that point the marginal product of labor is higher than the original real wage so a profit-maximizing firm would want to original real wage so a profit-maximizing firm would want to expand production To do this they must hire more labor than expand production To do this they must hire more labor than L3 and indeed they L3 and indeed they find it find it profitable profitable to hire more labor than to hire more labor than the original the original L1 The only way actually to increase labor L1 The only way actually to increase labor is to is to raise the real-wage raise the real-wage rate above its original level Technological rate above its original level Technological progress therefore favors progress therefore favors workers by increasing employment workers by increasing employment and wagesand wages

bull Early in the 19th century hand-woven cloth was very Early in the 19th century hand-woven cloth was very expensive and a worker was lucky to own the clothes on his expensive and a worker was lucky to own the clothes on his back and a spare set for church on Sunday Textiles were one of back and a spare set for church on Sunday Textiles were one of the first industries to benefit from the Industrial Revolution so the first industries to benefit from the Industrial Revolution so that by the end of the 19th century machine-made fabrics and that by the end of the 19th century machine-made fabrics and mass-production made decent clothing in larger quantities mass-production made decent clothing in larger quantities accessible to most of the population of the more developed accessible to most of the population of the more developed countries Similar progress has been made in most forms of countries Similar progress has been made in most forms of production Agricultural production which at the turn of the production Agricultural production which at the turn of the 20th century absorbed half the labor force now absorbs less 20th century absorbed half the labor force now absorbs less than 3 percent while producing more food more cheaply than than 3 percent while producing more food more cheaply than ever ever

bull We must be careful not to dismiss the Luddites as altogether We must be careful not to dismiss the Luddites as altogether foolish While new technology especially over decades has foolish While new technology especially over decades has proved to be a net gain for workers in general the Luddites proved to be a net gain for workers in general the Luddites were in fact correct that their way of life was threatened were in fact correct that their way of life was threatened Independent weavers became factory hands unskilled Independent weavers became factory hands unskilled workers increasingly women and often children replaced workers increasingly women and often children replaced skilled craftsmen and factory work often involved long hours skilled craftsmen and factory work often involved long hours in brutal conditions The wider society reaps the benefits of in brutal conditions The wider society reaps the benefits of technological change while a narrow group sometimes technological change while a narrow group sometimes disproportionately bears its costs Our analysis also assumes disproportionately bears its costs Our analysis also assumes that markets generally clear The implicit assumption is that that markets generally clear The implicit assumption is that displaced workers move on to new jobs possibly in other forms displaced workers move on to new jobs possibly in other forms of production Markets may have a tendency to clear in the of production Markets may have a tendency to clear in the long run yet workers may find themselves displaced in the long run yet workers may find themselves displaced in the short run say over the course of a business cycleshort run say over the course of a business cycle

Issue 3 Immigration Jobs and Real WagesIssue 3 Immigration Jobs and Real Wages

bull How does an increase in the labor force through immigration or How does an increase in the labor force through immigration or natural population growth affect labor and GDP natural population growth affect labor and GDP

bull One of the emotional issues associated with US immigration One of the emotional issues associated with US immigration policy ndash particularly towards low-wage workers from Mexico ndash policy ndash particularly towards low-wage workers from Mexico ndash is the idea that is the idea that immigrants take jobs away from native immigrants take jobs away from native workers workers We might be tempted to dismiss this fear as another We might be tempted to dismiss this fear as another example of the lump-of-labor fallacy Yet there is a sensible example of the lump-of-labor fallacy Yet there is a sensible intuition behind the argument An increase in the labor force ndash intuition behind the argument An increase in the labor force ndash due either to immigration or to higher population growth rates due either to immigration or to higher population growth rates ndash can be represented as an outward shift of the aggregate labor ndash can be represented as an outward shift of the aggregate labor supply curve as shown in the following Figure Employment supply curve as shown in the following Figure Employment increases but real wages fall It is not then that immigrants increases but real wages fall It is not then that immigrants take jobs away from natives take jobs away from natives Rather they compete for jobsRather they compete for jobs putting downward pressure on real wagesputting downward pressure on real wages

bull Again we must exercise care in interpreting the analysis Again we must exercise care in interpreting the analysis Remember that aggregate labor and average wage rates hide Remember that aggregate labor and average wage rates hide many details of the labor process The incomes of the new many details of the labor process The incomes of the new immigrants immigrants creates demand creates demand for the new production that they for the new production that they make possible Immigrant workers (at least those ndash whether make possible Immigrant workers (at least those ndash whether legal or illegal ndash who have become the focus of the most intense legal or illegal ndash who have become the focus of the most intense political debate) political debate) are likely to possess fewer skills than nativesare likely to possess fewer skills than natives The net effect is that the increased demand for goods and The net effect is that the increased demand for goods and services generated by immigrants is likely to increase the services generated by immigrants is likely to increase the demand for skilled (demand for skilled (and largely nativeand largely native) workers relative to ) workers relative to their supply and so to increase real wages of skilled workers their supply and so to increase real wages of skilled workers Low-skilled immigration may lower the real wage for farm Low-skilled immigration may lower the real wage for farm workers but if anything it would raise the real wage for workers but if anything it would raise the real wage for computer programmerscomputer programmers

Next Task Labor Market in Kuwait

Appendix Is Labor Supply Stable Over Time

bull Statistics on participation rates or average hours for a Statistics on participation rates or average hours for a particular month or year are snapshot of the labor market particular month or year are snapshot of the labor market Can we analyze the effects of that increase on the labor market Can we analyze the effects of that increase on the labor market under the assumption that the labor-supply curves of workers under the assumption that the labor-supply curves of workers remain essentially stableremain essentially stable

bull Data on participation rates in the United States appear to Data on participation rates in the United States appear to support this conjecture (see Figure 811) which shows the support this conjecture (see Figure 811) which shows the overall civilian participation rate trending upward ndash at least overall civilian participation rate trending upward ndash at least from the middle of the 1960sfrom the middle of the 1960s

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

bull Factors that Shift the Labor-demand curveFactors that Shift the Labor-demand curve

bull The labor-demand curve is not independent of theThe labor-demand curve is not independent of the production production functionfunction As a result anything that shifts the production As a result anything that shifts the production function will in general function will in general shift the labor-demand curveshift the labor-demand curve and the and the labor-demand curve cannot shift unless the production labor-demand curve cannot shift unless the production function also shifts function also shifts Technological progress or an increase in Technological progress or an increase in the capital stock shifts the capital stock shifts the production function upward the production function upward

bull Consider an Consider an increase in the capital stockincrease in the capital stock how does it shift the how does it shift the labor-demand curvelabor-demand curve

bull An increase in capital raises An increase in capital raises MPLMPL at every level of labor at every level of labor demand the higher MP means that the profit-maximizing firm demand the higher MP means that the profit-maximizing firm can afford can afford higher real wage higher real wage at each level of labor The labor-at each level of labor The labor-demand curve shifts vertically upwarddemand curve shifts vertically upward

bull But why would the firm pay workers more for a particular But why would the firm pay workers more for a particular level of labor level of labor when additional capital raises when additional capital raises their marginal their marginal products Why does the firm not just pocket the windfall The products Why does the firm not just pocket the windfall The answer answer competitioncompetition When the marginal product rises each When the marginal product rises each firm tries to hire firm tries to hire more workersmore workers Since we have assumed that Since we have assumed that markets are all in equilibrium all available workers are markets are all in equilibrium all available workers are already employed and it is only by paying higher wages that already employed and it is only by paying higher wages that the firm can attract them the firm can attract them

THE AGGREGATE DEMAND FOR LABOR

bull In macroeconomic analysis we are more concerned with the In macroeconomic analysis we are more concerned with the aggregate demand for laboraggregate demand for labor If all firms produced the If all firms produced the samesame products and if all workers were products and if all workers were alikealike then aggregation from then aggregation from the firm to the economy as a whole would be easy (see the the firm to the economy as a whole would be easy (see the figure) Unfortunately it is not that simplefigure) Unfortunately it is not that simple

bull The first problem is that all firms are The first problem is that all firms are not producing the same not producing the same productproduct When different firms produce different goods we When different firms produce different goods we must find a common unit of measurement must find a common unit of measurement

bull The second problem is that The second problem is that not all workers are alikenot all workers are alike Different Different kinds of workers may face kinds of workers may face different wage rates different wage rates and therefore and therefore have have different marginal products different marginal products at the optimum For our at the optimum For our purposes the wage structure can be summarized in the purposes the wage structure can be summarized in the average average wage ratewage rate Though It provides an imperfect index of the Though It provides an imperfect index of the movements of the wage structure movements of the wage structure

Labor Supply

bull Two measures reflect two aspects of the workerrsquos labor supply Two measures reflect two aspects of the workerrsquos labor supply decision (i) decision (i) participationparticipation ndash that is whether to work or not ndash that is whether to work or not work and (ii) work and (ii) intensityintensity ndash that is how many hours to work It is ndash that is how many hours to work It is easier if we consider intensity first conditional on having easier if we consider intensity first conditional on having decided to work what factors govern the workerrsquos choice of decided to work what factors govern the workerrsquos choice of how many hours of work to supplyhow many hours of work to supply

bull THE WORKER CHOOSING HOURS OF WORKTHE WORKER CHOOSING HOURS OF WORK

bull The Price of LeisureThe Price of Leisure

bull People work for a variety of reasons The most obvious is to People work for a variety of reasons The most obvious is to earn the incomeearn the income Many people ndash though not all ndash find their Many people ndash though not all ndash find their work work fulfilling and interestingfulfilling and interesting Still even those people will Still even those people will generally prefer another generally prefer another hour of leisure hour of leisure to another hour of to another hour of work It is therefore reasonable to assume that work It is therefore reasonable to assume that leisure is a leisure is a goodgood

bull Goods generally have a price Yet there is Goods generally have a price Yet there is nono market for market for leisureleisure Even though there is no explicit price there is an Even though there is no explicit price there is an implicit price or opportunity cost The implicit price or opportunity cost The OPPORTUNITY COST OPPORTUNITY COST of any choice is the value of the best alternative choice that it of any choice is the value of the best alternative choice that it foreclosesforecloses The implicit price of leisure is its opportunity cost The implicit price of leisure is its opportunity cost which is measured by the real wage (which is measured by the real wage (wp) wp)

bull The Labor-Leisure ChoiceThe Labor-Leisure Choice

bull Once we see leisure as a good and the real-wage rate as its Once we see leisure as a good and the real-wage rate as its price it is easier to understand the choices a worker faces price it is easier to understand the choices a worker faces There are 168 hours in a week If a worker chooses There are 168 hours in a week If a worker chooses not to work not to work at allat all he enjoys 168 hours of leisure but forgoes the income he enjoys 168 hours of leisure but forgoes the income needed to buy any other goods If the worker instead takes needed to buy any other goods If the worker instead takes fewer hours of leisure he supplies labor fewer hours of leisure he supplies labor l = 168 ndash hours of l = 168 ndash hours of leisure leisure and he gains the ability to purchase goods worth wp times l and he gains the ability to purchase goods worth wp times l The problem The problem for the worker for the worker is to choose is to choose the hours of labor (the hours of labor (l ) l ) that at the margin makes the psychic value of a small loss that at the margin makes the psychic value of a small loss further loss of leisure time (ie a small increase in labor time) further loss of leisure time (ie a small increase in labor time) exactly equal to the psychic value of the small gain in exactly equal to the psychic value of the small gain in consumption goods that would be purchased by that laborconsumption goods that would be purchased by that labor

bull INCOME EFFECT How would your supply of labor change if you could receive the income that results from the increased wage rate without facing a changed opportunity cost of leisure

bull As a general rule an increase in income ceteris paribus increases the demand for all goods The extra $20 per week would permit you to buy more goods including leisure without reducing your purchases of other goods The reduction in the supply of labor as the result of an increase in income is called the income effect

bull SUBSTITUTION EFFECTSUBSTITUTION EFFECT

bull If the wage rate rose If the wage rate rose would people work more or less As a would people work more or less As a general rule whenever general rule whenever ceteris paribus the price of anything rises ceteris paribus the price of anything rises relative to alternativesrelative to alternatives the demand for it decreases Here the the demand for it decreases Here the price of leisure price of leisure (its opportunity cost) has risen relative to the (its opportunity cost) has risen relative to the price of other goods the supply of price of other goods the supply of labor would riselabor would rise The change The change in the wage rate encourages people to substitute the now in the wage rate encourages people to substitute the now cheaper goods (what you buy using your wage) for the now cheaper goods (what you buy using your wage) for the now more expensive leisure more expensive leisure The increase in the supply of labor as The increase in the supply of labor as the result of an increase in the price (or opportunity cost) of the result of an increase in the price (or opportunity cost) of leisure is called theleisure is called the SUBSTITUTION EFFECT SUBSTITUTION EFFECT

bull The Labor-supply CurveThe Labor-supply Curve

bull The following figure represents the workerrsquos labor-supply The following figure represents the workerrsquos labor-supply decision Look first at panel (A) Suppose that at point A decision Look first at panel (A) Suppose that at point A where the real wage is (where the real wage is (wp)1 the worker decides that providing l wp)1 the worker decides that providing l hours of work balances the advantages of a little more hours of work balances the advantages of a little more consumption against a little more leisure at the margin Now consumption against a little more leisure at the margin Now consider what happens when the real wage rises to (consider what happens when the real wage rises to (wp)2 wp)2 There is a substitution effect shown by the arrow pointing to There is a substitution effect shown by the arrow pointing to the right which encourages the worker to supply more labor the right which encourages the worker to supply more labor The size of the substitution effect is measured by the length of The size of the substitution effect is measured by the length of the arrowthe arrow

bull There is also an income effect shown by the arrow pointing to There is also an income effect shown by the arrow pointing to the left which encourages the worker to supply less laborthe left which encourages the worker to supply less labor

The Slope of the Labor-Supply Curve

bull The net effect The net effect is measured by the difference between the is measured by the difference between the substitution and income effects shown at point B so that an substitution and income effects shown at point B so that an increase in the wage rate increases the workerrsquos supply of labor increase in the wage rate increases the workerrsquos supply of labor to to l2 to the right of l1 If the substitution effect is always stronger l2 to the right of l1 If the substitution effect is always stronger then the labor supply then the labor supply curve slopes upward curve slopes upward

bull Substitution effects are not necessarily stronger than income Substitution effects are not necessarily stronger than income effectseffects Panel (B) shows the construction of the labor-supply Panel (B) shows the construction of the labor-supply curve starting from point C when income effects are stronger curve starting from point C when income effects are stronger than substitution effects When the real-wage rate increases than substitution effects When the real-wage rate increases from (from (wp)1 to (wp)2 the dominant income effect overwhelms wp)1 to (wp)2 the dominant income effect overwhelms the substitution effect and labor the substitution effect and labor supply (point C) falls from supply (point C) falls from l1 to l1 to l2 If income effects are stronger for all wage rates above l2 If income effects are stronger for all wage rates above ((wp)1 wp)1 then the labor-supply curve will slope downward toward point C then the labor-supply curve will slope downward toward point C higher real wage higher real wage rates lower labor supplyrates lower labor supply

bull Although the labor-supply curve can slope downward towards Although the labor-supply curve can slope downward towards a point like A it is not reasonable to believe that it could slope a point like A it is not reasonable to believe that it could slope downward for every possible wage rate At very low wage rates downward for every possible wage rate At very low wage rates it is more reasonable to suppose that with very low incomes it is more reasonable to suppose that with very low incomes the workerrsquos need for food clothing shelter and other the workerrsquos need for food clothing shelter and other ldquoessentialrdquo goods the income effect is weak and the ldquoessentialrdquo goods the income effect is weak and the substitution effect is strong We should therefore expect the substitution effect is strong We should therefore expect the labor-supply curve to be upward sloping when wage rates are labor-supply curve to be upward sloping when wage rates are low Hence labor supply would be backward bending low Hence labor supply would be backward bending

Backward-bending Labor-supply Curve

Adding Realism TaxesAdding Realism Taxes

bull How does the tax affect the income from a little more or a little How does the tax affect the income from a little more or a little less work To answer this question we must know the less work To answer this question we must know the marginal marginal tax ratetax rate ((the fraction of an additional dollar of income that is the fraction of an additional dollar of income that is paid as taxes) paid as taxes) To keep things simple assume that all income is To keep things simple assume that all income is taxed at the same taxed at the same flatflat rate rate ττ In this case the marginal tax rate In this case the marginal tax rate must also be τ which takes a value between zero and one If a must also be τ which takes a value between zero and one If a worker earns worker earns wpwp for an hour of work the government takes for an hour of work the government takes τ(wp) τ(wp) as taxes and leaves the worker as taxes and leaves the worker (1ndashτ)(wp) (1ndashτ)(wp) as the after-as the after-tax real wagetax real wage

bull Since the worker actually receives the Since the worker actually receives the after-tax real wageafter-tax real wage it is it is the the true opportunity cost of leisure true opportunity cost of leisure Any increase in the Any increase in the marginal tax rate represents a decrease in the opportunity cost marginal tax rate represents a decrease in the opportunity cost of leisure If of leisure If substitution effectssubstitution effects are stronger than income are stronger than income effects then any increase in marginal tax rates effects then any increase in marginal tax rates reducesreduces the the supply of labor supply of labor as shown in the following figureas shown in the following figure

The Effect of a Tax Increase on Labor Supply

bull The labor-supply curve with no taxes is shown on the right of The labor-supply curve with no taxes is shown on the right of the figure At the figure At (wp)1(wp)1 the worker supplies labor the worker supplies labor l1l1 If a tax of If a tax of τ1τ1 is imposed the after-tax real wage is is imposed the after-tax real wage is (1ndashτ1)(wp)1(1ndashτ1)(wp)1 The worker The worker should react exactly as if he paid no taxes but suffered a cut in should react exactly as if he paid no taxes but suffered a cut in his wages This is shown as a movement from point A to point B his wages This is shown as a movement from point A to point B where labor supply has fallen to where labor supply has fallen to l2l2 But of course the wage rate But of course the wage rate did not really falldid not really fall the employer still pays (wp)1 This means the employer still pays (wp)1 This means that (l2 (wp)1) is the labor-supply (point C)that (l2 (wp)1) is the labor-supply (point C)

bull Since this would apply for any real-wage rate every point on Since this would apply for any real-wage rate every point on the original curve shifts to the left Because the the original curve shifts to the left Because the tax rate is tax rate is proportional its absolute effect is greaterproportional its absolute effect is greater as is the shift in the as is the shift in the labor-supply curve at high wage rates resulting in a labor-supply curve at high wage rates resulting in a steepening of the curve Any further increase in the tax rate to steepening of the curve Any further increase in the tax rate to say τ2 would shift the labor-supply curve further to the left say τ2 would shift the labor-supply curve further to the left

bull The length of the line segment BC measures the The length of the line segment BC measures the TAX WEDGETAX WEDGE between the real wage paid by employers and the after-tax real between the real wage paid by employers and the after-tax real wage received by workewage received by workersrs The The largerlarger the tax wedge the the tax wedge the largerlarger the leftward shift of the labor-supply curve and the the leftward shift of the labor-supply curve and the greater the greater the reductionreduction in labor supplied at any real wage in labor supplied at any real wage

bull The idea that tax increases lower labor supply and conversely The idea that tax increases lower labor supply and conversely that tax cuts increase labor supply was a major tenet of the so-that tax cuts increase labor supply was a major tenet of the so-called called supply-side economicssupply-side economics popular in the early 1980s popular in the early 1980s President Ronald Reagan and his advisors used it to argue that President Ronald Reagan and his advisors used it to argue that cuts in marginal tax rates cuts in marginal tax rates would stimulate people would stimulate people to to workwork harder and to harder and to earn larger earn larger incomesincomes

Adding Realism A Standard WorkweekAdding Realism A Standard Workweek

bull Another way in which the simple analysis of labor supply is Another way in which the simple analysis of labor supply is unrealistic is that many unrealistic is that many workers are not given an option about workers are not given an option about the number of hours they workthe number of hours they work Although people work part- Although people work part-time and overtime either may be voluntary or mandatory time and overtime either may be voluntary or mandatory

bull Assuming that workers are Assuming that workers are not permitted to work more than not permitted to work more than 40 hours a week40 hours a week the following figure includes a constraint of the following figure includes a constraint of 40 hours If the worker were permitted to choose freely then 40 hours If the worker were permitted to choose freely then the labor-supply curve would backward bending curve The the labor-supply curve would backward bending curve The overall effect is to of the standard work week is to reshape the overall effect is to of the standard work week is to reshape the labor-supply curve as indicated by the heavy curve with the labor-supply curve as indicated by the heavy curve with the vertical segment that runs through points A F G D and E vertical segment that runs through points A F G D and E Any worker on this vertical segment is constrainedAny worker on this vertical segment is constrained

The Individual Labor-Supply Curve in PracticeThe Individual Labor-Supply Curve in Practice

bull What does the individual labor-supply curve look like in What does the individual labor-supply curve look like in realityreality It is difficult to answer this question because in reality It is difficult to answer this question because in reality we can observe we can observe only one pointonly one point on the labor-supply curve for a on the labor-supply curve for a single worker single worker at a particular timeat a particular time All the other points are All the other points are conjecturesconjectures about what the worker would supply if faced with about what the worker would supply if faced with different wage rates If we imagine that on average workers are different wage rates If we imagine that on average workers are substantially substantially similarsimilar we might nonetheless get some idea of we might nonetheless get some idea of what the individual labor-supply curve might look likewhat the individual labor-supply curve might look like

bull The The National Longitudinal SurveyNational Longitudinal Survey (Youth) has catalogued the (Youth) has catalogued the work histories of a large sample of individuals starting at a work histories of a large sample of individuals starting at a young age The following figure plots the real-wage rates and young age The following figure plots the real-wage rates and average weekly hours of labor for about average weekly hours of labor for about 1000010000 male workers male workers from this survey for a from this survey for a single periodsingle period with the best fitting flexible with the best fitting flexible line through these points serves as our empirical estimate of the line through these points serves as our empirical estimate of the labor-supply curve for these workerslabor-supply curve for these workers

bull The regression line traces out a shape very The regression line traces out a shape very like the backward-like the backward-bendingbending labor-supply curve with a 40-hour constraint What labor-supply curve with a 40-hour constraint What looks like a vertical line above 40 hours is looks like a vertical line above 40 hours is not really a solid line not really a solid line at all but a reflection of the fact that about at all but a reflection of the fact that about 7500 7500 of the 10000 of the 10000 workers in the sample supply 40 hours per week at a variety of workers in the sample supply 40 hours per week at a variety of wage rates The labor-supply curve traces out a segment above wage rates The labor-supply curve traces out a segment above the 40-hour point that corresponds to the constraintthe 40-hour point that corresponds to the constraint

bull There are There are points to the rightpoints to the right of 40 hours This is reasonable of 40 hours This is reasonable since in the real world workers do since in the real world workers do work overtimework overtime ndash either ndash either because they are supervisors or professionals or because because they are supervisors or professionals or because employers offer them the required time-and-half wage rate employers offer them the required time-and-half wage rate The fit of the regression line is far from perfect points lie on The fit of the regression line is far from perfect points lie on both sides of the line We should interpret it as a both sides of the line We should interpret it as a snapshotsnapshot of of the behavior of the typical worker But ofthe behavior of the typical worker But of course the typical course the typical worker is not any actual worker in particularworker is not any actual worker in particular

THE WORKER CHOOSING TO PARTICIPATETHE WORKER CHOOSING TO PARTICIPATE

bull So far we have examined only one aspect of the workerrsquos So far we have examined only one aspect of the workerrsquos labor-supply decision labor-supply decision how many hours to work for given real how many hours to work for given real wagewage We now take up the second aspect We now take up the second aspect participationparticipation ndash that ndash that is is whether or not to work at allwhether or not to work at all A labor-supply curve that starts A labor-supply curve that starts at the origin and slopes upwards for at least a portion of its at the origin and slopes upwards for at least a portion of its length suggests that even length suggests that even if the wage were very lowif the wage were very low ndash say 1cent ndash say 1cent per hour ndash the worker would work a little bit That is clearly per hour ndash the worker would work a little bit That is clearly unrealisticunrealistic no one would work at all for 1cent per hour no one would work at all for 1cent per hour What What factors determine how high the wage factors determine how high the wage must be to induce a person must be to induce a person to participate in the labor marketto participate in the labor market

bull The labor force The labor force participationparticipation decision is a question of decision is a question of opportunity costopportunity cost Idleness has its charms Before anyone enters Idleness has its charms Before anyone enters the labor force the wage rate must be high enough to overcome the labor force the wage rate must be high enough to overcome them them The opportunity cost of participatingThe opportunity cost of participating in the labor force is in the labor force is sum of sum of

1048766 1048766 the implicit valuethe implicit value the worker places on complete idleness the worker places on complete idleness

1048766 1048766 the explicit coststhe explicit costs of working compared to not working such as of working compared to not working such as clothing transport childcare) andclothing transport childcare) and

1048766 1048766 the explicit losses the explicit losses from working (for instance housework not from working (for instance housework not done)done)

bull The opportunity cost is partly psychological and partly material The opportunity cost is partly psychological and partly material If people were completely If people were completely independentindependent of each other the worker of each other the worker might place a lower value on the opportunity cost of might place a lower value on the opportunity cost of participation because then the choice might be literally between participation because then the choice might be literally between work and starvationwork and starvation

bull But most people are not But most people are not completely independentcompletely independent Whether or Whether or not to participate in the labor force could be a not to participate in the labor force could be a genuine choicegenuine choice and would depend on the and would depend on the real wagereal wage

bull The The RESERVATION WAGE RESERVATION WAGE is defined to be is defined to be the opportunity the opportunity cost of working compared to not workingcost of working compared to not working ndash ndash that is the real wage that is the real wage that is high enough to make it just worthwhile for a worker to that is high enough to make it just worthwhile for a worker to participate in the labor forceparticipate in the labor force

bull Taking account of the opportunity costs of participation affects Taking account of the opportunity costs of participation affects the shape of the labor-supply curve As long as the the shape of the labor-supply curve As long as the real wage is real wage is below the reservationbelow the reservation wage ((wp)R) the worker supplies no wage ((wp)R) the worker supplies no labor at all Above the reservation wage there is a normal labor at all Above the reservation wage there is a normal labor-supply curvelabor-supply curve

bull The following captures the two stages of the labor supply The following captures the two stages of the labor supply decision decision FirstFirst at low wages the worker will at low wages the worker will notnot supply any supply any labor at all and small increases in wages have no effect But labor at all and small increases in wages have no effect But secondsecond as soon as the wage rises enough for the worker to bite as soon as the wage rises enough for the worker to bite the bullet and join the labor force the minimum labor supplied the bullet and join the labor force the minimum labor supplied will be well will be well above zeroabove zero and the worker will decide how many and the worker will decide how many hours to supply above this minimum through the usual process hours to supply above this minimum through the usual process of balancing the opportunity cost of leisure against the desire of balancing the opportunity cost of leisure against the desire for consumption goodsfor consumption goods

AGGREGATE LABOR SUPPLY

bull How can we moveHow can we move from the microeconomics of the labor supply from the microeconomics of the labor supply back to an aggregate relationship usable in macroeconomic back to an aggregate relationship usable in macroeconomic analysis analysis If workers were essentially alikeIf workers were essentially alike the problem would the problem would be easy be easy

bull As we have seen labor supply has two dimensions ndash As we have seen labor supply has two dimensions ndash participationparticipation in the labor force and in the labor force and choice of hourschoice of hours of labor of labor Take the participation decision first If all workers were alike Take the participation decision first If all workers were alike except for except for differences in their reservation wagedifferences in their reservation wage then we could then we could rank them from lowest to highest reservation wage The rank them from lowest to highest reservation wage The aggregate labor-supply (participation) curve is strictly aggregate labor-supply (participation) curve is strictly upwardslopingupwardsloping

bull Of course this is too easy Just as we observed in deriving the Of course this is too easy Just as we observed in deriving the aggregate labor demand curve workers are aggregate labor demand curve workers are not all alikenot all alike Once Once again we must interpret the vertical axis as measuring the again we must interpret the vertical axis as measuring the average real wageaverage real wage that at best provides a kind of index for the that at best provides a kind of index for the level of the wage structure level of the wage structure

bull The The problemproblem remains the remains the samesame when we turn to the choice of when we turn to the choice of hourshours Workers are all different and face a structure of wages Workers are all different and face a structure of wages For each worker individually there is a jump from supplying For each worker individually there is a jump from supplying zero to supplying some positive number of hours zero to supplying some positive number of hours when his own when his own wage rate surpasses their wage rate surpasses their reservation wagereservation wage But in aggregate But in aggregate we are we are unlikely to see such a jumpunlikely to see such a jump Not only are there a variety Not only are there a variety of wages offered at any time but reservation wages differof wages offered at any time but reservation wages differ

Derivation of the Aggregate Labor-supply Curve

bull A curve like the one in this figure can be used to display either A curve like the one in this figure can be used to display either the the participation participation decision or decision or the hoursthe hours The horizontal axis can The horizontal axis can either be used for workers either be used for workers or worker-hoursor worker-hours as measures of the as measures of the labor supply The two meanings are not completely labor supply The two meanings are not completely independent by definition independent by definition

bull workers equiv aggregate worker ndash hours average hours per worker workers equiv aggregate worker ndash hours average hours per worker

The Participation Rate and Average Hours

bull Let us look first at the aggregate participation decision The Let us look first at the aggregate participation decision The aggregate number of workers who have decided to participate aggregate number of workers who have decided to participate is known as the is known as the labor forcelabor force the the civilian labor force over 16 civilian labor force over 16 years of ageyears of age This number excludes uniformed members of the This number excludes uniformed members of the armed services and the small number of workers under 16 armed services and the small number of workers under 16 years old The labor force of course has grown right along years old The labor force of course has grown right along with population with population

bull The participation rateThe participation rate (PR) measures (PR) measures the labor force as its ratio the labor force as its ratio to the relevant populationto the relevant population

bull participation rate = labor forcerelevant population participation rate = labor forcerelevant population

bull ldquoldquonon-institutionalrdquo non-institutionalrdquo excludes people in prison or in homes for excludes people in prison or in homes for the aged) the aged)

bull The aggregate number of hours The aggregate number of hours worked is worked is not as easy not as easy as the as the participation rate to relate to the individual workerrsquos choices participation rate to relate to the individual workerrsquos choices If every worker had the same labor-supply curve we would If every worker had the same labor-supply curve we would have to know the wage offered to each one in order to calculate have to know the wage offered to each one in order to calculate the total number of labor hours supplied In reality workers the total number of labor hours supplied In reality workers are not all alike are not all alike Labor-supply curves may vary systematically Labor-supply curves may vary systematically according to the sex age ethnic group education experience according to the sex age ethnic group education experience or other social or economic characteristics of the workersor other social or economic characteristics of the workers And And within any group the labor-supply curves of individuals are within any group the labor-supply curves of individuals are likely to varylikely to vary

bull In principle In principle if we had a good statistical estimate of the typical if we had a good statistical estimate of the typical distribution of the wagesdistribution of the wages we could make a reasonable we could make a reasonable calculation But statisticians at the Bureau of Labor Statistics calculation But statisticians at the Bureau of Labor Statistics (BLS) do not try to calculate the labor supply in this way (BLS) do not try to calculate the labor supply in this way Instead they Instead they count the number of hours that workers actually count the number of hours that workers actually workwork and the average and the average wages and salaries they are paid wages and salaries they are paid

bull In USA the total hours of labor in 1998 was In USA the total hours of labor in 1998 was 236882236882 million million The average hours of work is The average hours of work is 17211721 hours per year = hours per year = 344344 hours hours per week (assuming a 50 week year) This number is 14 percent per week (assuming a 50 week year) This number is 14 percent below the full time 40-hour week which makes sense since it below the full time 40-hour week which makes sense since it averages over full-time part-time and overtime workers averages over full-time part-time and overtime workers

Labor Market EquilibriumLabor Market Equilibrium

bull MARKET CLEARINGMARKET CLEARING

bull When both demand and supply curves are plotted on the same When both demand and supply curves are plotted on the same diagram the crossing point defines the diagram the crossing point defines the equilibrium real-wage equilibrium real-wage rate and the rate and the equilibrium level of labor employedequilibrium level of labor employed

bull The real wage The real wage looks different looks different from the point of view of the firm from the point of view of the firm and the worker For the and the worker For the firmfirm the relevant real wage is the the relevant real wage is the product-real wage product-real wage defined as defined as the number of units of the good the number of units of the good the firm produces that the wage will purchase the firm produces that the wage will purchase ((price of price of productproduct = = w) w) For the For the workerworker the relevant real wage is the the relevant real wage is the consumption-consumption-real real wagewage defined as defined as the number of typical consumption baskets the number of typical consumption baskets that the wage will purchase that the wage will purchase ((price of price of consumption basket consumption basket = = w)w)

bull For aggregate analysis we might use the For aggregate analysis we might use the Producer Price IndexProducer Price Index or the GDP deflator to approximate the or the GDP deflator to approximate the product priceproduct price and the and the CPICPI to approximate the to approximate the consumption price consumption price

bull Suppose that the product-real wage and the consumption-real Suppose that the product-real wage and the consumption-real wage in the following figure start out with the identical value wage in the following figure start out with the identical value ((wp) at the market-clearing point Awp) at the market-clearing point A Now suppose that Now suppose that imported Japanese cars are a large portion of the typical imported Japanese cars are a large portion of the typical workerrsquos consumption basket workerrsquos consumption basket and that and that ceteris paribus ceteris paribus the price the price of Japanese cars rises sharply This means that the of Japanese cars rises sharply This means that the real wage real wage from the point of view of the from the point of view of the consumer falls to (consumer falls to (wpwpCPICPI ) )11 at point at point

B B on the labor-supply curve (LS) so that the worker would on the labor-supply curve (LS) so that the worker would want to supply less labor (want to supply less labor (LL11))

bull The rise in the price of Japanese cars has no effect on the price The rise in the price of Japanese cars has no effect on the price of their products Nevertheless they see a reduction of labor of their products Nevertheless they see a reduction of labor supply at the original market clearing wage It is as if the supply at the original market clearing wage It is as if the labor-supply curve labor-supply curve has shifted to the left to has shifted to the left to LSLSrsquo which passes rsquo which passes through ((through ((wp) L1) at point C wp) L1) at point C At the original wage rate labor At the original wage rate labor demand exceeds labor supply so firms raise wages in an effort demand exceeds labor supply so firms raise wages in an effort to attract workers until they reach the new market-clearing to attract workers until they reach the new market-clearing wage at point D where they pay (wage at point D where they pay (wpwpPPIPPI ) for labor of L ) for labor of L The The

rise in the price of Japanese cars has the effect of raising the rise in the price of Japanese cars has the effect of raising the wages that firms must pay and reducing labor employedwages that firms must pay and reducing labor employed Higher wages partly compensate workers for the higher costs Higher wages partly compensate workers for the higher costs of consumption but firms can afford to pay those higher wages of consumption but firms can afford to pay those higher wages only if marginal products rise as a result of their using less only if marginal products rise as a result of their using less labor labor

bull The rise in wage rates is not enough to compensate workers The rise in wage rates is not enough to compensate workers fully so the consumption-real wage in equilibrium is (wpfully so the consumption-real wage in equilibrium is (wpCPI CPI ) )

atat point E We can think of import prices as a tax levied on point E We can think of import prices as a tax levied on consumers and of an increase in import prices as widening the consumers and of an increase in import prices as widening the tax wedge Unless the issue that we want to analyze depends on tax wedge Unless the issue that we want to analyze depends on the difference between product- and consumption-real wages the difference between product- and consumption-real wages we will treat the real wage as the same for both labor supply we will treat the real wage as the same for both labor supply and labor demandand labor demand

An Increase in the Price of Consumption GoodsAn Increase in the Price of Consumption GoodsRelative to the Price of OutputRelative to the Price of Output

ANALYZING IDEAL LABOR MARKETSANALYZING IDEAL LABOR MARKETS

bull The aggregate labor-supplylabor-demand diagram provides us The aggregate labor-supplylabor-demand diagram provides us with a powerful tool We now analyze three important with a powerful tool We now analyze three important macroeconomic issues macroeconomic issues

(1) the effect of tax cuts on employment (1) the effect of tax cuts on employment

(2) the effect of technological progress on the well-being of (2) the effect of technological progress on the well-being of workers and workers and

(3) the effect of immigration on existing workers (3) the effect of immigration on existing workers

bull Issue 1 Tax Cuts Issue 1 Tax Cuts What are the effects of a cut in marginal What are the effects of a cut in marginal income-tax rates on employment and the level of GDP in the income-tax rates on employment and the level of GDP in the economyeconomy Recall from section that a lower marginal income-Recall from section that a lower marginal income-tax rate increases labor supply at each real wage (a rightward tax rate increases labor supply at each real wage (a rightward shift of the labor-supply) shift of the labor-supply)

bull Labor-market equilibrium moves from point A to point B in Labor-market equilibrium moves from point A to point B in the lower panel of the following Notice that the amount of the lower panel of the following Notice that the amount of labor available to firms increases so that firms move labor available to firms increases so that firms move production from Arsquo to Brsquo on the labor production function in production from Arsquo to Brsquo on the labor production function in the upper panel Also notice that the real wage falls from (the upper panel Also notice that the real wage falls from (wp)1 wp)1 to (wp)2 Since the cut in taxes increases the number of to (wp)2 Since the cut in taxes increases the number of workers workers willing to work at each wage Workers care about their take-willing to work at each wage Workers care about their take-home pay ndash that is about their home pay ndash that is about their after-tax real wage after-tax real wage This is This is perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 can be greater than the old after-tax real wage (1ndashcan be greater than the old after-tax real wage (1ndashτ1τ1)(wp)1 so )(wp)1 so long as the rise in the take-home share (1 ndash τ) is long as the rise in the take-home share (1 ndash τ) is proportionately greater than the fall in the before-tax real proportionately greater than the fall in the before-tax real wage (wp)wage (wp)

bull The analysis depends on substitution effects dominating The analysis depends on substitution effects dominating income effects which they probably do in aggregate if not for income effects which they probably do in aggregate if not for every worker So the supply-siders of the Reagan years are every worker So the supply-siders of the Reagan years are correct in principle How much output will increase depends on correct in principle How much output will increase depends on how large the substitution effect is If most people work a how large the substitution effect is If most people work a standard 40-hour week the effect could be quite small and the standard 40-hour week the effect could be quite small and the increase in output might also be very small in practiceincrease in output might also be very small in practice

Issue 1 The Effect of a Cut in Marginal Tax RatesIssue 1 The Effect of a Cut in Marginal Tax Rates

Issue 2 Technological Progress and Worker WelfareIssue 2 Technological Progress and Worker Welfare

bull Is technological progress and increasing use of machinery and Is technological progress and increasing use of machinery and other capital beneficial for workersother capital beneficial for workers

bull Technological change or capital accumulation have been Technological change or capital accumulation have been known as ldquoLudditesrdquo (known as ldquoLudditesrdquo (it negatively affects the demand for it negatively affects the demand for laborlabor) To see why the Luddites are wrong ndash at least for ) To see why the Luddites are wrong ndash at least for clearing labor markets ndash recall that technological progress or clearing labor markets ndash recall that technological progress or increased capital both increased capital both shift the labor-demand curve upwardshift the labor-demand curve upward The lower panel of the following figure shows that the effect of The lower panel of the following figure shows that the effect of the increased demand for labor is to increase total employment the increased demand for labor is to increase total employment and the real wage Firms and the real wage Firms can pay a higher real wage can pay a higher real wage because because the additional capital or technological progress the additional capital or technological progress increases the increases the marginal product of labormarginal product of labor

bull The The Ludditesrsquo mistake Ludditesrsquo mistake is most easily seen in the upper panel is most easily seen in the upper panel The Luddite argument assumes that fewer workers will The Luddite argument assumes that fewer workers will produce the same total output Production starts at Arsquo using produce the same total output Production starts at Arsquo using L1 L1 workers to produce Y1 After the upward shift in the production workers to produce Y1 After the upward shift in the production function the same output could be produced using less labor function the same output could be produced using less labor ((L3) at point Arsquorsquo The L3) at point Arsquorsquo The problem is that Arsquorsquo is not an equilibrium problem is that Arsquorsquo is not an equilibrium At that point the marginal product of labor is higher than the At that point the marginal product of labor is higher than the original real wage so a profit-maximizing firm would want to original real wage so a profit-maximizing firm would want to expand production To do this they must hire more labor than expand production To do this they must hire more labor than L3 and indeed they L3 and indeed they find it find it profitable profitable to hire more labor than to hire more labor than the original the original L1 The only way actually to increase labor L1 The only way actually to increase labor is to is to raise the real-wage raise the real-wage rate above its original level Technological rate above its original level Technological progress therefore favors progress therefore favors workers by increasing employment workers by increasing employment and wagesand wages

bull Early in the 19th century hand-woven cloth was very Early in the 19th century hand-woven cloth was very expensive and a worker was lucky to own the clothes on his expensive and a worker was lucky to own the clothes on his back and a spare set for church on Sunday Textiles were one of back and a spare set for church on Sunday Textiles were one of the first industries to benefit from the Industrial Revolution so the first industries to benefit from the Industrial Revolution so that by the end of the 19th century machine-made fabrics and that by the end of the 19th century machine-made fabrics and mass-production made decent clothing in larger quantities mass-production made decent clothing in larger quantities accessible to most of the population of the more developed accessible to most of the population of the more developed countries Similar progress has been made in most forms of countries Similar progress has been made in most forms of production Agricultural production which at the turn of the production Agricultural production which at the turn of the 20th century absorbed half the labor force now absorbs less 20th century absorbed half the labor force now absorbs less than 3 percent while producing more food more cheaply than than 3 percent while producing more food more cheaply than ever ever

bull We must be careful not to dismiss the Luddites as altogether We must be careful not to dismiss the Luddites as altogether foolish While new technology especially over decades has foolish While new technology especially over decades has proved to be a net gain for workers in general the Luddites proved to be a net gain for workers in general the Luddites were in fact correct that their way of life was threatened were in fact correct that their way of life was threatened Independent weavers became factory hands unskilled Independent weavers became factory hands unskilled workers increasingly women and often children replaced workers increasingly women and often children replaced skilled craftsmen and factory work often involved long hours skilled craftsmen and factory work often involved long hours in brutal conditions The wider society reaps the benefits of in brutal conditions The wider society reaps the benefits of technological change while a narrow group sometimes technological change while a narrow group sometimes disproportionately bears its costs Our analysis also assumes disproportionately bears its costs Our analysis also assumes that markets generally clear The implicit assumption is that that markets generally clear The implicit assumption is that displaced workers move on to new jobs possibly in other forms displaced workers move on to new jobs possibly in other forms of production Markets may have a tendency to clear in the of production Markets may have a tendency to clear in the long run yet workers may find themselves displaced in the long run yet workers may find themselves displaced in the short run say over the course of a business cycleshort run say over the course of a business cycle

Issue 3 Immigration Jobs and Real WagesIssue 3 Immigration Jobs and Real Wages

bull How does an increase in the labor force through immigration or How does an increase in the labor force through immigration or natural population growth affect labor and GDP natural population growth affect labor and GDP

bull One of the emotional issues associated with US immigration One of the emotional issues associated with US immigration policy ndash particularly towards low-wage workers from Mexico ndash policy ndash particularly towards low-wage workers from Mexico ndash is the idea that is the idea that immigrants take jobs away from native immigrants take jobs away from native workers workers We might be tempted to dismiss this fear as another We might be tempted to dismiss this fear as another example of the lump-of-labor fallacy Yet there is a sensible example of the lump-of-labor fallacy Yet there is a sensible intuition behind the argument An increase in the labor force ndash intuition behind the argument An increase in the labor force ndash due either to immigration or to higher population growth rates due either to immigration or to higher population growth rates ndash can be represented as an outward shift of the aggregate labor ndash can be represented as an outward shift of the aggregate labor supply curve as shown in the following Figure Employment supply curve as shown in the following Figure Employment increases but real wages fall It is not then that immigrants increases but real wages fall It is not then that immigrants take jobs away from natives take jobs away from natives Rather they compete for jobsRather they compete for jobs putting downward pressure on real wagesputting downward pressure on real wages

bull Again we must exercise care in interpreting the analysis Again we must exercise care in interpreting the analysis Remember that aggregate labor and average wage rates hide Remember that aggregate labor and average wage rates hide many details of the labor process The incomes of the new many details of the labor process The incomes of the new immigrants immigrants creates demand creates demand for the new production that they for the new production that they make possible Immigrant workers (at least those ndash whether make possible Immigrant workers (at least those ndash whether legal or illegal ndash who have become the focus of the most intense legal or illegal ndash who have become the focus of the most intense political debate) political debate) are likely to possess fewer skills than nativesare likely to possess fewer skills than natives The net effect is that the increased demand for goods and The net effect is that the increased demand for goods and services generated by immigrants is likely to increase the services generated by immigrants is likely to increase the demand for skilled (demand for skilled (and largely nativeand largely native) workers relative to ) workers relative to their supply and so to increase real wages of skilled workers their supply and so to increase real wages of skilled workers Low-skilled immigration may lower the real wage for farm Low-skilled immigration may lower the real wage for farm workers but if anything it would raise the real wage for workers but if anything it would raise the real wage for computer programmerscomputer programmers

Next Task Labor Market in Kuwait

Appendix Is Labor Supply Stable Over Time

bull Statistics on participation rates or average hours for a Statistics on participation rates or average hours for a particular month or year are snapshot of the labor market particular month or year are snapshot of the labor market Can we analyze the effects of that increase on the labor market Can we analyze the effects of that increase on the labor market under the assumption that the labor-supply curves of workers under the assumption that the labor-supply curves of workers remain essentially stableremain essentially stable

bull Data on participation rates in the United States appear to Data on participation rates in the United States appear to support this conjecture (see Figure 811) which shows the support this conjecture (see Figure 811) which shows the overall civilian participation rate trending upward ndash at least overall civilian participation rate trending upward ndash at least from the middle of the 1960sfrom the middle of the 1960s

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

bull But why would the firm pay workers more for a particular But why would the firm pay workers more for a particular level of labor level of labor when additional capital raises when additional capital raises their marginal their marginal products Why does the firm not just pocket the windfall The products Why does the firm not just pocket the windfall The answer answer competitioncompetition When the marginal product rises each When the marginal product rises each firm tries to hire firm tries to hire more workersmore workers Since we have assumed that Since we have assumed that markets are all in equilibrium all available workers are markets are all in equilibrium all available workers are already employed and it is only by paying higher wages that already employed and it is only by paying higher wages that the firm can attract them the firm can attract them

THE AGGREGATE DEMAND FOR LABOR

bull In macroeconomic analysis we are more concerned with the In macroeconomic analysis we are more concerned with the aggregate demand for laboraggregate demand for labor If all firms produced the If all firms produced the samesame products and if all workers were products and if all workers were alikealike then aggregation from then aggregation from the firm to the economy as a whole would be easy (see the the firm to the economy as a whole would be easy (see the figure) Unfortunately it is not that simplefigure) Unfortunately it is not that simple

bull The first problem is that all firms are The first problem is that all firms are not producing the same not producing the same productproduct When different firms produce different goods we When different firms produce different goods we must find a common unit of measurement must find a common unit of measurement

bull The second problem is that The second problem is that not all workers are alikenot all workers are alike Different Different kinds of workers may face kinds of workers may face different wage rates different wage rates and therefore and therefore have have different marginal products different marginal products at the optimum For our at the optimum For our purposes the wage structure can be summarized in the purposes the wage structure can be summarized in the average average wage ratewage rate Though It provides an imperfect index of the Though It provides an imperfect index of the movements of the wage structure movements of the wage structure

Labor Supply

bull Two measures reflect two aspects of the workerrsquos labor supply Two measures reflect two aspects of the workerrsquos labor supply decision (i) decision (i) participationparticipation ndash that is whether to work or not ndash that is whether to work or not work and (ii) work and (ii) intensityintensity ndash that is how many hours to work It is ndash that is how many hours to work It is easier if we consider intensity first conditional on having easier if we consider intensity first conditional on having decided to work what factors govern the workerrsquos choice of decided to work what factors govern the workerrsquos choice of how many hours of work to supplyhow many hours of work to supply

bull THE WORKER CHOOSING HOURS OF WORKTHE WORKER CHOOSING HOURS OF WORK

bull The Price of LeisureThe Price of Leisure

bull People work for a variety of reasons The most obvious is to People work for a variety of reasons The most obvious is to earn the incomeearn the income Many people ndash though not all ndash find their Many people ndash though not all ndash find their work work fulfilling and interestingfulfilling and interesting Still even those people will Still even those people will generally prefer another generally prefer another hour of leisure hour of leisure to another hour of to another hour of work It is therefore reasonable to assume that work It is therefore reasonable to assume that leisure is a leisure is a goodgood

bull Goods generally have a price Yet there is Goods generally have a price Yet there is nono market for market for leisureleisure Even though there is no explicit price there is an Even though there is no explicit price there is an implicit price or opportunity cost The implicit price or opportunity cost The OPPORTUNITY COST OPPORTUNITY COST of any choice is the value of the best alternative choice that it of any choice is the value of the best alternative choice that it foreclosesforecloses The implicit price of leisure is its opportunity cost The implicit price of leisure is its opportunity cost which is measured by the real wage (which is measured by the real wage (wp) wp)

bull The Labor-Leisure ChoiceThe Labor-Leisure Choice

bull Once we see leisure as a good and the real-wage rate as its Once we see leisure as a good and the real-wage rate as its price it is easier to understand the choices a worker faces price it is easier to understand the choices a worker faces There are 168 hours in a week If a worker chooses There are 168 hours in a week If a worker chooses not to work not to work at allat all he enjoys 168 hours of leisure but forgoes the income he enjoys 168 hours of leisure but forgoes the income needed to buy any other goods If the worker instead takes needed to buy any other goods If the worker instead takes fewer hours of leisure he supplies labor fewer hours of leisure he supplies labor l = 168 ndash hours of l = 168 ndash hours of leisure leisure and he gains the ability to purchase goods worth wp times l and he gains the ability to purchase goods worth wp times l The problem The problem for the worker for the worker is to choose is to choose the hours of labor (the hours of labor (l ) l ) that at the margin makes the psychic value of a small loss that at the margin makes the psychic value of a small loss further loss of leisure time (ie a small increase in labor time) further loss of leisure time (ie a small increase in labor time) exactly equal to the psychic value of the small gain in exactly equal to the psychic value of the small gain in consumption goods that would be purchased by that laborconsumption goods that would be purchased by that labor

bull INCOME EFFECT How would your supply of labor change if you could receive the income that results from the increased wage rate without facing a changed opportunity cost of leisure

bull As a general rule an increase in income ceteris paribus increases the demand for all goods The extra $20 per week would permit you to buy more goods including leisure without reducing your purchases of other goods The reduction in the supply of labor as the result of an increase in income is called the income effect

bull SUBSTITUTION EFFECTSUBSTITUTION EFFECT

bull If the wage rate rose If the wage rate rose would people work more or less As a would people work more or less As a general rule whenever general rule whenever ceteris paribus the price of anything rises ceteris paribus the price of anything rises relative to alternativesrelative to alternatives the demand for it decreases Here the the demand for it decreases Here the price of leisure price of leisure (its opportunity cost) has risen relative to the (its opportunity cost) has risen relative to the price of other goods the supply of price of other goods the supply of labor would riselabor would rise The change The change in the wage rate encourages people to substitute the now in the wage rate encourages people to substitute the now cheaper goods (what you buy using your wage) for the now cheaper goods (what you buy using your wage) for the now more expensive leisure more expensive leisure The increase in the supply of labor as The increase in the supply of labor as the result of an increase in the price (or opportunity cost) of the result of an increase in the price (or opportunity cost) of leisure is called theleisure is called the SUBSTITUTION EFFECT SUBSTITUTION EFFECT

bull The Labor-supply CurveThe Labor-supply Curve

bull The following figure represents the workerrsquos labor-supply The following figure represents the workerrsquos labor-supply decision Look first at panel (A) Suppose that at point A decision Look first at panel (A) Suppose that at point A where the real wage is (where the real wage is (wp)1 the worker decides that providing l wp)1 the worker decides that providing l hours of work balances the advantages of a little more hours of work balances the advantages of a little more consumption against a little more leisure at the margin Now consumption against a little more leisure at the margin Now consider what happens when the real wage rises to (consider what happens when the real wage rises to (wp)2 wp)2 There is a substitution effect shown by the arrow pointing to There is a substitution effect shown by the arrow pointing to the right which encourages the worker to supply more labor the right which encourages the worker to supply more labor The size of the substitution effect is measured by the length of The size of the substitution effect is measured by the length of the arrowthe arrow

bull There is also an income effect shown by the arrow pointing to There is also an income effect shown by the arrow pointing to the left which encourages the worker to supply less laborthe left which encourages the worker to supply less labor

The Slope of the Labor-Supply Curve

bull The net effect The net effect is measured by the difference between the is measured by the difference between the substitution and income effects shown at point B so that an substitution and income effects shown at point B so that an increase in the wage rate increases the workerrsquos supply of labor increase in the wage rate increases the workerrsquos supply of labor to to l2 to the right of l1 If the substitution effect is always stronger l2 to the right of l1 If the substitution effect is always stronger then the labor supply then the labor supply curve slopes upward curve slopes upward

bull Substitution effects are not necessarily stronger than income Substitution effects are not necessarily stronger than income effectseffects Panel (B) shows the construction of the labor-supply Panel (B) shows the construction of the labor-supply curve starting from point C when income effects are stronger curve starting from point C when income effects are stronger than substitution effects When the real-wage rate increases than substitution effects When the real-wage rate increases from (from (wp)1 to (wp)2 the dominant income effect overwhelms wp)1 to (wp)2 the dominant income effect overwhelms the substitution effect and labor the substitution effect and labor supply (point C) falls from supply (point C) falls from l1 to l1 to l2 If income effects are stronger for all wage rates above l2 If income effects are stronger for all wage rates above ((wp)1 wp)1 then the labor-supply curve will slope downward toward point C then the labor-supply curve will slope downward toward point C higher real wage higher real wage rates lower labor supplyrates lower labor supply

bull Although the labor-supply curve can slope downward towards Although the labor-supply curve can slope downward towards a point like A it is not reasonable to believe that it could slope a point like A it is not reasonable to believe that it could slope downward for every possible wage rate At very low wage rates downward for every possible wage rate At very low wage rates it is more reasonable to suppose that with very low incomes it is more reasonable to suppose that with very low incomes the workerrsquos need for food clothing shelter and other the workerrsquos need for food clothing shelter and other ldquoessentialrdquo goods the income effect is weak and the ldquoessentialrdquo goods the income effect is weak and the substitution effect is strong We should therefore expect the substitution effect is strong We should therefore expect the labor-supply curve to be upward sloping when wage rates are labor-supply curve to be upward sloping when wage rates are low Hence labor supply would be backward bending low Hence labor supply would be backward bending

Backward-bending Labor-supply Curve

Adding Realism TaxesAdding Realism Taxes

bull How does the tax affect the income from a little more or a little How does the tax affect the income from a little more or a little less work To answer this question we must know the less work To answer this question we must know the marginal marginal tax ratetax rate ((the fraction of an additional dollar of income that is the fraction of an additional dollar of income that is paid as taxes) paid as taxes) To keep things simple assume that all income is To keep things simple assume that all income is taxed at the same taxed at the same flatflat rate rate ττ In this case the marginal tax rate In this case the marginal tax rate must also be τ which takes a value between zero and one If a must also be τ which takes a value between zero and one If a worker earns worker earns wpwp for an hour of work the government takes for an hour of work the government takes τ(wp) τ(wp) as taxes and leaves the worker as taxes and leaves the worker (1ndashτ)(wp) (1ndashτ)(wp) as the after-as the after-tax real wagetax real wage

bull Since the worker actually receives the Since the worker actually receives the after-tax real wageafter-tax real wage it is it is the the true opportunity cost of leisure true opportunity cost of leisure Any increase in the Any increase in the marginal tax rate represents a decrease in the opportunity cost marginal tax rate represents a decrease in the opportunity cost of leisure If of leisure If substitution effectssubstitution effects are stronger than income are stronger than income effects then any increase in marginal tax rates effects then any increase in marginal tax rates reducesreduces the the supply of labor supply of labor as shown in the following figureas shown in the following figure

The Effect of a Tax Increase on Labor Supply

bull The labor-supply curve with no taxes is shown on the right of The labor-supply curve with no taxes is shown on the right of the figure At the figure At (wp)1(wp)1 the worker supplies labor the worker supplies labor l1l1 If a tax of If a tax of τ1τ1 is imposed the after-tax real wage is is imposed the after-tax real wage is (1ndashτ1)(wp)1(1ndashτ1)(wp)1 The worker The worker should react exactly as if he paid no taxes but suffered a cut in should react exactly as if he paid no taxes but suffered a cut in his wages This is shown as a movement from point A to point B his wages This is shown as a movement from point A to point B where labor supply has fallen to where labor supply has fallen to l2l2 But of course the wage rate But of course the wage rate did not really falldid not really fall the employer still pays (wp)1 This means the employer still pays (wp)1 This means that (l2 (wp)1) is the labor-supply (point C)that (l2 (wp)1) is the labor-supply (point C)

bull Since this would apply for any real-wage rate every point on Since this would apply for any real-wage rate every point on the original curve shifts to the left Because the the original curve shifts to the left Because the tax rate is tax rate is proportional its absolute effect is greaterproportional its absolute effect is greater as is the shift in the as is the shift in the labor-supply curve at high wage rates resulting in a labor-supply curve at high wage rates resulting in a steepening of the curve Any further increase in the tax rate to steepening of the curve Any further increase in the tax rate to say τ2 would shift the labor-supply curve further to the left say τ2 would shift the labor-supply curve further to the left

bull The length of the line segment BC measures the The length of the line segment BC measures the TAX WEDGETAX WEDGE between the real wage paid by employers and the after-tax real between the real wage paid by employers and the after-tax real wage received by workewage received by workersrs The The largerlarger the tax wedge the the tax wedge the largerlarger the leftward shift of the labor-supply curve and the the leftward shift of the labor-supply curve and the greater the greater the reductionreduction in labor supplied at any real wage in labor supplied at any real wage

bull The idea that tax increases lower labor supply and conversely The idea that tax increases lower labor supply and conversely that tax cuts increase labor supply was a major tenet of the so-that tax cuts increase labor supply was a major tenet of the so-called called supply-side economicssupply-side economics popular in the early 1980s popular in the early 1980s President Ronald Reagan and his advisors used it to argue that President Ronald Reagan and his advisors used it to argue that cuts in marginal tax rates cuts in marginal tax rates would stimulate people would stimulate people to to workwork harder and to harder and to earn larger earn larger incomesincomes

Adding Realism A Standard WorkweekAdding Realism A Standard Workweek

bull Another way in which the simple analysis of labor supply is Another way in which the simple analysis of labor supply is unrealistic is that many unrealistic is that many workers are not given an option about workers are not given an option about the number of hours they workthe number of hours they work Although people work part- Although people work part-time and overtime either may be voluntary or mandatory time and overtime either may be voluntary or mandatory

bull Assuming that workers are Assuming that workers are not permitted to work more than not permitted to work more than 40 hours a week40 hours a week the following figure includes a constraint of the following figure includes a constraint of 40 hours If the worker were permitted to choose freely then 40 hours If the worker were permitted to choose freely then the labor-supply curve would backward bending curve The the labor-supply curve would backward bending curve The overall effect is to of the standard work week is to reshape the overall effect is to of the standard work week is to reshape the labor-supply curve as indicated by the heavy curve with the labor-supply curve as indicated by the heavy curve with the vertical segment that runs through points A F G D and E vertical segment that runs through points A F G D and E Any worker on this vertical segment is constrainedAny worker on this vertical segment is constrained

The Individual Labor-Supply Curve in PracticeThe Individual Labor-Supply Curve in Practice

bull What does the individual labor-supply curve look like in What does the individual labor-supply curve look like in realityreality It is difficult to answer this question because in reality It is difficult to answer this question because in reality we can observe we can observe only one pointonly one point on the labor-supply curve for a on the labor-supply curve for a single worker single worker at a particular timeat a particular time All the other points are All the other points are conjecturesconjectures about what the worker would supply if faced with about what the worker would supply if faced with different wage rates If we imagine that on average workers are different wage rates If we imagine that on average workers are substantially substantially similarsimilar we might nonetheless get some idea of we might nonetheless get some idea of what the individual labor-supply curve might look likewhat the individual labor-supply curve might look like

bull The The National Longitudinal SurveyNational Longitudinal Survey (Youth) has catalogued the (Youth) has catalogued the work histories of a large sample of individuals starting at a work histories of a large sample of individuals starting at a young age The following figure plots the real-wage rates and young age The following figure plots the real-wage rates and average weekly hours of labor for about average weekly hours of labor for about 1000010000 male workers male workers from this survey for a from this survey for a single periodsingle period with the best fitting flexible with the best fitting flexible line through these points serves as our empirical estimate of the line through these points serves as our empirical estimate of the labor-supply curve for these workerslabor-supply curve for these workers

bull The regression line traces out a shape very The regression line traces out a shape very like the backward-like the backward-bendingbending labor-supply curve with a 40-hour constraint What labor-supply curve with a 40-hour constraint What looks like a vertical line above 40 hours is looks like a vertical line above 40 hours is not really a solid line not really a solid line at all but a reflection of the fact that about at all but a reflection of the fact that about 7500 7500 of the 10000 of the 10000 workers in the sample supply 40 hours per week at a variety of workers in the sample supply 40 hours per week at a variety of wage rates The labor-supply curve traces out a segment above wage rates The labor-supply curve traces out a segment above the 40-hour point that corresponds to the constraintthe 40-hour point that corresponds to the constraint

bull There are There are points to the rightpoints to the right of 40 hours This is reasonable of 40 hours This is reasonable since in the real world workers do since in the real world workers do work overtimework overtime ndash either ndash either because they are supervisors or professionals or because because they are supervisors or professionals or because employers offer them the required time-and-half wage rate employers offer them the required time-and-half wage rate The fit of the regression line is far from perfect points lie on The fit of the regression line is far from perfect points lie on both sides of the line We should interpret it as a both sides of the line We should interpret it as a snapshotsnapshot of of the behavior of the typical worker But ofthe behavior of the typical worker But of course the typical course the typical worker is not any actual worker in particularworker is not any actual worker in particular

THE WORKER CHOOSING TO PARTICIPATETHE WORKER CHOOSING TO PARTICIPATE

bull So far we have examined only one aspect of the workerrsquos So far we have examined only one aspect of the workerrsquos labor-supply decision labor-supply decision how many hours to work for given real how many hours to work for given real wagewage We now take up the second aspect We now take up the second aspect participationparticipation ndash that ndash that is is whether or not to work at allwhether or not to work at all A labor-supply curve that starts A labor-supply curve that starts at the origin and slopes upwards for at least a portion of its at the origin and slopes upwards for at least a portion of its length suggests that even length suggests that even if the wage were very lowif the wage were very low ndash say 1cent ndash say 1cent per hour ndash the worker would work a little bit That is clearly per hour ndash the worker would work a little bit That is clearly unrealisticunrealistic no one would work at all for 1cent per hour no one would work at all for 1cent per hour What What factors determine how high the wage factors determine how high the wage must be to induce a person must be to induce a person to participate in the labor marketto participate in the labor market

bull The labor force The labor force participationparticipation decision is a question of decision is a question of opportunity costopportunity cost Idleness has its charms Before anyone enters Idleness has its charms Before anyone enters the labor force the wage rate must be high enough to overcome the labor force the wage rate must be high enough to overcome them them The opportunity cost of participatingThe opportunity cost of participating in the labor force is in the labor force is sum of sum of

1048766 1048766 the implicit valuethe implicit value the worker places on complete idleness the worker places on complete idleness

1048766 1048766 the explicit coststhe explicit costs of working compared to not working such as of working compared to not working such as clothing transport childcare) andclothing transport childcare) and

1048766 1048766 the explicit losses the explicit losses from working (for instance housework not from working (for instance housework not done)done)

bull The opportunity cost is partly psychological and partly material The opportunity cost is partly psychological and partly material If people were completely If people were completely independentindependent of each other the worker of each other the worker might place a lower value on the opportunity cost of might place a lower value on the opportunity cost of participation because then the choice might be literally between participation because then the choice might be literally between work and starvationwork and starvation

bull But most people are not But most people are not completely independentcompletely independent Whether or Whether or not to participate in the labor force could be a not to participate in the labor force could be a genuine choicegenuine choice and would depend on the and would depend on the real wagereal wage

bull The The RESERVATION WAGE RESERVATION WAGE is defined to be is defined to be the opportunity the opportunity cost of working compared to not workingcost of working compared to not working ndash ndash that is the real wage that is the real wage that is high enough to make it just worthwhile for a worker to that is high enough to make it just worthwhile for a worker to participate in the labor forceparticipate in the labor force

bull Taking account of the opportunity costs of participation affects Taking account of the opportunity costs of participation affects the shape of the labor-supply curve As long as the the shape of the labor-supply curve As long as the real wage is real wage is below the reservationbelow the reservation wage ((wp)R) the worker supplies no wage ((wp)R) the worker supplies no labor at all Above the reservation wage there is a normal labor at all Above the reservation wage there is a normal labor-supply curvelabor-supply curve

bull The following captures the two stages of the labor supply The following captures the two stages of the labor supply decision decision FirstFirst at low wages the worker will at low wages the worker will notnot supply any supply any labor at all and small increases in wages have no effect But labor at all and small increases in wages have no effect But secondsecond as soon as the wage rises enough for the worker to bite as soon as the wage rises enough for the worker to bite the bullet and join the labor force the minimum labor supplied the bullet and join the labor force the minimum labor supplied will be well will be well above zeroabove zero and the worker will decide how many and the worker will decide how many hours to supply above this minimum through the usual process hours to supply above this minimum through the usual process of balancing the opportunity cost of leisure against the desire of balancing the opportunity cost of leisure against the desire for consumption goodsfor consumption goods

AGGREGATE LABOR SUPPLY

bull How can we moveHow can we move from the microeconomics of the labor supply from the microeconomics of the labor supply back to an aggregate relationship usable in macroeconomic back to an aggregate relationship usable in macroeconomic analysis analysis If workers were essentially alikeIf workers were essentially alike the problem would the problem would be easy be easy

bull As we have seen labor supply has two dimensions ndash As we have seen labor supply has two dimensions ndash participationparticipation in the labor force and in the labor force and choice of hourschoice of hours of labor of labor Take the participation decision first If all workers were alike Take the participation decision first If all workers were alike except for except for differences in their reservation wagedifferences in their reservation wage then we could then we could rank them from lowest to highest reservation wage The rank them from lowest to highest reservation wage The aggregate labor-supply (participation) curve is strictly aggregate labor-supply (participation) curve is strictly upwardslopingupwardsloping

bull Of course this is too easy Just as we observed in deriving the Of course this is too easy Just as we observed in deriving the aggregate labor demand curve workers are aggregate labor demand curve workers are not all alikenot all alike Once Once again we must interpret the vertical axis as measuring the again we must interpret the vertical axis as measuring the average real wageaverage real wage that at best provides a kind of index for the that at best provides a kind of index for the level of the wage structure level of the wage structure

bull The The problemproblem remains the remains the samesame when we turn to the choice of when we turn to the choice of hourshours Workers are all different and face a structure of wages Workers are all different and face a structure of wages For each worker individually there is a jump from supplying For each worker individually there is a jump from supplying zero to supplying some positive number of hours zero to supplying some positive number of hours when his own when his own wage rate surpasses their wage rate surpasses their reservation wagereservation wage But in aggregate But in aggregate we are we are unlikely to see such a jumpunlikely to see such a jump Not only are there a variety Not only are there a variety of wages offered at any time but reservation wages differof wages offered at any time but reservation wages differ

Derivation of the Aggregate Labor-supply Curve

bull A curve like the one in this figure can be used to display either A curve like the one in this figure can be used to display either the the participation participation decision or decision or the hoursthe hours The horizontal axis can The horizontal axis can either be used for workers either be used for workers or worker-hoursor worker-hours as measures of the as measures of the labor supply The two meanings are not completely labor supply The two meanings are not completely independent by definition independent by definition

bull workers equiv aggregate worker ndash hours average hours per worker workers equiv aggregate worker ndash hours average hours per worker

The Participation Rate and Average Hours

bull Let us look first at the aggregate participation decision The Let us look first at the aggregate participation decision The aggregate number of workers who have decided to participate aggregate number of workers who have decided to participate is known as the is known as the labor forcelabor force the the civilian labor force over 16 civilian labor force over 16 years of ageyears of age This number excludes uniformed members of the This number excludes uniformed members of the armed services and the small number of workers under 16 armed services and the small number of workers under 16 years old The labor force of course has grown right along years old The labor force of course has grown right along with population with population

bull The participation rateThe participation rate (PR) measures (PR) measures the labor force as its ratio the labor force as its ratio to the relevant populationto the relevant population

bull participation rate = labor forcerelevant population participation rate = labor forcerelevant population

bull ldquoldquonon-institutionalrdquo non-institutionalrdquo excludes people in prison or in homes for excludes people in prison or in homes for the aged) the aged)

bull The aggregate number of hours The aggregate number of hours worked is worked is not as easy not as easy as the as the participation rate to relate to the individual workerrsquos choices participation rate to relate to the individual workerrsquos choices If every worker had the same labor-supply curve we would If every worker had the same labor-supply curve we would have to know the wage offered to each one in order to calculate have to know the wage offered to each one in order to calculate the total number of labor hours supplied In reality workers the total number of labor hours supplied In reality workers are not all alike are not all alike Labor-supply curves may vary systematically Labor-supply curves may vary systematically according to the sex age ethnic group education experience according to the sex age ethnic group education experience or other social or economic characteristics of the workersor other social or economic characteristics of the workers And And within any group the labor-supply curves of individuals are within any group the labor-supply curves of individuals are likely to varylikely to vary

bull In principle In principle if we had a good statistical estimate of the typical if we had a good statistical estimate of the typical distribution of the wagesdistribution of the wages we could make a reasonable we could make a reasonable calculation But statisticians at the Bureau of Labor Statistics calculation But statisticians at the Bureau of Labor Statistics (BLS) do not try to calculate the labor supply in this way (BLS) do not try to calculate the labor supply in this way Instead they Instead they count the number of hours that workers actually count the number of hours that workers actually workwork and the average and the average wages and salaries they are paid wages and salaries they are paid

bull In USA the total hours of labor in 1998 was In USA the total hours of labor in 1998 was 236882236882 million million The average hours of work is The average hours of work is 17211721 hours per year = hours per year = 344344 hours hours per week (assuming a 50 week year) This number is 14 percent per week (assuming a 50 week year) This number is 14 percent below the full time 40-hour week which makes sense since it below the full time 40-hour week which makes sense since it averages over full-time part-time and overtime workers averages over full-time part-time and overtime workers

Labor Market EquilibriumLabor Market Equilibrium

bull MARKET CLEARINGMARKET CLEARING

bull When both demand and supply curves are plotted on the same When both demand and supply curves are plotted on the same diagram the crossing point defines the diagram the crossing point defines the equilibrium real-wage equilibrium real-wage rate and the rate and the equilibrium level of labor employedequilibrium level of labor employed

bull The real wage The real wage looks different looks different from the point of view of the firm from the point of view of the firm and the worker For the and the worker For the firmfirm the relevant real wage is the the relevant real wage is the product-real wage product-real wage defined as defined as the number of units of the good the number of units of the good the firm produces that the wage will purchase the firm produces that the wage will purchase ((price of price of productproduct = = w) w) For the For the workerworker the relevant real wage is the the relevant real wage is the consumption-consumption-real real wagewage defined as defined as the number of typical consumption baskets the number of typical consumption baskets that the wage will purchase that the wage will purchase ((price of price of consumption basket consumption basket = = w)w)

bull For aggregate analysis we might use the For aggregate analysis we might use the Producer Price IndexProducer Price Index or the GDP deflator to approximate the or the GDP deflator to approximate the product priceproduct price and the and the CPICPI to approximate the to approximate the consumption price consumption price

bull Suppose that the product-real wage and the consumption-real Suppose that the product-real wage and the consumption-real wage in the following figure start out with the identical value wage in the following figure start out with the identical value ((wp) at the market-clearing point Awp) at the market-clearing point A Now suppose that Now suppose that imported Japanese cars are a large portion of the typical imported Japanese cars are a large portion of the typical workerrsquos consumption basket workerrsquos consumption basket and that and that ceteris paribus ceteris paribus the price the price of Japanese cars rises sharply This means that the of Japanese cars rises sharply This means that the real wage real wage from the point of view of the from the point of view of the consumer falls to (consumer falls to (wpwpCPICPI ) )11 at point at point

B B on the labor-supply curve (LS) so that the worker would on the labor-supply curve (LS) so that the worker would want to supply less labor (want to supply less labor (LL11))

bull The rise in the price of Japanese cars has no effect on the price The rise in the price of Japanese cars has no effect on the price of their products Nevertheless they see a reduction of labor of their products Nevertheless they see a reduction of labor supply at the original market clearing wage It is as if the supply at the original market clearing wage It is as if the labor-supply curve labor-supply curve has shifted to the left to has shifted to the left to LSLSrsquo which passes rsquo which passes through ((through ((wp) L1) at point C wp) L1) at point C At the original wage rate labor At the original wage rate labor demand exceeds labor supply so firms raise wages in an effort demand exceeds labor supply so firms raise wages in an effort to attract workers until they reach the new market-clearing to attract workers until they reach the new market-clearing wage at point D where they pay (wage at point D where they pay (wpwpPPIPPI ) for labor of L ) for labor of L The The

rise in the price of Japanese cars has the effect of raising the rise in the price of Japanese cars has the effect of raising the wages that firms must pay and reducing labor employedwages that firms must pay and reducing labor employed Higher wages partly compensate workers for the higher costs Higher wages partly compensate workers for the higher costs of consumption but firms can afford to pay those higher wages of consumption but firms can afford to pay those higher wages only if marginal products rise as a result of their using less only if marginal products rise as a result of their using less labor labor

bull The rise in wage rates is not enough to compensate workers The rise in wage rates is not enough to compensate workers fully so the consumption-real wage in equilibrium is (wpfully so the consumption-real wage in equilibrium is (wpCPI CPI ) )

atat point E We can think of import prices as a tax levied on point E We can think of import prices as a tax levied on consumers and of an increase in import prices as widening the consumers and of an increase in import prices as widening the tax wedge Unless the issue that we want to analyze depends on tax wedge Unless the issue that we want to analyze depends on the difference between product- and consumption-real wages the difference between product- and consumption-real wages we will treat the real wage as the same for both labor supply we will treat the real wage as the same for both labor supply and labor demandand labor demand

An Increase in the Price of Consumption GoodsAn Increase in the Price of Consumption GoodsRelative to the Price of OutputRelative to the Price of Output

ANALYZING IDEAL LABOR MARKETSANALYZING IDEAL LABOR MARKETS

bull The aggregate labor-supplylabor-demand diagram provides us The aggregate labor-supplylabor-demand diagram provides us with a powerful tool We now analyze three important with a powerful tool We now analyze three important macroeconomic issues macroeconomic issues

(1) the effect of tax cuts on employment (1) the effect of tax cuts on employment

(2) the effect of technological progress on the well-being of (2) the effect of technological progress on the well-being of workers and workers and

(3) the effect of immigration on existing workers (3) the effect of immigration on existing workers

bull Issue 1 Tax Cuts Issue 1 Tax Cuts What are the effects of a cut in marginal What are the effects of a cut in marginal income-tax rates on employment and the level of GDP in the income-tax rates on employment and the level of GDP in the economyeconomy Recall from section that a lower marginal income-Recall from section that a lower marginal income-tax rate increases labor supply at each real wage (a rightward tax rate increases labor supply at each real wage (a rightward shift of the labor-supply) shift of the labor-supply)

bull Labor-market equilibrium moves from point A to point B in Labor-market equilibrium moves from point A to point B in the lower panel of the following Notice that the amount of the lower panel of the following Notice that the amount of labor available to firms increases so that firms move labor available to firms increases so that firms move production from Arsquo to Brsquo on the labor production function in production from Arsquo to Brsquo on the labor production function in the upper panel Also notice that the real wage falls from (the upper panel Also notice that the real wage falls from (wp)1 wp)1 to (wp)2 Since the cut in taxes increases the number of to (wp)2 Since the cut in taxes increases the number of workers workers willing to work at each wage Workers care about their take-willing to work at each wage Workers care about their take-home pay ndash that is about their home pay ndash that is about their after-tax real wage after-tax real wage This is This is perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 can be greater than the old after-tax real wage (1ndashcan be greater than the old after-tax real wage (1ndashτ1τ1)(wp)1 so )(wp)1 so long as the rise in the take-home share (1 ndash τ) is long as the rise in the take-home share (1 ndash τ) is proportionately greater than the fall in the before-tax real proportionately greater than the fall in the before-tax real wage (wp)wage (wp)

bull The analysis depends on substitution effects dominating The analysis depends on substitution effects dominating income effects which they probably do in aggregate if not for income effects which they probably do in aggregate if not for every worker So the supply-siders of the Reagan years are every worker So the supply-siders of the Reagan years are correct in principle How much output will increase depends on correct in principle How much output will increase depends on how large the substitution effect is If most people work a how large the substitution effect is If most people work a standard 40-hour week the effect could be quite small and the standard 40-hour week the effect could be quite small and the increase in output might also be very small in practiceincrease in output might also be very small in practice

Issue 1 The Effect of a Cut in Marginal Tax RatesIssue 1 The Effect of a Cut in Marginal Tax Rates

Issue 2 Technological Progress and Worker WelfareIssue 2 Technological Progress and Worker Welfare

bull Is technological progress and increasing use of machinery and Is technological progress and increasing use of machinery and other capital beneficial for workersother capital beneficial for workers

bull Technological change or capital accumulation have been Technological change or capital accumulation have been known as ldquoLudditesrdquo (known as ldquoLudditesrdquo (it negatively affects the demand for it negatively affects the demand for laborlabor) To see why the Luddites are wrong ndash at least for ) To see why the Luddites are wrong ndash at least for clearing labor markets ndash recall that technological progress or clearing labor markets ndash recall that technological progress or increased capital both increased capital both shift the labor-demand curve upwardshift the labor-demand curve upward The lower panel of the following figure shows that the effect of The lower panel of the following figure shows that the effect of the increased demand for labor is to increase total employment the increased demand for labor is to increase total employment and the real wage Firms and the real wage Firms can pay a higher real wage can pay a higher real wage because because the additional capital or technological progress the additional capital or technological progress increases the increases the marginal product of labormarginal product of labor

bull The The Ludditesrsquo mistake Ludditesrsquo mistake is most easily seen in the upper panel is most easily seen in the upper panel The Luddite argument assumes that fewer workers will The Luddite argument assumes that fewer workers will produce the same total output Production starts at Arsquo using produce the same total output Production starts at Arsquo using L1 L1 workers to produce Y1 After the upward shift in the production workers to produce Y1 After the upward shift in the production function the same output could be produced using less labor function the same output could be produced using less labor ((L3) at point Arsquorsquo The L3) at point Arsquorsquo The problem is that Arsquorsquo is not an equilibrium problem is that Arsquorsquo is not an equilibrium At that point the marginal product of labor is higher than the At that point the marginal product of labor is higher than the original real wage so a profit-maximizing firm would want to original real wage so a profit-maximizing firm would want to expand production To do this they must hire more labor than expand production To do this they must hire more labor than L3 and indeed they L3 and indeed they find it find it profitable profitable to hire more labor than to hire more labor than the original the original L1 The only way actually to increase labor L1 The only way actually to increase labor is to is to raise the real-wage raise the real-wage rate above its original level Technological rate above its original level Technological progress therefore favors progress therefore favors workers by increasing employment workers by increasing employment and wagesand wages

bull Early in the 19th century hand-woven cloth was very Early in the 19th century hand-woven cloth was very expensive and a worker was lucky to own the clothes on his expensive and a worker was lucky to own the clothes on his back and a spare set for church on Sunday Textiles were one of back and a spare set for church on Sunday Textiles were one of the first industries to benefit from the Industrial Revolution so the first industries to benefit from the Industrial Revolution so that by the end of the 19th century machine-made fabrics and that by the end of the 19th century machine-made fabrics and mass-production made decent clothing in larger quantities mass-production made decent clothing in larger quantities accessible to most of the population of the more developed accessible to most of the population of the more developed countries Similar progress has been made in most forms of countries Similar progress has been made in most forms of production Agricultural production which at the turn of the production Agricultural production which at the turn of the 20th century absorbed half the labor force now absorbs less 20th century absorbed half the labor force now absorbs less than 3 percent while producing more food more cheaply than than 3 percent while producing more food more cheaply than ever ever

bull We must be careful not to dismiss the Luddites as altogether We must be careful not to dismiss the Luddites as altogether foolish While new technology especially over decades has foolish While new technology especially over decades has proved to be a net gain for workers in general the Luddites proved to be a net gain for workers in general the Luddites were in fact correct that their way of life was threatened were in fact correct that their way of life was threatened Independent weavers became factory hands unskilled Independent weavers became factory hands unskilled workers increasingly women and often children replaced workers increasingly women and often children replaced skilled craftsmen and factory work often involved long hours skilled craftsmen and factory work often involved long hours in brutal conditions The wider society reaps the benefits of in brutal conditions The wider society reaps the benefits of technological change while a narrow group sometimes technological change while a narrow group sometimes disproportionately bears its costs Our analysis also assumes disproportionately bears its costs Our analysis also assumes that markets generally clear The implicit assumption is that that markets generally clear The implicit assumption is that displaced workers move on to new jobs possibly in other forms displaced workers move on to new jobs possibly in other forms of production Markets may have a tendency to clear in the of production Markets may have a tendency to clear in the long run yet workers may find themselves displaced in the long run yet workers may find themselves displaced in the short run say over the course of a business cycleshort run say over the course of a business cycle

Issue 3 Immigration Jobs and Real WagesIssue 3 Immigration Jobs and Real Wages

bull How does an increase in the labor force through immigration or How does an increase in the labor force through immigration or natural population growth affect labor and GDP natural population growth affect labor and GDP

bull One of the emotional issues associated with US immigration One of the emotional issues associated with US immigration policy ndash particularly towards low-wage workers from Mexico ndash policy ndash particularly towards low-wage workers from Mexico ndash is the idea that is the idea that immigrants take jobs away from native immigrants take jobs away from native workers workers We might be tempted to dismiss this fear as another We might be tempted to dismiss this fear as another example of the lump-of-labor fallacy Yet there is a sensible example of the lump-of-labor fallacy Yet there is a sensible intuition behind the argument An increase in the labor force ndash intuition behind the argument An increase in the labor force ndash due either to immigration or to higher population growth rates due either to immigration or to higher population growth rates ndash can be represented as an outward shift of the aggregate labor ndash can be represented as an outward shift of the aggregate labor supply curve as shown in the following Figure Employment supply curve as shown in the following Figure Employment increases but real wages fall It is not then that immigrants increases but real wages fall It is not then that immigrants take jobs away from natives take jobs away from natives Rather they compete for jobsRather they compete for jobs putting downward pressure on real wagesputting downward pressure on real wages

bull Again we must exercise care in interpreting the analysis Again we must exercise care in interpreting the analysis Remember that aggregate labor and average wage rates hide Remember that aggregate labor and average wage rates hide many details of the labor process The incomes of the new many details of the labor process The incomes of the new immigrants immigrants creates demand creates demand for the new production that they for the new production that they make possible Immigrant workers (at least those ndash whether make possible Immigrant workers (at least those ndash whether legal or illegal ndash who have become the focus of the most intense legal or illegal ndash who have become the focus of the most intense political debate) political debate) are likely to possess fewer skills than nativesare likely to possess fewer skills than natives The net effect is that the increased demand for goods and The net effect is that the increased demand for goods and services generated by immigrants is likely to increase the services generated by immigrants is likely to increase the demand for skilled (demand for skilled (and largely nativeand largely native) workers relative to ) workers relative to their supply and so to increase real wages of skilled workers their supply and so to increase real wages of skilled workers Low-skilled immigration may lower the real wage for farm Low-skilled immigration may lower the real wage for farm workers but if anything it would raise the real wage for workers but if anything it would raise the real wage for computer programmerscomputer programmers

Next Task Labor Market in Kuwait

Appendix Is Labor Supply Stable Over Time

bull Statistics on participation rates or average hours for a Statistics on participation rates or average hours for a particular month or year are snapshot of the labor market particular month or year are snapshot of the labor market Can we analyze the effects of that increase on the labor market Can we analyze the effects of that increase on the labor market under the assumption that the labor-supply curves of workers under the assumption that the labor-supply curves of workers remain essentially stableremain essentially stable

bull Data on participation rates in the United States appear to Data on participation rates in the United States appear to support this conjecture (see Figure 811) which shows the support this conjecture (see Figure 811) which shows the overall civilian participation rate trending upward ndash at least overall civilian participation rate trending upward ndash at least from the middle of the 1960sfrom the middle of the 1960s

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

THE AGGREGATE DEMAND FOR LABOR

bull In macroeconomic analysis we are more concerned with the In macroeconomic analysis we are more concerned with the aggregate demand for laboraggregate demand for labor If all firms produced the If all firms produced the samesame products and if all workers were products and if all workers were alikealike then aggregation from then aggregation from the firm to the economy as a whole would be easy (see the the firm to the economy as a whole would be easy (see the figure) Unfortunately it is not that simplefigure) Unfortunately it is not that simple

bull The first problem is that all firms are The first problem is that all firms are not producing the same not producing the same productproduct When different firms produce different goods we When different firms produce different goods we must find a common unit of measurement must find a common unit of measurement

bull The second problem is that The second problem is that not all workers are alikenot all workers are alike Different Different kinds of workers may face kinds of workers may face different wage rates different wage rates and therefore and therefore have have different marginal products different marginal products at the optimum For our at the optimum For our purposes the wage structure can be summarized in the purposes the wage structure can be summarized in the average average wage ratewage rate Though It provides an imperfect index of the Though It provides an imperfect index of the movements of the wage structure movements of the wage structure

Labor Supply

bull Two measures reflect two aspects of the workerrsquos labor supply Two measures reflect two aspects of the workerrsquos labor supply decision (i) decision (i) participationparticipation ndash that is whether to work or not ndash that is whether to work or not work and (ii) work and (ii) intensityintensity ndash that is how many hours to work It is ndash that is how many hours to work It is easier if we consider intensity first conditional on having easier if we consider intensity first conditional on having decided to work what factors govern the workerrsquos choice of decided to work what factors govern the workerrsquos choice of how many hours of work to supplyhow many hours of work to supply

bull THE WORKER CHOOSING HOURS OF WORKTHE WORKER CHOOSING HOURS OF WORK

bull The Price of LeisureThe Price of Leisure

bull People work for a variety of reasons The most obvious is to People work for a variety of reasons The most obvious is to earn the incomeearn the income Many people ndash though not all ndash find their Many people ndash though not all ndash find their work work fulfilling and interestingfulfilling and interesting Still even those people will Still even those people will generally prefer another generally prefer another hour of leisure hour of leisure to another hour of to another hour of work It is therefore reasonable to assume that work It is therefore reasonable to assume that leisure is a leisure is a goodgood

bull Goods generally have a price Yet there is Goods generally have a price Yet there is nono market for market for leisureleisure Even though there is no explicit price there is an Even though there is no explicit price there is an implicit price or opportunity cost The implicit price or opportunity cost The OPPORTUNITY COST OPPORTUNITY COST of any choice is the value of the best alternative choice that it of any choice is the value of the best alternative choice that it foreclosesforecloses The implicit price of leisure is its opportunity cost The implicit price of leisure is its opportunity cost which is measured by the real wage (which is measured by the real wage (wp) wp)

bull The Labor-Leisure ChoiceThe Labor-Leisure Choice

bull Once we see leisure as a good and the real-wage rate as its Once we see leisure as a good and the real-wage rate as its price it is easier to understand the choices a worker faces price it is easier to understand the choices a worker faces There are 168 hours in a week If a worker chooses There are 168 hours in a week If a worker chooses not to work not to work at allat all he enjoys 168 hours of leisure but forgoes the income he enjoys 168 hours of leisure but forgoes the income needed to buy any other goods If the worker instead takes needed to buy any other goods If the worker instead takes fewer hours of leisure he supplies labor fewer hours of leisure he supplies labor l = 168 ndash hours of l = 168 ndash hours of leisure leisure and he gains the ability to purchase goods worth wp times l and he gains the ability to purchase goods worth wp times l The problem The problem for the worker for the worker is to choose is to choose the hours of labor (the hours of labor (l ) l ) that at the margin makes the psychic value of a small loss that at the margin makes the psychic value of a small loss further loss of leisure time (ie a small increase in labor time) further loss of leisure time (ie a small increase in labor time) exactly equal to the psychic value of the small gain in exactly equal to the psychic value of the small gain in consumption goods that would be purchased by that laborconsumption goods that would be purchased by that labor

bull INCOME EFFECT How would your supply of labor change if you could receive the income that results from the increased wage rate without facing a changed opportunity cost of leisure

bull As a general rule an increase in income ceteris paribus increases the demand for all goods The extra $20 per week would permit you to buy more goods including leisure without reducing your purchases of other goods The reduction in the supply of labor as the result of an increase in income is called the income effect

bull SUBSTITUTION EFFECTSUBSTITUTION EFFECT

bull If the wage rate rose If the wage rate rose would people work more or less As a would people work more or less As a general rule whenever general rule whenever ceteris paribus the price of anything rises ceteris paribus the price of anything rises relative to alternativesrelative to alternatives the demand for it decreases Here the the demand for it decreases Here the price of leisure price of leisure (its opportunity cost) has risen relative to the (its opportunity cost) has risen relative to the price of other goods the supply of price of other goods the supply of labor would riselabor would rise The change The change in the wage rate encourages people to substitute the now in the wage rate encourages people to substitute the now cheaper goods (what you buy using your wage) for the now cheaper goods (what you buy using your wage) for the now more expensive leisure more expensive leisure The increase in the supply of labor as The increase in the supply of labor as the result of an increase in the price (or opportunity cost) of the result of an increase in the price (or opportunity cost) of leisure is called theleisure is called the SUBSTITUTION EFFECT SUBSTITUTION EFFECT

bull The Labor-supply CurveThe Labor-supply Curve

bull The following figure represents the workerrsquos labor-supply The following figure represents the workerrsquos labor-supply decision Look first at panel (A) Suppose that at point A decision Look first at panel (A) Suppose that at point A where the real wage is (where the real wage is (wp)1 the worker decides that providing l wp)1 the worker decides that providing l hours of work balances the advantages of a little more hours of work balances the advantages of a little more consumption against a little more leisure at the margin Now consumption against a little more leisure at the margin Now consider what happens when the real wage rises to (consider what happens when the real wage rises to (wp)2 wp)2 There is a substitution effect shown by the arrow pointing to There is a substitution effect shown by the arrow pointing to the right which encourages the worker to supply more labor the right which encourages the worker to supply more labor The size of the substitution effect is measured by the length of The size of the substitution effect is measured by the length of the arrowthe arrow

bull There is also an income effect shown by the arrow pointing to There is also an income effect shown by the arrow pointing to the left which encourages the worker to supply less laborthe left which encourages the worker to supply less labor

The Slope of the Labor-Supply Curve

bull The net effect The net effect is measured by the difference between the is measured by the difference between the substitution and income effects shown at point B so that an substitution and income effects shown at point B so that an increase in the wage rate increases the workerrsquos supply of labor increase in the wage rate increases the workerrsquos supply of labor to to l2 to the right of l1 If the substitution effect is always stronger l2 to the right of l1 If the substitution effect is always stronger then the labor supply then the labor supply curve slopes upward curve slopes upward

bull Substitution effects are not necessarily stronger than income Substitution effects are not necessarily stronger than income effectseffects Panel (B) shows the construction of the labor-supply Panel (B) shows the construction of the labor-supply curve starting from point C when income effects are stronger curve starting from point C when income effects are stronger than substitution effects When the real-wage rate increases than substitution effects When the real-wage rate increases from (from (wp)1 to (wp)2 the dominant income effect overwhelms wp)1 to (wp)2 the dominant income effect overwhelms the substitution effect and labor the substitution effect and labor supply (point C) falls from supply (point C) falls from l1 to l1 to l2 If income effects are stronger for all wage rates above l2 If income effects are stronger for all wage rates above ((wp)1 wp)1 then the labor-supply curve will slope downward toward point C then the labor-supply curve will slope downward toward point C higher real wage higher real wage rates lower labor supplyrates lower labor supply

bull Although the labor-supply curve can slope downward towards Although the labor-supply curve can slope downward towards a point like A it is not reasonable to believe that it could slope a point like A it is not reasonable to believe that it could slope downward for every possible wage rate At very low wage rates downward for every possible wage rate At very low wage rates it is more reasonable to suppose that with very low incomes it is more reasonable to suppose that with very low incomes the workerrsquos need for food clothing shelter and other the workerrsquos need for food clothing shelter and other ldquoessentialrdquo goods the income effect is weak and the ldquoessentialrdquo goods the income effect is weak and the substitution effect is strong We should therefore expect the substitution effect is strong We should therefore expect the labor-supply curve to be upward sloping when wage rates are labor-supply curve to be upward sloping when wage rates are low Hence labor supply would be backward bending low Hence labor supply would be backward bending

Backward-bending Labor-supply Curve

Adding Realism TaxesAdding Realism Taxes

bull How does the tax affect the income from a little more or a little How does the tax affect the income from a little more or a little less work To answer this question we must know the less work To answer this question we must know the marginal marginal tax ratetax rate ((the fraction of an additional dollar of income that is the fraction of an additional dollar of income that is paid as taxes) paid as taxes) To keep things simple assume that all income is To keep things simple assume that all income is taxed at the same taxed at the same flatflat rate rate ττ In this case the marginal tax rate In this case the marginal tax rate must also be τ which takes a value between zero and one If a must also be τ which takes a value between zero and one If a worker earns worker earns wpwp for an hour of work the government takes for an hour of work the government takes τ(wp) τ(wp) as taxes and leaves the worker as taxes and leaves the worker (1ndashτ)(wp) (1ndashτ)(wp) as the after-as the after-tax real wagetax real wage

bull Since the worker actually receives the Since the worker actually receives the after-tax real wageafter-tax real wage it is it is the the true opportunity cost of leisure true opportunity cost of leisure Any increase in the Any increase in the marginal tax rate represents a decrease in the opportunity cost marginal tax rate represents a decrease in the opportunity cost of leisure If of leisure If substitution effectssubstitution effects are stronger than income are stronger than income effects then any increase in marginal tax rates effects then any increase in marginal tax rates reducesreduces the the supply of labor supply of labor as shown in the following figureas shown in the following figure

The Effect of a Tax Increase on Labor Supply

bull The labor-supply curve with no taxes is shown on the right of The labor-supply curve with no taxes is shown on the right of the figure At the figure At (wp)1(wp)1 the worker supplies labor the worker supplies labor l1l1 If a tax of If a tax of τ1τ1 is imposed the after-tax real wage is is imposed the after-tax real wage is (1ndashτ1)(wp)1(1ndashτ1)(wp)1 The worker The worker should react exactly as if he paid no taxes but suffered a cut in should react exactly as if he paid no taxes but suffered a cut in his wages This is shown as a movement from point A to point B his wages This is shown as a movement from point A to point B where labor supply has fallen to where labor supply has fallen to l2l2 But of course the wage rate But of course the wage rate did not really falldid not really fall the employer still pays (wp)1 This means the employer still pays (wp)1 This means that (l2 (wp)1) is the labor-supply (point C)that (l2 (wp)1) is the labor-supply (point C)

bull Since this would apply for any real-wage rate every point on Since this would apply for any real-wage rate every point on the original curve shifts to the left Because the the original curve shifts to the left Because the tax rate is tax rate is proportional its absolute effect is greaterproportional its absolute effect is greater as is the shift in the as is the shift in the labor-supply curve at high wage rates resulting in a labor-supply curve at high wage rates resulting in a steepening of the curve Any further increase in the tax rate to steepening of the curve Any further increase in the tax rate to say τ2 would shift the labor-supply curve further to the left say τ2 would shift the labor-supply curve further to the left

bull The length of the line segment BC measures the The length of the line segment BC measures the TAX WEDGETAX WEDGE between the real wage paid by employers and the after-tax real between the real wage paid by employers and the after-tax real wage received by workewage received by workersrs The The largerlarger the tax wedge the the tax wedge the largerlarger the leftward shift of the labor-supply curve and the the leftward shift of the labor-supply curve and the greater the greater the reductionreduction in labor supplied at any real wage in labor supplied at any real wage

bull The idea that tax increases lower labor supply and conversely The idea that tax increases lower labor supply and conversely that tax cuts increase labor supply was a major tenet of the so-that tax cuts increase labor supply was a major tenet of the so-called called supply-side economicssupply-side economics popular in the early 1980s popular in the early 1980s President Ronald Reagan and his advisors used it to argue that President Ronald Reagan and his advisors used it to argue that cuts in marginal tax rates cuts in marginal tax rates would stimulate people would stimulate people to to workwork harder and to harder and to earn larger earn larger incomesincomes

Adding Realism A Standard WorkweekAdding Realism A Standard Workweek

bull Another way in which the simple analysis of labor supply is Another way in which the simple analysis of labor supply is unrealistic is that many unrealistic is that many workers are not given an option about workers are not given an option about the number of hours they workthe number of hours they work Although people work part- Although people work part-time and overtime either may be voluntary or mandatory time and overtime either may be voluntary or mandatory

bull Assuming that workers are Assuming that workers are not permitted to work more than not permitted to work more than 40 hours a week40 hours a week the following figure includes a constraint of the following figure includes a constraint of 40 hours If the worker were permitted to choose freely then 40 hours If the worker were permitted to choose freely then the labor-supply curve would backward bending curve The the labor-supply curve would backward bending curve The overall effect is to of the standard work week is to reshape the overall effect is to of the standard work week is to reshape the labor-supply curve as indicated by the heavy curve with the labor-supply curve as indicated by the heavy curve with the vertical segment that runs through points A F G D and E vertical segment that runs through points A F G D and E Any worker on this vertical segment is constrainedAny worker on this vertical segment is constrained

The Individual Labor-Supply Curve in PracticeThe Individual Labor-Supply Curve in Practice

bull What does the individual labor-supply curve look like in What does the individual labor-supply curve look like in realityreality It is difficult to answer this question because in reality It is difficult to answer this question because in reality we can observe we can observe only one pointonly one point on the labor-supply curve for a on the labor-supply curve for a single worker single worker at a particular timeat a particular time All the other points are All the other points are conjecturesconjectures about what the worker would supply if faced with about what the worker would supply if faced with different wage rates If we imagine that on average workers are different wage rates If we imagine that on average workers are substantially substantially similarsimilar we might nonetheless get some idea of we might nonetheless get some idea of what the individual labor-supply curve might look likewhat the individual labor-supply curve might look like

bull The The National Longitudinal SurveyNational Longitudinal Survey (Youth) has catalogued the (Youth) has catalogued the work histories of a large sample of individuals starting at a work histories of a large sample of individuals starting at a young age The following figure plots the real-wage rates and young age The following figure plots the real-wage rates and average weekly hours of labor for about average weekly hours of labor for about 1000010000 male workers male workers from this survey for a from this survey for a single periodsingle period with the best fitting flexible with the best fitting flexible line through these points serves as our empirical estimate of the line through these points serves as our empirical estimate of the labor-supply curve for these workerslabor-supply curve for these workers

bull The regression line traces out a shape very The regression line traces out a shape very like the backward-like the backward-bendingbending labor-supply curve with a 40-hour constraint What labor-supply curve with a 40-hour constraint What looks like a vertical line above 40 hours is looks like a vertical line above 40 hours is not really a solid line not really a solid line at all but a reflection of the fact that about at all but a reflection of the fact that about 7500 7500 of the 10000 of the 10000 workers in the sample supply 40 hours per week at a variety of workers in the sample supply 40 hours per week at a variety of wage rates The labor-supply curve traces out a segment above wage rates The labor-supply curve traces out a segment above the 40-hour point that corresponds to the constraintthe 40-hour point that corresponds to the constraint

bull There are There are points to the rightpoints to the right of 40 hours This is reasonable of 40 hours This is reasonable since in the real world workers do since in the real world workers do work overtimework overtime ndash either ndash either because they are supervisors or professionals or because because they are supervisors or professionals or because employers offer them the required time-and-half wage rate employers offer them the required time-and-half wage rate The fit of the regression line is far from perfect points lie on The fit of the regression line is far from perfect points lie on both sides of the line We should interpret it as a both sides of the line We should interpret it as a snapshotsnapshot of of the behavior of the typical worker But ofthe behavior of the typical worker But of course the typical course the typical worker is not any actual worker in particularworker is not any actual worker in particular

THE WORKER CHOOSING TO PARTICIPATETHE WORKER CHOOSING TO PARTICIPATE

bull So far we have examined only one aspect of the workerrsquos So far we have examined only one aspect of the workerrsquos labor-supply decision labor-supply decision how many hours to work for given real how many hours to work for given real wagewage We now take up the second aspect We now take up the second aspect participationparticipation ndash that ndash that is is whether or not to work at allwhether or not to work at all A labor-supply curve that starts A labor-supply curve that starts at the origin and slopes upwards for at least a portion of its at the origin and slopes upwards for at least a portion of its length suggests that even length suggests that even if the wage were very lowif the wage were very low ndash say 1cent ndash say 1cent per hour ndash the worker would work a little bit That is clearly per hour ndash the worker would work a little bit That is clearly unrealisticunrealistic no one would work at all for 1cent per hour no one would work at all for 1cent per hour What What factors determine how high the wage factors determine how high the wage must be to induce a person must be to induce a person to participate in the labor marketto participate in the labor market

bull The labor force The labor force participationparticipation decision is a question of decision is a question of opportunity costopportunity cost Idleness has its charms Before anyone enters Idleness has its charms Before anyone enters the labor force the wage rate must be high enough to overcome the labor force the wage rate must be high enough to overcome them them The opportunity cost of participatingThe opportunity cost of participating in the labor force is in the labor force is sum of sum of

1048766 1048766 the implicit valuethe implicit value the worker places on complete idleness the worker places on complete idleness

1048766 1048766 the explicit coststhe explicit costs of working compared to not working such as of working compared to not working such as clothing transport childcare) andclothing transport childcare) and

1048766 1048766 the explicit losses the explicit losses from working (for instance housework not from working (for instance housework not done)done)

bull The opportunity cost is partly psychological and partly material The opportunity cost is partly psychological and partly material If people were completely If people were completely independentindependent of each other the worker of each other the worker might place a lower value on the opportunity cost of might place a lower value on the opportunity cost of participation because then the choice might be literally between participation because then the choice might be literally between work and starvationwork and starvation

bull But most people are not But most people are not completely independentcompletely independent Whether or Whether or not to participate in the labor force could be a not to participate in the labor force could be a genuine choicegenuine choice and would depend on the and would depend on the real wagereal wage

bull The The RESERVATION WAGE RESERVATION WAGE is defined to be is defined to be the opportunity the opportunity cost of working compared to not workingcost of working compared to not working ndash ndash that is the real wage that is the real wage that is high enough to make it just worthwhile for a worker to that is high enough to make it just worthwhile for a worker to participate in the labor forceparticipate in the labor force

bull Taking account of the opportunity costs of participation affects Taking account of the opportunity costs of participation affects the shape of the labor-supply curve As long as the the shape of the labor-supply curve As long as the real wage is real wage is below the reservationbelow the reservation wage ((wp)R) the worker supplies no wage ((wp)R) the worker supplies no labor at all Above the reservation wage there is a normal labor at all Above the reservation wage there is a normal labor-supply curvelabor-supply curve

bull The following captures the two stages of the labor supply The following captures the two stages of the labor supply decision decision FirstFirst at low wages the worker will at low wages the worker will notnot supply any supply any labor at all and small increases in wages have no effect But labor at all and small increases in wages have no effect But secondsecond as soon as the wage rises enough for the worker to bite as soon as the wage rises enough for the worker to bite the bullet and join the labor force the minimum labor supplied the bullet and join the labor force the minimum labor supplied will be well will be well above zeroabove zero and the worker will decide how many and the worker will decide how many hours to supply above this minimum through the usual process hours to supply above this minimum through the usual process of balancing the opportunity cost of leisure against the desire of balancing the opportunity cost of leisure against the desire for consumption goodsfor consumption goods

AGGREGATE LABOR SUPPLY

bull How can we moveHow can we move from the microeconomics of the labor supply from the microeconomics of the labor supply back to an aggregate relationship usable in macroeconomic back to an aggregate relationship usable in macroeconomic analysis analysis If workers were essentially alikeIf workers were essentially alike the problem would the problem would be easy be easy

bull As we have seen labor supply has two dimensions ndash As we have seen labor supply has two dimensions ndash participationparticipation in the labor force and in the labor force and choice of hourschoice of hours of labor of labor Take the participation decision first If all workers were alike Take the participation decision first If all workers were alike except for except for differences in their reservation wagedifferences in their reservation wage then we could then we could rank them from lowest to highest reservation wage The rank them from lowest to highest reservation wage The aggregate labor-supply (participation) curve is strictly aggregate labor-supply (participation) curve is strictly upwardslopingupwardsloping

bull Of course this is too easy Just as we observed in deriving the Of course this is too easy Just as we observed in deriving the aggregate labor demand curve workers are aggregate labor demand curve workers are not all alikenot all alike Once Once again we must interpret the vertical axis as measuring the again we must interpret the vertical axis as measuring the average real wageaverage real wage that at best provides a kind of index for the that at best provides a kind of index for the level of the wage structure level of the wage structure

bull The The problemproblem remains the remains the samesame when we turn to the choice of when we turn to the choice of hourshours Workers are all different and face a structure of wages Workers are all different and face a structure of wages For each worker individually there is a jump from supplying For each worker individually there is a jump from supplying zero to supplying some positive number of hours zero to supplying some positive number of hours when his own when his own wage rate surpasses their wage rate surpasses their reservation wagereservation wage But in aggregate But in aggregate we are we are unlikely to see such a jumpunlikely to see such a jump Not only are there a variety Not only are there a variety of wages offered at any time but reservation wages differof wages offered at any time but reservation wages differ

Derivation of the Aggregate Labor-supply Curve

bull A curve like the one in this figure can be used to display either A curve like the one in this figure can be used to display either the the participation participation decision or decision or the hoursthe hours The horizontal axis can The horizontal axis can either be used for workers either be used for workers or worker-hoursor worker-hours as measures of the as measures of the labor supply The two meanings are not completely labor supply The two meanings are not completely independent by definition independent by definition

bull workers equiv aggregate worker ndash hours average hours per worker workers equiv aggregate worker ndash hours average hours per worker

The Participation Rate and Average Hours

bull Let us look first at the aggregate participation decision The Let us look first at the aggregate participation decision The aggregate number of workers who have decided to participate aggregate number of workers who have decided to participate is known as the is known as the labor forcelabor force the the civilian labor force over 16 civilian labor force over 16 years of ageyears of age This number excludes uniformed members of the This number excludes uniformed members of the armed services and the small number of workers under 16 armed services and the small number of workers under 16 years old The labor force of course has grown right along years old The labor force of course has grown right along with population with population

bull The participation rateThe participation rate (PR) measures (PR) measures the labor force as its ratio the labor force as its ratio to the relevant populationto the relevant population

bull participation rate = labor forcerelevant population participation rate = labor forcerelevant population

bull ldquoldquonon-institutionalrdquo non-institutionalrdquo excludes people in prison or in homes for excludes people in prison or in homes for the aged) the aged)

bull The aggregate number of hours The aggregate number of hours worked is worked is not as easy not as easy as the as the participation rate to relate to the individual workerrsquos choices participation rate to relate to the individual workerrsquos choices If every worker had the same labor-supply curve we would If every worker had the same labor-supply curve we would have to know the wage offered to each one in order to calculate have to know the wage offered to each one in order to calculate the total number of labor hours supplied In reality workers the total number of labor hours supplied In reality workers are not all alike are not all alike Labor-supply curves may vary systematically Labor-supply curves may vary systematically according to the sex age ethnic group education experience according to the sex age ethnic group education experience or other social or economic characteristics of the workersor other social or economic characteristics of the workers And And within any group the labor-supply curves of individuals are within any group the labor-supply curves of individuals are likely to varylikely to vary

bull In principle In principle if we had a good statistical estimate of the typical if we had a good statistical estimate of the typical distribution of the wagesdistribution of the wages we could make a reasonable we could make a reasonable calculation But statisticians at the Bureau of Labor Statistics calculation But statisticians at the Bureau of Labor Statistics (BLS) do not try to calculate the labor supply in this way (BLS) do not try to calculate the labor supply in this way Instead they Instead they count the number of hours that workers actually count the number of hours that workers actually workwork and the average and the average wages and salaries they are paid wages and salaries they are paid

bull In USA the total hours of labor in 1998 was In USA the total hours of labor in 1998 was 236882236882 million million The average hours of work is The average hours of work is 17211721 hours per year = hours per year = 344344 hours hours per week (assuming a 50 week year) This number is 14 percent per week (assuming a 50 week year) This number is 14 percent below the full time 40-hour week which makes sense since it below the full time 40-hour week which makes sense since it averages over full-time part-time and overtime workers averages over full-time part-time and overtime workers

Labor Market EquilibriumLabor Market Equilibrium

bull MARKET CLEARINGMARKET CLEARING

bull When both demand and supply curves are plotted on the same When both demand and supply curves are plotted on the same diagram the crossing point defines the diagram the crossing point defines the equilibrium real-wage equilibrium real-wage rate and the rate and the equilibrium level of labor employedequilibrium level of labor employed

bull The real wage The real wage looks different looks different from the point of view of the firm from the point of view of the firm and the worker For the and the worker For the firmfirm the relevant real wage is the the relevant real wage is the product-real wage product-real wage defined as defined as the number of units of the good the number of units of the good the firm produces that the wage will purchase the firm produces that the wage will purchase ((price of price of productproduct = = w) w) For the For the workerworker the relevant real wage is the the relevant real wage is the consumption-consumption-real real wagewage defined as defined as the number of typical consumption baskets the number of typical consumption baskets that the wage will purchase that the wage will purchase ((price of price of consumption basket consumption basket = = w)w)

bull For aggregate analysis we might use the For aggregate analysis we might use the Producer Price IndexProducer Price Index or the GDP deflator to approximate the or the GDP deflator to approximate the product priceproduct price and the and the CPICPI to approximate the to approximate the consumption price consumption price

bull Suppose that the product-real wage and the consumption-real Suppose that the product-real wage and the consumption-real wage in the following figure start out with the identical value wage in the following figure start out with the identical value ((wp) at the market-clearing point Awp) at the market-clearing point A Now suppose that Now suppose that imported Japanese cars are a large portion of the typical imported Japanese cars are a large portion of the typical workerrsquos consumption basket workerrsquos consumption basket and that and that ceteris paribus ceteris paribus the price the price of Japanese cars rises sharply This means that the of Japanese cars rises sharply This means that the real wage real wage from the point of view of the from the point of view of the consumer falls to (consumer falls to (wpwpCPICPI ) )11 at point at point

B B on the labor-supply curve (LS) so that the worker would on the labor-supply curve (LS) so that the worker would want to supply less labor (want to supply less labor (LL11))

bull The rise in the price of Japanese cars has no effect on the price The rise in the price of Japanese cars has no effect on the price of their products Nevertheless they see a reduction of labor of their products Nevertheless they see a reduction of labor supply at the original market clearing wage It is as if the supply at the original market clearing wage It is as if the labor-supply curve labor-supply curve has shifted to the left to has shifted to the left to LSLSrsquo which passes rsquo which passes through ((through ((wp) L1) at point C wp) L1) at point C At the original wage rate labor At the original wage rate labor demand exceeds labor supply so firms raise wages in an effort demand exceeds labor supply so firms raise wages in an effort to attract workers until they reach the new market-clearing to attract workers until they reach the new market-clearing wage at point D where they pay (wage at point D where they pay (wpwpPPIPPI ) for labor of L ) for labor of L The The

rise in the price of Japanese cars has the effect of raising the rise in the price of Japanese cars has the effect of raising the wages that firms must pay and reducing labor employedwages that firms must pay and reducing labor employed Higher wages partly compensate workers for the higher costs Higher wages partly compensate workers for the higher costs of consumption but firms can afford to pay those higher wages of consumption but firms can afford to pay those higher wages only if marginal products rise as a result of their using less only if marginal products rise as a result of their using less labor labor

bull The rise in wage rates is not enough to compensate workers The rise in wage rates is not enough to compensate workers fully so the consumption-real wage in equilibrium is (wpfully so the consumption-real wage in equilibrium is (wpCPI CPI ) )

atat point E We can think of import prices as a tax levied on point E We can think of import prices as a tax levied on consumers and of an increase in import prices as widening the consumers and of an increase in import prices as widening the tax wedge Unless the issue that we want to analyze depends on tax wedge Unless the issue that we want to analyze depends on the difference between product- and consumption-real wages the difference between product- and consumption-real wages we will treat the real wage as the same for both labor supply we will treat the real wage as the same for both labor supply and labor demandand labor demand

An Increase in the Price of Consumption GoodsAn Increase in the Price of Consumption GoodsRelative to the Price of OutputRelative to the Price of Output

ANALYZING IDEAL LABOR MARKETSANALYZING IDEAL LABOR MARKETS

bull The aggregate labor-supplylabor-demand diagram provides us The aggregate labor-supplylabor-demand diagram provides us with a powerful tool We now analyze three important with a powerful tool We now analyze three important macroeconomic issues macroeconomic issues

(1) the effect of tax cuts on employment (1) the effect of tax cuts on employment

(2) the effect of technological progress on the well-being of (2) the effect of technological progress on the well-being of workers and workers and

(3) the effect of immigration on existing workers (3) the effect of immigration on existing workers

bull Issue 1 Tax Cuts Issue 1 Tax Cuts What are the effects of a cut in marginal What are the effects of a cut in marginal income-tax rates on employment and the level of GDP in the income-tax rates on employment and the level of GDP in the economyeconomy Recall from section that a lower marginal income-Recall from section that a lower marginal income-tax rate increases labor supply at each real wage (a rightward tax rate increases labor supply at each real wage (a rightward shift of the labor-supply) shift of the labor-supply)

bull Labor-market equilibrium moves from point A to point B in Labor-market equilibrium moves from point A to point B in the lower panel of the following Notice that the amount of the lower panel of the following Notice that the amount of labor available to firms increases so that firms move labor available to firms increases so that firms move production from Arsquo to Brsquo on the labor production function in production from Arsquo to Brsquo on the labor production function in the upper panel Also notice that the real wage falls from (the upper panel Also notice that the real wage falls from (wp)1 wp)1 to (wp)2 Since the cut in taxes increases the number of to (wp)2 Since the cut in taxes increases the number of workers workers willing to work at each wage Workers care about their take-willing to work at each wage Workers care about their take-home pay ndash that is about their home pay ndash that is about their after-tax real wage after-tax real wage This is This is perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 can be greater than the old after-tax real wage (1ndashcan be greater than the old after-tax real wage (1ndashτ1τ1)(wp)1 so )(wp)1 so long as the rise in the take-home share (1 ndash τ) is long as the rise in the take-home share (1 ndash τ) is proportionately greater than the fall in the before-tax real proportionately greater than the fall in the before-tax real wage (wp)wage (wp)

bull The analysis depends on substitution effects dominating The analysis depends on substitution effects dominating income effects which they probably do in aggregate if not for income effects which they probably do in aggregate if not for every worker So the supply-siders of the Reagan years are every worker So the supply-siders of the Reagan years are correct in principle How much output will increase depends on correct in principle How much output will increase depends on how large the substitution effect is If most people work a how large the substitution effect is If most people work a standard 40-hour week the effect could be quite small and the standard 40-hour week the effect could be quite small and the increase in output might also be very small in practiceincrease in output might also be very small in practice

Issue 1 The Effect of a Cut in Marginal Tax RatesIssue 1 The Effect of a Cut in Marginal Tax Rates

Issue 2 Technological Progress and Worker WelfareIssue 2 Technological Progress and Worker Welfare

bull Is technological progress and increasing use of machinery and Is technological progress and increasing use of machinery and other capital beneficial for workersother capital beneficial for workers

bull Technological change or capital accumulation have been Technological change or capital accumulation have been known as ldquoLudditesrdquo (known as ldquoLudditesrdquo (it negatively affects the demand for it negatively affects the demand for laborlabor) To see why the Luddites are wrong ndash at least for ) To see why the Luddites are wrong ndash at least for clearing labor markets ndash recall that technological progress or clearing labor markets ndash recall that technological progress or increased capital both increased capital both shift the labor-demand curve upwardshift the labor-demand curve upward The lower panel of the following figure shows that the effect of The lower panel of the following figure shows that the effect of the increased demand for labor is to increase total employment the increased demand for labor is to increase total employment and the real wage Firms and the real wage Firms can pay a higher real wage can pay a higher real wage because because the additional capital or technological progress the additional capital or technological progress increases the increases the marginal product of labormarginal product of labor

bull The The Ludditesrsquo mistake Ludditesrsquo mistake is most easily seen in the upper panel is most easily seen in the upper panel The Luddite argument assumes that fewer workers will The Luddite argument assumes that fewer workers will produce the same total output Production starts at Arsquo using produce the same total output Production starts at Arsquo using L1 L1 workers to produce Y1 After the upward shift in the production workers to produce Y1 After the upward shift in the production function the same output could be produced using less labor function the same output could be produced using less labor ((L3) at point Arsquorsquo The L3) at point Arsquorsquo The problem is that Arsquorsquo is not an equilibrium problem is that Arsquorsquo is not an equilibrium At that point the marginal product of labor is higher than the At that point the marginal product of labor is higher than the original real wage so a profit-maximizing firm would want to original real wage so a profit-maximizing firm would want to expand production To do this they must hire more labor than expand production To do this they must hire more labor than L3 and indeed they L3 and indeed they find it find it profitable profitable to hire more labor than to hire more labor than the original the original L1 The only way actually to increase labor L1 The only way actually to increase labor is to is to raise the real-wage raise the real-wage rate above its original level Technological rate above its original level Technological progress therefore favors progress therefore favors workers by increasing employment workers by increasing employment and wagesand wages

bull Early in the 19th century hand-woven cloth was very Early in the 19th century hand-woven cloth was very expensive and a worker was lucky to own the clothes on his expensive and a worker was lucky to own the clothes on his back and a spare set for church on Sunday Textiles were one of back and a spare set for church on Sunday Textiles were one of the first industries to benefit from the Industrial Revolution so the first industries to benefit from the Industrial Revolution so that by the end of the 19th century machine-made fabrics and that by the end of the 19th century machine-made fabrics and mass-production made decent clothing in larger quantities mass-production made decent clothing in larger quantities accessible to most of the population of the more developed accessible to most of the population of the more developed countries Similar progress has been made in most forms of countries Similar progress has been made in most forms of production Agricultural production which at the turn of the production Agricultural production which at the turn of the 20th century absorbed half the labor force now absorbs less 20th century absorbed half the labor force now absorbs less than 3 percent while producing more food more cheaply than than 3 percent while producing more food more cheaply than ever ever

bull We must be careful not to dismiss the Luddites as altogether We must be careful not to dismiss the Luddites as altogether foolish While new technology especially over decades has foolish While new technology especially over decades has proved to be a net gain for workers in general the Luddites proved to be a net gain for workers in general the Luddites were in fact correct that their way of life was threatened were in fact correct that their way of life was threatened Independent weavers became factory hands unskilled Independent weavers became factory hands unskilled workers increasingly women and often children replaced workers increasingly women and often children replaced skilled craftsmen and factory work often involved long hours skilled craftsmen and factory work often involved long hours in brutal conditions The wider society reaps the benefits of in brutal conditions The wider society reaps the benefits of technological change while a narrow group sometimes technological change while a narrow group sometimes disproportionately bears its costs Our analysis also assumes disproportionately bears its costs Our analysis also assumes that markets generally clear The implicit assumption is that that markets generally clear The implicit assumption is that displaced workers move on to new jobs possibly in other forms displaced workers move on to new jobs possibly in other forms of production Markets may have a tendency to clear in the of production Markets may have a tendency to clear in the long run yet workers may find themselves displaced in the long run yet workers may find themselves displaced in the short run say over the course of a business cycleshort run say over the course of a business cycle

Issue 3 Immigration Jobs and Real WagesIssue 3 Immigration Jobs and Real Wages

bull How does an increase in the labor force through immigration or How does an increase in the labor force through immigration or natural population growth affect labor and GDP natural population growth affect labor and GDP

bull One of the emotional issues associated with US immigration One of the emotional issues associated with US immigration policy ndash particularly towards low-wage workers from Mexico ndash policy ndash particularly towards low-wage workers from Mexico ndash is the idea that is the idea that immigrants take jobs away from native immigrants take jobs away from native workers workers We might be tempted to dismiss this fear as another We might be tempted to dismiss this fear as another example of the lump-of-labor fallacy Yet there is a sensible example of the lump-of-labor fallacy Yet there is a sensible intuition behind the argument An increase in the labor force ndash intuition behind the argument An increase in the labor force ndash due either to immigration or to higher population growth rates due either to immigration or to higher population growth rates ndash can be represented as an outward shift of the aggregate labor ndash can be represented as an outward shift of the aggregate labor supply curve as shown in the following Figure Employment supply curve as shown in the following Figure Employment increases but real wages fall It is not then that immigrants increases but real wages fall It is not then that immigrants take jobs away from natives take jobs away from natives Rather they compete for jobsRather they compete for jobs putting downward pressure on real wagesputting downward pressure on real wages

bull Again we must exercise care in interpreting the analysis Again we must exercise care in interpreting the analysis Remember that aggregate labor and average wage rates hide Remember that aggregate labor and average wage rates hide many details of the labor process The incomes of the new many details of the labor process The incomes of the new immigrants immigrants creates demand creates demand for the new production that they for the new production that they make possible Immigrant workers (at least those ndash whether make possible Immigrant workers (at least those ndash whether legal or illegal ndash who have become the focus of the most intense legal or illegal ndash who have become the focus of the most intense political debate) political debate) are likely to possess fewer skills than nativesare likely to possess fewer skills than natives The net effect is that the increased demand for goods and The net effect is that the increased demand for goods and services generated by immigrants is likely to increase the services generated by immigrants is likely to increase the demand for skilled (demand for skilled (and largely nativeand largely native) workers relative to ) workers relative to their supply and so to increase real wages of skilled workers their supply and so to increase real wages of skilled workers Low-skilled immigration may lower the real wage for farm Low-skilled immigration may lower the real wage for farm workers but if anything it would raise the real wage for workers but if anything it would raise the real wage for computer programmerscomputer programmers

Next Task Labor Market in Kuwait

Appendix Is Labor Supply Stable Over Time

bull Statistics on participation rates or average hours for a Statistics on participation rates or average hours for a particular month or year are snapshot of the labor market particular month or year are snapshot of the labor market Can we analyze the effects of that increase on the labor market Can we analyze the effects of that increase on the labor market under the assumption that the labor-supply curves of workers under the assumption that the labor-supply curves of workers remain essentially stableremain essentially stable

bull Data on participation rates in the United States appear to Data on participation rates in the United States appear to support this conjecture (see Figure 811) which shows the support this conjecture (see Figure 811) which shows the overall civilian participation rate trending upward ndash at least overall civilian participation rate trending upward ndash at least from the middle of the 1960sfrom the middle of the 1960s

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

Labor Supply

bull Two measures reflect two aspects of the workerrsquos labor supply Two measures reflect two aspects of the workerrsquos labor supply decision (i) decision (i) participationparticipation ndash that is whether to work or not ndash that is whether to work or not work and (ii) work and (ii) intensityintensity ndash that is how many hours to work It is ndash that is how many hours to work It is easier if we consider intensity first conditional on having easier if we consider intensity first conditional on having decided to work what factors govern the workerrsquos choice of decided to work what factors govern the workerrsquos choice of how many hours of work to supplyhow many hours of work to supply

bull THE WORKER CHOOSING HOURS OF WORKTHE WORKER CHOOSING HOURS OF WORK

bull The Price of LeisureThe Price of Leisure

bull People work for a variety of reasons The most obvious is to People work for a variety of reasons The most obvious is to earn the incomeearn the income Many people ndash though not all ndash find their Many people ndash though not all ndash find their work work fulfilling and interestingfulfilling and interesting Still even those people will Still even those people will generally prefer another generally prefer another hour of leisure hour of leisure to another hour of to another hour of work It is therefore reasonable to assume that work It is therefore reasonable to assume that leisure is a leisure is a goodgood

bull Goods generally have a price Yet there is Goods generally have a price Yet there is nono market for market for leisureleisure Even though there is no explicit price there is an Even though there is no explicit price there is an implicit price or opportunity cost The implicit price or opportunity cost The OPPORTUNITY COST OPPORTUNITY COST of any choice is the value of the best alternative choice that it of any choice is the value of the best alternative choice that it foreclosesforecloses The implicit price of leisure is its opportunity cost The implicit price of leisure is its opportunity cost which is measured by the real wage (which is measured by the real wage (wp) wp)

bull The Labor-Leisure ChoiceThe Labor-Leisure Choice

bull Once we see leisure as a good and the real-wage rate as its Once we see leisure as a good and the real-wage rate as its price it is easier to understand the choices a worker faces price it is easier to understand the choices a worker faces There are 168 hours in a week If a worker chooses There are 168 hours in a week If a worker chooses not to work not to work at allat all he enjoys 168 hours of leisure but forgoes the income he enjoys 168 hours of leisure but forgoes the income needed to buy any other goods If the worker instead takes needed to buy any other goods If the worker instead takes fewer hours of leisure he supplies labor fewer hours of leisure he supplies labor l = 168 ndash hours of l = 168 ndash hours of leisure leisure and he gains the ability to purchase goods worth wp times l and he gains the ability to purchase goods worth wp times l The problem The problem for the worker for the worker is to choose is to choose the hours of labor (the hours of labor (l ) l ) that at the margin makes the psychic value of a small loss that at the margin makes the psychic value of a small loss further loss of leisure time (ie a small increase in labor time) further loss of leisure time (ie a small increase in labor time) exactly equal to the psychic value of the small gain in exactly equal to the psychic value of the small gain in consumption goods that would be purchased by that laborconsumption goods that would be purchased by that labor

bull INCOME EFFECT How would your supply of labor change if you could receive the income that results from the increased wage rate without facing a changed opportunity cost of leisure

bull As a general rule an increase in income ceteris paribus increases the demand for all goods The extra $20 per week would permit you to buy more goods including leisure without reducing your purchases of other goods The reduction in the supply of labor as the result of an increase in income is called the income effect

bull SUBSTITUTION EFFECTSUBSTITUTION EFFECT

bull If the wage rate rose If the wage rate rose would people work more or less As a would people work more or less As a general rule whenever general rule whenever ceteris paribus the price of anything rises ceteris paribus the price of anything rises relative to alternativesrelative to alternatives the demand for it decreases Here the the demand for it decreases Here the price of leisure price of leisure (its opportunity cost) has risen relative to the (its opportunity cost) has risen relative to the price of other goods the supply of price of other goods the supply of labor would riselabor would rise The change The change in the wage rate encourages people to substitute the now in the wage rate encourages people to substitute the now cheaper goods (what you buy using your wage) for the now cheaper goods (what you buy using your wage) for the now more expensive leisure more expensive leisure The increase in the supply of labor as The increase in the supply of labor as the result of an increase in the price (or opportunity cost) of the result of an increase in the price (or opportunity cost) of leisure is called theleisure is called the SUBSTITUTION EFFECT SUBSTITUTION EFFECT

bull The Labor-supply CurveThe Labor-supply Curve

bull The following figure represents the workerrsquos labor-supply The following figure represents the workerrsquos labor-supply decision Look first at panel (A) Suppose that at point A decision Look first at panel (A) Suppose that at point A where the real wage is (where the real wage is (wp)1 the worker decides that providing l wp)1 the worker decides that providing l hours of work balances the advantages of a little more hours of work balances the advantages of a little more consumption against a little more leisure at the margin Now consumption against a little more leisure at the margin Now consider what happens when the real wage rises to (consider what happens when the real wage rises to (wp)2 wp)2 There is a substitution effect shown by the arrow pointing to There is a substitution effect shown by the arrow pointing to the right which encourages the worker to supply more labor the right which encourages the worker to supply more labor The size of the substitution effect is measured by the length of The size of the substitution effect is measured by the length of the arrowthe arrow

bull There is also an income effect shown by the arrow pointing to There is also an income effect shown by the arrow pointing to the left which encourages the worker to supply less laborthe left which encourages the worker to supply less labor

The Slope of the Labor-Supply Curve

bull The net effect The net effect is measured by the difference between the is measured by the difference between the substitution and income effects shown at point B so that an substitution and income effects shown at point B so that an increase in the wage rate increases the workerrsquos supply of labor increase in the wage rate increases the workerrsquos supply of labor to to l2 to the right of l1 If the substitution effect is always stronger l2 to the right of l1 If the substitution effect is always stronger then the labor supply then the labor supply curve slopes upward curve slopes upward

bull Substitution effects are not necessarily stronger than income Substitution effects are not necessarily stronger than income effectseffects Panel (B) shows the construction of the labor-supply Panel (B) shows the construction of the labor-supply curve starting from point C when income effects are stronger curve starting from point C when income effects are stronger than substitution effects When the real-wage rate increases than substitution effects When the real-wage rate increases from (from (wp)1 to (wp)2 the dominant income effect overwhelms wp)1 to (wp)2 the dominant income effect overwhelms the substitution effect and labor the substitution effect and labor supply (point C) falls from supply (point C) falls from l1 to l1 to l2 If income effects are stronger for all wage rates above l2 If income effects are stronger for all wage rates above ((wp)1 wp)1 then the labor-supply curve will slope downward toward point C then the labor-supply curve will slope downward toward point C higher real wage higher real wage rates lower labor supplyrates lower labor supply

bull Although the labor-supply curve can slope downward towards Although the labor-supply curve can slope downward towards a point like A it is not reasonable to believe that it could slope a point like A it is not reasonable to believe that it could slope downward for every possible wage rate At very low wage rates downward for every possible wage rate At very low wage rates it is more reasonable to suppose that with very low incomes it is more reasonable to suppose that with very low incomes the workerrsquos need for food clothing shelter and other the workerrsquos need for food clothing shelter and other ldquoessentialrdquo goods the income effect is weak and the ldquoessentialrdquo goods the income effect is weak and the substitution effect is strong We should therefore expect the substitution effect is strong We should therefore expect the labor-supply curve to be upward sloping when wage rates are labor-supply curve to be upward sloping when wage rates are low Hence labor supply would be backward bending low Hence labor supply would be backward bending

Backward-bending Labor-supply Curve

Adding Realism TaxesAdding Realism Taxes

bull How does the tax affect the income from a little more or a little How does the tax affect the income from a little more or a little less work To answer this question we must know the less work To answer this question we must know the marginal marginal tax ratetax rate ((the fraction of an additional dollar of income that is the fraction of an additional dollar of income that is paid as taxes) paid as taxes) To keep things simple assume that all income is To keep things simple assume that all income is taxed at the same taxed at the same flatflat rate rate ττ In this case the marginal tax rate In this case the marginal tax rate must also be τ which takes a value between zero and one If a must also be τ which takes a value between zero and one If a worker earns worker earns wpwp for an hour of work the government takes for an hour of work the government takes τ(wp) τ(wp) as taxes and leaves the worker as taxes and leaves the worker (1ndashτ)(wp) (1ndashτ)(wp) as the after-as the after-tax real wagetax real wage

bull Since the worker actually receives the Since the worker actually receives the after-tax real wageafter-tax real wage it is it is the the true opportunity cost of leisure true opportunity cost of leisure Any increase in the Any increase in the marginal tax rate represents a decrease in the opportunity cost marginal tax rate represents a decrease in the opportunity cost of leisure If of leisure If substitution effectssubstitution effects are stronger than income are stronger than income effects then any increase in marginal tax rates effects then any increase in marginal tax rates reducesreduces the the supply of labor supply of labor as shown in the following figureas shown in the following figure

The Effect of a Tax Increase on Labor Supply

bull The labor-supply curve with no taxes is shown on the right of The labor-supply curve with no taxes is shown on the right of the figure At the figure At (wp)1(wp)1 the worker supplies labor the worker supplies labor l1l1 If a tax of If a tax of τ1τ1 is imposed the after-tax real wage is is imposed the after-tax real wage is (1ndashτ1)(wp)1(1ndashτ1)(wp)1 The worker The worker should react exactly as if he paid no taxes but suffered a cut in should react exactly as if he paid no taxes but suffered a cut in his wages This is shown as a movement from point A to point B his wages This is shown as a movement from point A to point B where labor supply has fallen to where labor supply has fallen to l2l2 But of course the wage rate But of course the wage rate did not really falldid not really fall the employer still pays (wp)1 This means the employer still pays (wp)1 This means that (l2 (wp)1) is the labor-supply (point C)that (l2 (wp)1) is the labor-supply (point C)

bull Since this would apply for any real-wage rate every point on Since this would apply for any real-wage rate every point on the original curve shifts to the left Because the the original curve shifts to the left Because the tax rate is tax rate is proportional its absolute effect is greaterproportional its absolute effect is greater as is the shift in the as is the shift in the labor-supply curve at high wage rates resulting in a labor-supply curve at high wage rates resulting in a steepening of the curve Any further increase in the tax rate to steepening of the curve Any further increase in the tax rate to say τ2 would shift the labor-supply curve further to the left say τ2 would shift the labor-supply curve further to the left

bull The length of the line segment BC measures the The length of the line segment BC measures the TAX WEDGETAX WEDGE between the real wage paid by employers and the after-tax real between the real wage paid by employers and the after-tax real wage received by workewage received by workersrs The The largerlarger the tax wedge the the tax wedge the largerlarger the leftward shift of the labor-supply curve and the the leftward shift of the labor-supply curve and the greater the greater the reductionreduction in labor supplied at any real wage in labor supplied at any real wage

bull The idea that tax increases lower labor supply and conversely The idea that tax increases lower labor supply and conversely that tax cuts increase labor supply was a major tenet of the so-that tax cuts increase labor supply was a major tenet of the so-called called supply-side economicssupply-side economics popular in the early 1980s popular in the early 1980s President Ronald Reagan and his advisors used it to argue that President Ronald Reagan and his advisors used it to argue that cuts in marginal tax rates cuts in marginal tax rates would stimulate people would stimulate people to to workwork harder and to harder and to earn larger earn larger incomesincomes

Adding Realism A Standard WorkweekAdding Realism A Standard Workweek

bull Another way in which the simple analysis of labor supply is Another way in which the simple analysis of labor supply is unrealistic is that many unrealistic is that many workers are not given an option about workers are not given an option about the number of hours they workthe number of hours they work Although people work part- Although people work part-time and overtime either may be voluntary or mandatory time and overtime either may be voluntary or mandatory

bull Assuming that workers are Assuming that workers are not permitted to work more than not permitted to work more than 40 hours a week40 hours a week the following figure includes a constraint of the following figure includes a constraint of 40 hours If the worker were permitted to choose freely then 40 hours If the worker were permitted to choose freely then the labor-supply curve would backward bending curve The the labor-supply curve would backward bending curve The overall effect is to of the standard work week is to reshape the overall effect is to of the standard work week is to reshape the labor-supply curve as indicated by the heavy curve with the labor-supply curve as indicated by the heavy curve with the vertical segment that runs through points A F G D and E vertical segment that runs through points A F G D and E Any worker on this vertical segment is constrainedAny worker on this vertical segment is constrained

The Individual Labor-Supply Curve in PracticeThe Individual Labor-Supply Curve in Practice

bull What does the individual labor-supply curve look like in What does the individual labor-supply curve look like in realityreality It is difficult to answer this question because in reality It is difficult to answer this question because in reality we can observe we can observe only one pointonly one point on the labor-supply curve for a on the labor-supply curve for a single worker single worker at a particular timeat a particular time All the other points are All the other points are conjecturesconjectures about what the worker would supply if faced with about what the worker would supply if faced with different wage rates If we imagine that on average workers are different wage rates If we imagine that on average workers are substantially substantially similarsimilar we might nonetheless get some idea of we might nonetheless get some idea of what the individual labor-supply curve might look likewhat the individual labor-supply curve might look like

bull The The National Longitudinal SurveyNational Longitudinal Survey (Youth) has catalogued the (Youth) has catalogued the work histories of a large sample of individuals starting at a work histories of a large sample of individuals starting at a young age The following figure plots the real-wage rates and young age The following figure plots the real-wage rates and average weekly hours of labor for about average weekly hours of labor for about 1000010000 male workers male workers from this survey for a from this survey for a single periodsingle period with the best fitting flexible with the best fitting flexible line through these points serves as our empirical estimate of the line through these points serves as our empirical estimate of the labor-supply curve for these workerslabor-supply curve for these workers

bull The regression line traces out a shape very The regression line traces out a shape very like the backward-like the backward-bendingbending labor-supply curve with a 40-hour constraint What labor-supply curve with a 40-hour constraint What looks like a vertical line above 40 hours is looks like a vertical line above 40 hours is not really a solid line not really a solid line at all but a reflection of the fact that about at all but a reflection of the fact that about 7500 7500 of the 10000 of the 10000 workers in the sample supply 40 hours per week at a variety of workers in the sample supply 40 hours per week at a variety of wage rates The labor-supply curve traces out a segment above wage rates The labor-supply curve traces out a segment above the 40-hour point that corresponds to the constraintthe 40-hour point that corresponds to the constraint

bull There are There are points to the rightpoints to the right of 40 hours This is reasonable of 40 hours This is reasonable since in the real world workers do since in the real world workers do work overtimework overtime ndash either ndash either because they are supervisors or professionals or because because they are supervisors or professionals or because employers offer them the required time-and-half wage rate employers offer them the required time-and-half wage rate The fit of the regression line is far from perfect points lie on The fit of the regression line is far from perfect points lie on both sides of the line We should interpret it as a both sides of the line We should interpret it as a snapshotsnapshot of of the behavior of the typical worker But ofthe behavior of the typical worker But of course the typical course the typical worker is not any actual worker in particularworker is not any actual worker in particular

THE WORKER CHOOSING TO PARTICIPATETHE WORKER CHOOSING TO PARTICIPATE

bull So far we have examined only one aspect of the workerrsquos So far we have examined only one aspect of the workerrsquos labor-supply decision labor-supply decision how many hours to work for given real how many hours to work for given real wagewage We now take up the second aspect We now take up the second aspect participationparticipation ndash that ndash that is is whether or not to work at allwhether or not to work at all A labor-supply curve that starts A labor-supply curve that starts at the origin and slopes upwards for at least a portion of its at the origin and slopes upwards for at least a portion of its length suggests that even length suggests that even if the wage were very lowif the wage were very low ndash say 1cent ndash say 1cent per hour ndash the worker would work a little bit That is clearly per hour ndash the worker would work a little bit That is clearly unrealisticunrealistic no one would work at all for 1cent per hour no one would work at all for 1cent per hour What What factors determine how high the wage factors determine how high the wage must be to induce a person must be to induce a person to participate in the labor marketto participate in the labor market

bull The labor force The labor force participationparticipation decision is a question of decision is a question of opportunity costopportunity cost Idleness has its charms Before anyone enters Idleness has its charms Before anyone enters the labor force the wage rate must be high enough to overcome the labor force the wage rate must be high enough to overcome them them The opportunity cost of participatingThe opportunity cost of participating in the labor force is in the labor force is sum of sum of

1048766 1048766 the implicit valuethe implicit value the worker places on complete idleness the worker places on complete idleness

1048766 1048766 the explicit coststhe explicit costs of working compared to not working such as of working compared to not working such as clothing transport childcare) andclothing transport childcare) and

1048766 1048766 the explicit losses the explicit losses from working (for instance housework not from working (for instance housework not done)done)

bull The opportunity cost is partly psychological and partly material The opportunity cost is partly psychological and partly material If people were completely If people were completely independentindependent of each other the worker of each other the worker might place a lower value on the opportunity cost of might place a lower value on the opportunity cost of participation because then the choice might be literally between participation because then the choice might be literally between work and starvationwork and starvation

bull But most people are not But most people are not completely independentcompletely independent Whether or Whether or not to participate in the labor force could be a not to participate in the labor force could be a genuine choicegenuine choice and would depend on the and would depend on the real wagereal wage

bull The The RESERVATION WAGE RESERVATION WAGE is defined to be is defined to be the opportunity the opportunity cost of working compared to not workingcost of working compared to not working ndash ndash that is the real wage that is the real wage that is high enough to make it just worthwhile for a worker to that is high enough to make it just worthwhile for a worker to participate in the labor forceparticipate in the labor force

bull Taking account of the opportunity costs of participation affects Taking account of the opportunity costs of participation affects the shape of the labor-supply curve As long as the the shape of the labor-supply curve As long as the real wage is real wage is below the reservationbelow the reservation wage ((wp)R) the worker supplies no wage ((wp)R) the worker supplies no labor at all Above the reservation wage there is a normal labor at all Above the reservation wage there is a normal labor-supply curvelabor-supply curve

bull The following captures the two stages of the labor supply The following captures the two stages of the labor supply decision decision FirstFirst at low wages the worker will at low wages the worker will notnot supply any supply any labor at all and small increases in wages have no effect But labor at all and small increases in wages have no effect But secondsecond as soon as the wage rises enough for the worker to bite as soon as the wage rises enough for the worker to bite the bullet and join the labor force the minimum labor supplied the bullet and join the labor force the minimum labor supplied will be well will be well above zeroabove zero and the worker will decide how many and the worker will decide how many hours to supply above this minimum through the usual process hours to supply above this minimum through the usual process of balancing the opportunity cost of leisure against the desire of balancing the opportunity cost of leisure against the desire for consumption goodsfor consumption goods

AGGREGATE LABOR SUPPLY

bull How can we moveHow can we move from the microeconomics of the labor supply from the microeconomics of the labor supply back to an aggregate relationship usable in macroeconomic back to an aggregate relationship usable in macroeconomic analysis analysis If workers were essentially alikeIf workers were essentially alike the problem would the problem would be easy be easy

bull As we have seen labor supply has two dimensions ndash As we have seen labor supply has two dimensions ndash participationparticipation in the labor force and in the labor force and choice of hourschoice of hours of labor of labor Take the participation decision first If all workers were alike Take the participation decision first If all workers were alike except for except for differences in their reservation wagedifferences in their reservation wage then we could then we could rank them from lowest to highest reservation wage The rank them from lowest to highest reservation wage The aggregate labor-supply (participation) curve is strictly aggregate labor-supply (participation) curve is strictly upwardslopingupwardsloping

bull Of course this is too easy Just as we observed in deriving the Of course this is too easy Just as we observed in deriving the aggregate labor demand curve workers are aggregate labor demand curve workers are not all alikenot all alike Once Once again we must interpret the vertical axis as measuring the again we must interpret the vertical axis as measuring the average real wageaverage real wage that at best provides a kind of index for the that at best provides a kind of index for the level of the wage structure level of the wage structure

bull The The problemproblem remains the remains the samesame when we turn to the choice of when we turn to the choice of hourshours Workers are all different and face a structure of wages Workers are all different and face a structure of wages For each worker individually there is a jump from supplying For each worker individually there is a jump from supplying zero to supplying some positive number of hours zero to supplying some positive number of hours when his own when his own wage rate surpasses their wage rate surpasses their reservation wagereservation wage But in aggregate But in aggregate we are we are unlikely to see such a jumpunlikely to see such a jump Not only are there a variety Not only are there a variety of wages offered at any time but reservation wages differof wages offered at any time but reservation wages differ

Derivation of the Aggregate Labor-supply Curve

bull A curve like the one in this figure can be used to display either A curve like the one in this figure can be used to display either the the participation participation decision or decision or the hoursthe hours The horizontal axis can The horizontal axis can either be used for workers either be used for workers or worker-hoursor worker-hours as measures of the as measures of the labor supply The two meanings are not completely labor supply The two meanings are not completely independent by definition independent by definition

bull workers equiv aggregate worker ndash hours average hours per worker workers equiv aggregate worker ndash hours average hours per worker

The Participation Rate and Average Hours

bull Let us look first at the aggregate participation decision The Let us look first at the aggregate participation decision The aggregate number of workers who have decided to participate aggregate number of workers who have decided to participate is known as the is known as the labor forcelabor force the the civilian labor force over 16 civilian labor force over 16 years of ageyears of age This number excludes uniformed members of the This number excludes uniformed members of the armed services and the small number of workers under 16 armed services and the small number of workers under 16 years old The labor force of course has grown right along years old The labor force of course has grown right along with population with population

bull The participation rateThe participation rate (PR) measures (PR) measures the labor force as its ratio the labor force as its ratio to the relevant populationto the relevant population

bull participation rate = labor forcerelevant population participation rate = labor forcerelevant population

bull ldquoldquonon-institutionalrdquo non-institutionalrdquo excludes people in prison or in homes for excludes people in prison or in homes for the aged) the aged)

bull The aggregate number of hours The aggregate number of hours worked is worked is not as easy not as easy as the as the participation rate to relate to the individual workerrsquos choices participation rate to relate to the individual workerrsquos choices If every worker had the same labor-supply curve we would If every worker had the same labor-supply curve we would have to know the wage offered to each one in order to calculate have to know the wage offered to each one in order to calculate the total number of labor hours supplied In reality workers the total number of labor hours supplied In reality workers are not all alike are not all alike Labor-supply curves may vary systematically Labor-supply curves may vary systematically according to the sex age ethnic group education experience according to the sex age ethnic group education experience or other social or economic characteristics of the workersor other social or economic characteristics of the workers And And within any group the labor-supply curves of individuals are within any group the labor-supply curves of individuals are likely to varylikely to vary

bull In principle In principle if we had a good statistical estimate of the typical if we had a good statistical estimate of the typical distribution of the wagesdistribution of the wages we could make a reasonable we could make a reasonable calculation But statisticians at the Bureau of Labor Statistics calculation But statisticians at the Bureau of Labor Statistics (BLS) do not try to calculate the labor supply in this way (BLS) do not try to calculate the labor supply in this way Instead they Instead they count the number of hours that workers actually count the number of hours that workers actually workwork and the average and the average wages and salaries they are paid wages and salaries they are paid

bull In USA the total hours of labor in 1998 was In USA the total hours of labor in 1998 was 236882236882 million million The average hours of work is The average hours of work is 17211721 hours per year = hours per year = 344344 hours hours per week (assuming a 50 week year) This number is 14 percent per week (assuming a 50 week year) This number is 14 percent below the full time 40-hour week which makes sense since it below the full time 40-hour week which makes sense since it averages over full-time part-time and overtime workers averages over full-time part-time and overtime workers

Labor Market EquilibriumLabor Market Equilibrium

bull MARKET CLEARINGMARKET CLEARING

bull When both demand and supply curves are plotted on the same When both demand and supply curves are plotted on the same diagram the crossing point defines the diagram the crossing point defines the equilibrium real-wage equilibrium real-wage rate and the rate and the equilibrium level of labor employedequilibrium level of labor employed

bull The real wage The real wage looks different looks different from the point of view of the firm from the point of view of the firm and the worker For the and the worker For the firmfirm the relevant real wage is the the relevant real wage is the product-real wage product-real wage defined as defined as the number of units of the good the number of units of the good the firm produces that the wage will purchase the firm produces that the wage will purchase ((price of price of productproduct = = w) w) For the For the workerworker the relevant real wage is the the relevant real wage is the consumption-consumption-real real wagewage defined as defined as the number of typical consumption baskets the number of typical consumption baskets that the wage will purchase that the wage will purchase ((price of price of consumption basket consumption basket = = w)w)

bull For aggregate analysis we might use the For aggregate analysis we might use the Producer Price IndexProducer Price Index or the GDP deflator to approximate the or the GDP deflator to approximate the product priceproduct price and the and the CPICPI to approximate the to approximate the consumption price consumption price

bull Suppose that the product-real wage and the consumption-real Suppose that the product-real wage and the consumption-real wage in the following figure start out with the identical value wage in the following figure start out with the identical value ((wp) at the market-clearing point Awp) at the market-clearing point A Now suppose that Now suppose that imported Japanese cars are a large portion of the typical imported Japanese cars are a large portion of the typical workerrsquos consumption basket workerrsquos consumption basket and that and that ceteris paribus ceteris paribus the price the price of Japanese cars rises sharply This means that the of Japanese cars rises sharply This means that the real wage real wage from the point of view of the from the point of view of the consumer falls to (consumer falls to (wpwpCPICPI ) )11 at point at point

B B on the labor-supply curve (LS) so that the worker would on the labor-supply curve (LS) so that the worker would want to supply less labor (want to supply less labor (LL11))

bull The rise in the price of Japanese cars has no effect on the price The rise in the price of Japanese cars has no effect on the price of their products Nevertheless they see a reduction of labor of their products Nevertheless they see a reduction of labor supply at the original market clearing wage It is as if the supply at the original market clearing wage It is as if the labor-supply curve labor-supply curve has shifted to the left to has shifted to the left to LSLSrsquo which passes rsquo which passes through ((through ((wp) L1) at point C wp) L1) at point C At the original wage rate labor At the original wage rate labor demand exceeds labor supply so firms raise wages in an effort demand exceeds labor supply so firms raise wages in an effort to attract workers until they reach the new market-clearing to attract workers until they reach the new market-clearing wage at point D where they pay (wage at point D where they pay (wpwpPPIPPI ) for labor of L ) for labor of L The The

rise in the price of Japanese cars has the effect of raising the rise in the price of Japanese cars has the effect of raising the wages that firms must pay and reducing labor employedwages that firms must pay and reducing labor employed Higher wages partly compensate workers for the higher costs Higher wages partly compensate workers for the higher costs of consumption but firms can afford to pay those higher wages of consumption but firms can afford to pay those higher wages only if marginal products rise as a result of their using less only if marginal products rise as a result of their using less labor labor

bull The rise in wage rates is not enough to compensate workers The rise in wage rates is not enough to compensate workers fully so the consumption-real wage in equilibrium is (wpfully so the consumption-real wage in equilibrium is (wpCPI CPI ) )

atat point E We can think of import prices as a tax levied on point E We can think of import prices as a tax levied on consumers and of an increase in import prices as widening the consumers and of an increase in import prices as widening the tax wedge Unless the issue that we want to analyze depends on tax wedge Unless the issue that we want to analyze depends on the difference between product- and consumption-real wages the difference between product- and consumption-real wages we will treat the real wage as the same for both labor supply we will treat the real wage as the same for both labor supply and labor demandand labor demand

An Increase in the Price of Consumption GoodsAn Increase in the Price of Consumption GoodsRelative to the Price of OutputRelative to the Price of Output

ANALYZING IDEAL LABOR MARKETSANALYZING IDEAL LABOR MARKETS

bull The aggregate labor-supplylabor-demand diagram provides us The aggregate labor-supplylabor-demand diagram provides us with a powerful tool We now analyze three important with a powerful tool We now analyze three important macroeconomic issues macroeconomic issues

(1) the effect of tax cuts on employment (1) the effect of tax cuts on employment

(2) the effect of technological progress on the well-being of (2) the effect of technological progress on the well-being of workers and workers and

(3) the effect of immigration on existing workers (3) the effect of immigration on existing workers

bull Issue 1 Tax Cuts Issue 1 Tax Cuts What are the effects of a cut in marginal What are the effects of a cut in marginal income-tax rates on employment and the level of GDP in the income-tax rates on employment and the level of GDP in the economyeconomy Recall from section that a lower marginal income-Recall from section that a lower marginal income-tax rate increases labor supply at each real wage (a rightward tax rate increases labor supply at each real wage (a rightward shift of the labor-supply) shift of the labor-supply)

bull Labor-market equilibrium moves from point A to point B in Labor-market equilibrium moves from point A to point B in the lower panel of the following Notice that the amount of the lower panel of the following Notice that the amount of labor available to firms increases so that firms move labor available to firms increases so that firms move production from Arsquo to Brsquo on the labor production function in production from Arsquo to Brsquo on the labor production function in the upper panel Also notice that the real wage falls from (the upper panel Also notice that the real wage falls from (wp)1 wp)1 to (wp)2 Since the cut in taxes increases the number of to (wp)2 Since the cut in taxes increases the number of workers workers willing to work at each wage Workers care about their take-willing to work at each wage Workers care about their take-home pay ndash that is about their home pay ndash that is about their after-tax real wage after-tax real wage This is This is perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 can be greater than the old after-tax real wage (1ndashcan be greater than the old after-tax real wage (1ndashτ1τ1)(wp)1 so )(wp)1 so long as the rise in the take-home share (1 ndash τ) is long as the rise in the take-home share (1 ndash τ) is proportionately greater than the fall in the before-tax real proportionately greater than the fall in the before-tax real wage (wp)wage (wp)

bull The analysis depends on substitution effects dominating The analysis depends on substitution effects dominating income effects which they probably do in aggregate if not for income effects which they probably do in aggregate if not for every worker So the supply-siders of the Reagan years are every worker So the supply-siders of the Reagan years are correct in principle How much output will increase depends on correct in principle How much output will increase depends on how large the substitution effect is If most people work a how large the substitution effect is If most people work a standard 40-hour week the effect could be quite small and the standard 40-hour week the effect could be quite small and the increase in output might also be very small in practiceincrease in output might also be very small in practice

Issue 1 The Effect of a Cut in Marginal Tax RatesIssue 1 The Effect of a Cut in Marginal Tax Rates

Issue 2 Technological Progress and Worker WelfareIssue 2 Technological Progress and Worker Welfare

bull Is technological progress and increasing use of machinery and Is technological progress and increasing use of machinery and other capital beneficial for workersother capital beneficial for workers

bull Technological change or capital accumulation have been Technological change or capital accumulation have been known as ldquoLudditesrdquo (known as ldquoLudditesrdquo (it negatively affects the demand for it negatively affects the demand for laborlabor) To see why the Luddites are wrong ndash at least for ) To see why the Luddites are wrong ndash at least for clearing labor markets ndash recall that technological progress or clearing labor markets ndash recall that technological progress or increased capital both increased capital both shift the labor-demand curve upwardshift the labor-demand curve upward The lower panel of the following figure shows that the effect of The lower panel of the following figure shows that the effect of the increased demand for labor is to increase total employment the increased demand for labor is to increase total employment and the real wage Firms and the real wage Firms can pay a higher real wage can pay a higher real wage because because the additional capital or technological progress the additional capital or technological progress increases the increases the marginal product of labormarginal product of labor

bull The The Ludditesrsquo mistake Ludditesrsquo mistake is most easily seen in the upper panel is most easily seen in the upper panel The Luddite argument assumes that fewer workers will The Luddite argument assumes that fewer workers will produce the same total output Production starts at Arsquo using produce the same total output Production starts at Arsquo using L1 L1 workers to produce Y1 After the upward shift in the production workers to produce Y1 After the upward shift in the production function the same output could be produced using less labor function the same output could be produced using less labor ((L3) at point Arsquorsquo The L3) at point Arsquorsquo The problem is that Arsquorsquo is not an equilibrium problem is that Arsquorsquo is not an equilibrium At that point the marginal product of labor is higher than the At that point the marginal product of labor is higher than the original real wage so a profit-maximizing firm would want to original real wage so a profit-maximizing firm would want to expand production To do this they must hire more labor than expand production To do this they must hire more labor than L3 and indeed they L3 and indeed they find it find it profitable profitable to hire more labor than to hire more labor than the original the original L1 The only way actually to increase labor L1 The only way actually to increase labor is to is to raise the real-wage raise the real-wage rate above its original level Technological rate above its original level Technological progress therefore favors progress therefore favors workers by increasing employment workers by increasing employment and wagesand wages

bull Early in the 19th century hand-woven cloth was very Early in the 19th century hand-woven cloth was very expensive and a worker was lucky to own the clothes on his expensive and a worker was lucky to own the clothes on his back and a spare set for church on Sunday Textiles were one of back and a spare set for church on Sunday Textiles were one of the first industries to benefit from the Industrial Revolution so the first industries to benefit from the Industrial Revolution so that by the end of the 19th century machine-made fabrics and that by the end of the 19th century machine-made fabrics and mass-production made decent clothing in larger quantities mass-production made decent clothing in larger quantities accessible to most of the population of the more developed accessible to most of the population of the more developed countries Similar progress has been made in most forms of countries Similar progress has been made in most forms of production Agricultural production which at the turn of the production Agricultural production which at the turn of the 20th century absorbed half the labor force now absorbs less 20th century absorbed half the labor force now absorbs less than 3 percent while producing more food more cheaply than than 3 percent while producing more food more cheaply than ever ever

bull We must be careful not to dismiss the Luddites as altogether We must be careful not to dismiss the Luddites as altogether foolish While new technology especially over decades has foolish While new technology especially over decades has proved to be a net gain for workers in general the Luddites proved to be a net gain for workers in general the Luddites were in fact correct that their way of life was threatened were in fact correct that their way of life was threatened Independent weavers became factory hands unskilled Independent weavers became factory hands unskilled workers increasingly women and often children replaced workers increasingly women and often children replaced skilled craftsmen and factory work often involved long hours skilled craftsmen and factory work often involved long hours in brutal conditions The wider society reaps the benefits of in brutal conditions The wider society reaps the benefits of technological change while a narrow group sometimes technological change while a narrow group sometimes disproportionately bears its costs Our analysis also assumes disproportionately bears its costs Our analysis also assumes that markets generally clear The implicit assumption is that that markets generally clear The implicit assumption is that displaced workers move on to new jobs possibly in other forms displaced workers move on to new jobs possibly in other forms of production Markets may have a tendency to clear in the of production Markets may have a tendency to clear in the long run yet workers may find themselves displaced in the long run yet workers may find themselves displaced in the short run say over the course of a business cycleshort run say over the course of a business cycle

Issue 3 Immigration Jobs and Real WagesIssue 3 Immigration Jobs and Real Wages

bull How does an increase in the labor force through immigration or How does an increase in the labor force through immigration or natural population growth affect labor and GDP natural population growth affect labor and GDP

bull One of the emotional issues associated with US immigration One of the emotional issues associated with US immigration policy ndash particularly towards low-wage workers from Mexico ndash policy ndash particularly towards low-wage workers from Mexico ndash is the idea that is the idea that immigrants take jobs away from native immigrants take jobs away from native workers workers We might be tempted to dismiss this fear as another We might be tempted to dismiss this fear as another example of the lump-of-labor fallacy Yet there is a sensible example of the lump-of-labor fallacy Yet there is a sensible intuition behind the argument An increase in the labor force ndash intuition behind the argument An increase in the labor force ndash due either to immigration or to higher population growth rates due either to immigration or to higher population growth rates ndash can be represented as an outward shift of the aggregate labor ndash can be represented as an outward shift of the aggregate labor supply curve as shown in the following Figure Employment supply curve as shown in the following Figure Employment increases but real wages fall It is not then that immigrants increases but real wages fall It is not then that immigrants take jobs away from natives take jobs away from natives Rather they compete for jobsRather they compete for jobs putting downward pressure on real wagesputting downward pressure on real wages

bull Again we must exercise care in interpreting the analysis Again we must exercise care in interpreting the analysis Remember that aggregate labor and average wage rates hide Remember that aggregate labor and average wage rates hide many details of the labor process The incomes of the new many details of the labor process The incomes of the new immigrants immigrants creates demand creates demand for the new production that they for the new production that they make possible Immigrant workers (at least those ndash whether make possible Immigrant workers (at least those ndash whether legal or illegal ndash who have become the focus of the most intense legal or illegal ndash who have become the focus of the most intense political debate) political debate) are likely to possess fewer skills than nativesare likely to possess fewer skills than natives The net effect is that the increased demand for goods and The net effect is that the increased demand for goods and services generated by immigrants is likely to increase the services generated by immigrants is likely to increase the demand for skilled (demand for skilled (and largely nativeand largely native) workers relative to ) workers relative to their supply and so to increase real wages of skilled workers their supply and so to increase real wages of skilled workers Low-skilled immigration may lower the real wage for farm Low-skilled immigration may lower the real wage for farm workers but if anything it would raise the real wage for workers but if anything it would raise the real wage for computer programmerscomputer programmers

Next Task Labor Market in Kuwait

Appendix Is Labor Supply Stable Over Time

bull Statistics on participation rates or average hours for a Statistics on participation rates or average hours for a particular month or year are snapshot of the labor market particular month or year are snapshot of the labor market Can we analyze the effects of that increase on the labor market Can we analyze the effects of that increase on the labor market under the assumption that the labor-supply curves of workers under the assumption that the labor-supply curves of workers remain essentially stableremain essentially stable

bull Data on participation rates in the United States appear to Data on participation rates in the United States appear to support this conjecture (see Figure 811) which shows the support this conjecture (see Figure 811) which shows the overall civilian participation rate trending upward ndash at least overall civilian participation rate trending upward ndash at least from the middle of the 1960sfrom the middle of the 1960s

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

bull Goods generally have a price Yet there is Goods generally have a price Yet there is nono market for market for leisureleisure Even though there is no explicit price there is an Even though there is no explicit price there is an implicit price or opportunity cost The implicit price or opportunity cost The OPPORTUNITY COST OPPORTUNITY COST of any choice is the value of the best alternative choice that it of any choice is the value of the best alternative choice that it foreclosesforecloses The implicit price of leisure is its opportunity cost The implicit price of leisure is its opportunity cost which is measured by the real wage (which is measured by the real wage (wp) wp)

bull The Labor-Leisure ChoiceThe Labor-Leisure Choice

bull Once we see leisure as a good and the real-wage rate as its Once we see leisure as a good and the real-wage rate as its price it is easier to understand the choices a worker faces price it is easier to understand the choices a worker faces There are 168 hours in a week If a worker chooses There are 168 hours in a week If a worker chooses not to work not to work at allat all he enjoys 168 hours of leisure but forgoes the income he enjoys 168 hours of leisure but forgoes the income needed to buy any other goods If the worker instead takes needed to buy any other goods If the worker instead takes fewer hours of leisure he supplies labor fewer hours of leisure he supplies labor l = 168 ndash hours of l = 168 ndash hours of leisure leisure and he gains the ability to purchase goods worth wp times l and he gains the ability to purchase goods worth wp times l The problem The problem for the worker for the worker is to choose is to choose the hours of labor (the hours of labor (l ) l ) that at the margin makes the psychic value of a small loss that at the margin makes the psychic value of a small loss further loss of leisure time (ie a small increase in labor time) further loss of leisure time (ie a small increase in labor time) exactly equal to the psychic value of the small gain in exactly equal to the psychic value of the small gain in consumption goods that would be purchased by that laborconsumption goods that would be purchased by that labor

bull INCOME EFFECT How would your supply of labor change if you could receive the income that results from the increased wage rate without facing a changed opportunity cost of leisure

bull As a general rule an increase in income ceteris paribus increases the demand for all goods The extra $20 per week would permit you to buy more goods including leisure without reducing your purchases of other goods The reduction in the supply of labor as the result of an increase in income is called the income effect

bull SUBSTITUTION EFFECTSUBSTITUTION EFFECT

bull If the wage rate rose If the wage rate rose would people work more or less As a would people work more or less As a general rule whenever general rule whenever ceteris paribus the price of anything rises ceteris paribus the price of anything rises relative to alternativesrelative to alternatives the demand for it decreases Here the the demand for it decreases Here the price of leisure price of leisure (its opportunity cost) has risen relative to the (its opportunity cost) has risen relative to the price of other goods the supply of price of other goods the supply of labor would riselabor would rise The change The change in the wage rate encourages people to substitute the now in the wage rate encourages people to substitute the now cheaper goods (what you buy using your wage) for the now cheaper goods (what you buy using your wage) for the now more expensive leisure more expensive leisure The increase in the supply of labor as The increase in the supply of labor as the result of an increase in the price (or opportunity cost) of the result of an increase in the price (or opportunity cost) of leisure is called theleisure is called the SUBSTITUTION EFFECT SUBSTITUTION EFFECT

bull The Labor-supply CurveThe Labor-supply Curve

bull The following figure represents the workerrsquos labor-supply The following figure represents the workerrsquos labor-supply decision Look first at panel (A) Suppose that at point A decision Look first at panel (A) Suppose that at point A where the real wage is (where the real wage is (wp)1 the worker decides that providing l wp)1 the worker decides that providing l hours of work balances the advantages of a little more hours of work balances the advantages of a little more consumption against a little more leisure at the margin Now consumption against a little more leisure at the margin Now consider what happens when the real wage rises to (consider what happens when the real wage rises to (wp)2 wp)2 There is a substitution effect shown by the arrow pointing to There is a substitution effect shown by the arrow pointing to the right which encourages the worker to supply more labor the right which encourages the worker to supply more labor The size of the substitution effect is measured by the length of The size of the substitution effect is measured by the length of the arrowthe arrow

bull There is also an income effect shown by the arrow pointing to There is also an income effect shown by the arrow pointing to the left which encourages the worker to supply less laborthe left which encourages the worker to supply less labor

The Slope of the Labor-Supply Curve

bull The net effect The net effect is measured by the difference between the is measured by the difference between the substitution and income effects shown at point B so that an substitution and income effects shown at point B so that an increase in the wage rate increases the workerrsquos supply of labor increase in the wage rate increases the workerrsquos supply of labor to to l2 to the right of l1 If the substitution effect is always stronger l2 to the right of l1 If the substitution effect is always stronger then the labor supply then the labor supply curve slopes upward curve slopes upward

bull Substitution effects are not necessarily stronger than income Substitution effects are not necessarily stronger than income effectseffects Panel (B) shows the construction of the labor-supply Panel (B) shows the construction of the labor-supply curve starting from point C when income effects are stronger curve starting from point C when income effects are stronger than substitution effects When the real-wage rate increases than substitution effects When the real-wage rate increases from (from (wp)1 to (wp)2 the dominant income effect overwhelms wp)1 to (wp)2 the dominant income effect overwhelms the substitution effect and labor the substitution effect and labor supply (point C) falls from supply (point C) falls from l1 to l1 to l2 If income effects are stronger for all wage rates above l2 If income effects are stronger for all wage rates above ((wp)1 wp)1 then the labor-supply curve will slope downward toward point C then the labor-supply curve will slope downward toward point C higher real wage higher real wage rates lower labor supplyrates lower labor supply

bull Although the labor-supply curve can slope downward towards Although the labor-supply curve can slope downward towards a point like A it is not reasonable to believe that it could slope a point like A it is not reasonable to believe that it could slope downward for every possible wage rate At very low wage rates downward for every possible wage rate At very low wage rates it is more reasonable to suppose that with very low incomes it is more reasonable to suppose that with very low incomes the workerrsquos need for food clothing shelter and other the workerrsquos need for food clothing shelter and other ldquoessentialrdquo goods the income effect is weak and the ldquoessentialrdquo goods the income effect is weak and the substitution effect is strong We should therefore expect the substitution effect is strong We should therefore expect the labor-supply curve to be upward sloping when wage rates are labor-supply curve to be upward sloping when wage rates are low Hence labor supply would be backward bending low Hence labor supply would be backward bending

Backward-bending Labor-supply Curve

Adding Realism TaxesAdding Realism Taxes

bull How does the tax affect the income from a little more or a little How does the tax affect the income from a little more or a little less work To answer this question we must know the less work To answer this question we must know the marginal marginal tax ratetax rate ((the fraction of an additional dollar of income that is the fraction of an additional dollar of income that is paid as taxes) paid as taxes) To keep things simple assume that all income is To keep things simple assume that all income is taxed at the same taxed at the same flatflat rate rate ττ In this case the marginal tax rate In this case the marginal tax rate must also be τ which takes a value between zero and one If a must also be τ which takes a value between zero and one If a worker earns worker earns wpwp for an hour of work the government takes for an hour of work the government takes τ(wp) τ(wp) as taxes and leaves the worker as taxes and leaves the worker (1ndashτ)(wp) (1ndashτ)(wp) as the after-as the after-tax real wagetax real wage

bull Since the worker actually receives the Since the worker actually receives the after-tax real wageafter-tax real wage it is it is the the true opportunity cost of leisure true opportunity cost of leisure Any increase in the Any increase in the marginal tax rate represents a decrease in the opportunity cost marginal tax rate represents a decrease in the opportunity cost of leisure If of leisure If substitution effectssubstitution effects are stronger than income are stronger than income effects then any increase in marginal tax rates effects then any increase in marginal tax rates reducesreduces the the supply of labor supply of labor as shown in the following figureas shown in the following figure

The Effect of a Tax Increase on Labor Supply

bull The labor-supply curve with no taxes is shown on the right of The labor-supply curve with no taxes is shown on the right of the figure At the figure At (wp)1(wp)1 the worker supplies labor the worker supplies labor l1l1 If a tax of If a tax of τ1τ1 is imposed the after-tax real wage is is imposed the after-tax real wage is (1ndashτ1)(wp)1(1ndashτ1)(wp)1 The worker The worker should react exactly as if he paid no taxes but suffered a cut in should react exactly as if he paid no taxes but suffered a cut in his wages This is shown as a movement from point A to point B his wages This is shown as a movement from point A to point B where labor supply has fallen to where labor supply has fallen to l2l2 But of course the wage rate But of course the wage rate did not really falldid not really fall the employer still pays (wp)1 This means the employer still pays (wp)1 This means that (l2 (wp)1) is the labor-supply (point C)that (l2 (wp)1) is the labor-supply (point C)

bull Since this would apply for any real-wage rate every point on Since this would apply for any real-wage rate every point on the original curve shifts to the left Because the the original curve shifts to the left Because the tax rate is tax rate is proportional its absolute effect is greaterproportional its absolute effect is greater as is the shift in the as is the shift in the labor-supply curve at high wage rates resulting in a labor-supply curve at high wage rates resulting in a steepening of the curve Any further increase in the tax rate to steepening of the curve Any further increase in the tax rate to say τ2 would shift the labor-supply curve further to the left say τ2 would shift the labor-supply curve further to the left

bull The length of the line segment BC measures the The length of the line segment BC measures the TAX WEDGETAX WEDGE between the real wage paid by employers and the after-tax real between the real wage paid by employers and the after-tax real wage received by workewage received by workersrs The The largerlarger the tax wedge the the tax wedge the largerlarger the leftward shift of the labor-supply curve and the the leftward shift of the labor-supply curve and the greater the greater the reductionreduction in labor supplied at any real wage in labor supplied at any real wage

bull The idea that tax increases lower labor supply and conversely The idea that tax increases lower labor supply and conversely that tax cuts increase labor supply was a major tenet of the so-that tax cuts increase labor supply was a major tenet of the so-called called supply-side economicssupply-side economics popular in the early 1980s popular in the early 1980s President Ronald Reagan and his advisors used it to argue that President Ronald Reagan and his advisors used it to argue that cuts in marginal tax rates cuts in marginal tax rates would stimulate people would stimulate people to to workwork harder and to harder and to earn larger earn larger incomesincomes

Adding Realism A Standard WorkweekAdding Realism A Standard Workweek

bull Another way in which the simple analysis of labor supply is Another way in which the simple analysis of labor supply is unrealistic is that many unrealistic is that many workers are not given an option about workers are not given an option about the number of hours they workthe number of hours they work Although people work part- Although people work part-time and overtime either may be voluntary or mandatory time and overtime either may be voluntary or mandatory

bull Assuming that workers are Assuming that workers are not permitted to work more than not permitted to work more than 40 hours a week40 hours a week the following figure includes a constraint of the following figure includes a constraint of 40 hours If the worker were permitted to choose freely then 40 hours If the worker were permitted to choose freely then the labor-supply curve would backward bending curve The the labor-supply curve would backward bending curve The overall effect is to of the standard work week is to reshape the overall effect is to of the standard work week is to reshape the labor-supply curve as indicated by the heavy curve with the labor-supply curve as indicated by the heavy curve with the vertical segment that runs through points A F G D and E vertical segment that runs through points A F G D and E Any worker on this vertical segment is constrainedAny worker on this vertical segment is constrained

The Individual Labor-Supply Curve in PracticeThe Individual Labor-Supply Curve in Practice

bull What does the individual labor-supply curve look like in What does the individual labor-supply curve look like in realityreality It is difficult to answer this question because in reality It is difficult to answer this question because in reality we can observe we can observe only one pointonly one point on the labor-supply curve for a on the labor-supply curve for a single worker single worker at a particular timeat a particular time All the other points are All the other points are conjecturesconjectures about what the worker would supply if faced with about what the worker would supply if faced with different wage rates If we imagine that on average workers are different wage rates If we imagine that on average workers are substantially substantially similarsimilar we might nonetheless get some idea of we might nonetheless get some idea of what the individual labor-supply curve might look likewhat the individual labor-supply curve might look like

bull The The National Longitudinal SurveyNational Longitudinal Survey (Youth) has catalogued the (Youth) has catalogued the work histories of a large sample of individuals starting at a work histories of a large sample of individuals starting at a young age The following figure plots the real-wage rates and young age The following figure plots the real-wage rates and average weekly hours of labor for about average weekly hours of labor for about 1000010000 male workers male workers from this survey for a from this survey for a single periodsingle period with the best fitting flexible with the best fitting flexible line through these points serves as our empirical estimate of the line through these points serves as our empirical estimate of the labor-supply curve for these workerslabor-supply curve for these workers

bull The regression line traces out a shape very The regression line traces out a shape very like the backward-like the backward-bendingbending labor-supply curve with a 40-hour constraint What labor-supply curve with a 40-hour constraint What looks like a vertical line above 40 hours is looks like a vertical line above 40 hours is not really a solid line not really a solid line at all but a reflection of the fact that about at all but a reflection of the fact that about 7500 7500 of the 10000 of the 10000 workers in the sample supply 40 hours per week at a variety of workers in the sample supply 40 hours per week at a variety of wage rates The labor-supply curve traces out a segment above wage rates The labor-supply curve traces out a segment above the 40-hour point that corresponds to the constraintthe 40-hour point that corresponds to the constraint

bull There are There are points to the rightpoints to the right of 40 hours This is reasonable of 40 hours This is reasonable since in the real world workers do since in the real world workers do work overtimework overtime ndash either ndash either because they are supervisors or professionals or because because they are supervisors or professionals or because employers offer them the required time-and-half wage rate employers offer them the required time-and-half wage rate The fit of the regression line is far from perfect points lie on The fit of the regression line is far from perfect points lie on both sides of the line We should interpret it as a both sides of the line We should interpret it as a snapshotsnapshot of of the behavior of the typical worker But ofthe behavior of the typical worker But of course the typical course the typical worker is not any actual worker in particularworker is not any actual worker in particular

THE WORKER CHOOSING TO PARTICIPATETHE WORKER CHOOSING TO PARTICIPATE

bull So far we have examined only one aspect of the workerrsquos So far we have examined only one aspect of the workerrsquos labor-supply decision labor-supply decision how many hours to work for given real how many hours to work for given real wagewage We now take up the second aspect We now take up the second aspect participationparticipation ndash that ndash that is is whether or not to work at allwhether or not to work at all A labor-supply curve that starts A labor-supply curve that starts at the origin and slopes upwards for at least a portion of its at the origin and slopes upwards for at least a portion of its length suggests that even length suggests that even if the wage were very lowif the wage were very low ndash say 1cent ndash say 1cent per hour ndash the worker would work a little bit That is clearly per hour ndash the worker would work a little bit That is clearly unrealisticunrealistic no one would work at all for 1cent per hour no one would work at all for 1cent per hour What What factors determine how high the wage factors determine how high the wage must be to induce a person must be to induce a person to participate in the labor marketto participate in the labor market

bull The labor force The labor force participationparticipation decision is a question of decision is a question of opportunity costopportunity cost Idleness has its charms Before anyone enters Idleness has its charms Before anyone enters the labor force the wage rate must be high enough to overcome the labor force the wage rate must be high enough to overcome them them The opportunity cost of participatingThe opportunity cost of participating in the labor force is in the labor force is sum of sum of

1048766 1048766 the implicit valuethe implicit value the worker places on complete idleness the worker places on complete idleness

1048766 1048766 the explicit coststhe explicit costs of working compared to not working such as of working compared to not working such as clothing transport childcare) andclothing transport childcare) and

1048766 1048766 the explicit losses the explicit losses from working (for instance housework not from working (for instance housework not done)done)

bull The opportunity cost is partly psychological and partly material The opportunity cost is partly psychological and partly material If people were completely If people were completely independentindependent of each other the worker of each other the worker might place a lower value on the opportunity cost of might place a lower value on the opportunity cost of participation because then the choice might be literally between participation because then the choice might be literally between work and starvationwork and starvation

bull But most people are not But most people are not completely independentcompletely independent Whether or Whether or not to participate in the labor force could be a not to participate in the labor force could be a genuine choicegenuine choice and would depend on the and would depend on the real wagereal wage

bull The The RESERVATION WAGE RESERVATION WAGE is defined to be is defined to be the opportunity the opportunity cost of working compared to not workingcost of working compared to not working ndash ndash that is the real wage that is the real wage that is high enough to make it just worthwhile for a worker to that is high enough to make it just worthwhile for a worker to participate in the labor forceparticipate in the labor force

bull Taking account of the opportunity costs of participation affects Taking account of the opportunity costs of participation affects the shape of the labor-supply curve As long as the the shape of the labor-supply curve As long as the real wage is real wage is below the reservationbelow the reservation wage ((wp)R) the worker supplies no wage ((wp)R) the worker supplies no labor at all Above the reservation wage there is a normal labor at all Above the reservation wage there is a normal labor-supply curvelabor-supply curve

bull The following captures the two stages of the labor supply The following captures the two stages of the labor supply decision decision FirstFirst at low wages the worker will at low wages the worker will notnot supply any supply any labor at all and small increases in wages have no effect But labor at all and small increases in wages have no effect But secondsecond as soon as the wage rises enough for the worker to bite as soon as the wage rises enough for the worker to bite the bullet and join the labor force the minimum labor supplied the bullet and join the labor force the minimum labor supplied will be well will be well above zeroabove zero and the worker will decide how many and the worker will decide how many hours to supply above this minimum through the usual process hours to supply above this minimum through the usual process of balancing the opportunity cost of leisure against the desire of balancing the opportunity cost of leisure against the desire for consumption goodsfor consumption goods

AGGREGATE LABOR SUPPLY

bull How can we moveHow can we move from the microeconomics of the labor supply from the microeconomics of the labor supply back to an aggregate relationship usable in macroeconomic back to an aggregate relationship usable in macroeconomic analysis analysis If workers were essentially alikeIf workers were essentially alike the problem would the problem would be easy be easy

bull As we have seen labor supply has two dimensions ndash As we have seen labor supply has two dimensions ndash participationparticipation in the labor force and in the labor force and choice of hourschoice of hours of labor of labor Take the participation decision first If all workers were alike Take the participation decision first If all workers were alike except for except for differences in their reservation wagedifferences in their reservation wage then we could then we could rank them from lowest to highest reservation wage The rank them from lowest to highest reservation wage The aggregate labor-supply (participation) curve is strictly aggregate labor-supply (participation) curve is strictly upwardslopingupwardsloping

bull Of course this is too easy Just as we observed in deriving the Of course this is too easy Just as we observed in deriving the aggregate labor demand curve workers are aggregate labor demand curve workers are not all alikenot all alike Once Once again we must interpret the vertical axis as measuring the again we must interpret the vertical axis as measuring the average real wageaverage real wage that at best provides a kind of index for the that at best provides a kind of index for the level of the wage structure level of the wage structure

bull The The problemproblem remains the remains the samesame when we turn to the choice of when we turn to the choice of hourshours Workers are all different and face a structure of wages Workers are all different and face a structure of wages For each worker individually there is a jump from supplying For each worker individually there is a jump from supplying zero to supplying some positive number of hours zero to supplying some positive number of hours when his own when his own wage rate surpasses their wage rate surpasses their reservation wagereservation wage But in aggregate But in aggregate we are we are unlikely to see such a jumpunlikely to see such a jump Not only are there a variety Not only are there a variety of wages offered at any time but reservation wages differof wages offered at any time but reservation wages differ

Derivation of the Aggregate Labor-supply Curve

bull A curve like the one in this figure can be used to display either A curve like the one in this figure can be used to display either the the participation participation decision or decision or the hoursthe hours The horizontal axis can The horizontal axis can either be used for workers either be used for workers or worker-hoursor worker-hours as measures of the as measures of the labor supply The two meanings are not completely labor supply The two meanings are not completely independent by definition independent by definition

bull workers equiv aggregate worker ndash hours average hours per worker workers equiv aggregate worker ndash hours average hours per worker

The Participation Rate and Average Hours

bull Let us look first at the aggregate participation decision The Let us look first at the aggregate participation decision The aggregate number of workers who have decided to participate aggregate number of workers who have decided to participate is known as the is known as the labor forcelabor force the the civilian labor force over 16 civilian labor force over 16 years of ageyears of age This number excludes uniformed members of the This number excludes uniformed members of the armed services and the small number of workers under 16 armed services and the small number of workers under 16 years old The labor force of course has grown right along years old The labor force of course has grown right along with population with population

bull The participation rateThe participation rate (PR) measures (PR) measures the labor force as its ratio the labor force as its ratio to the relevant populationto the relevant population

bull participation rate = labor forcerelevant population participation rate = labor forcerelevant population

bull ldquoldquonon-institutionalrdquo non-institutionalrdquo excludes people in prison or in homes for excludes people in prison or in homes for the aged) the aged)

bull The aggregate number of hours The aggregate number of hours worked is worked is not as easy not as easy as the as the participation rate to relate to the individual workerrsquos choices participation rate to relate to the individual workerrsquos choices If every worker had the same labor-supply curve we would If every worker had the same labor-supply curve we would have to know the wage offered to each one in order to calculate have to know the wage offered to each one in order to calculate the total number of labor hours supplied In reality workers the total number of labor hours supplied In reality workers are not all alike are not all alike Labor-supply curves may vary systematically Labor-supply curves may vary systematically according to the sex age ethnic group education experience according to the sex age ethnic group education experience or other social or economic characteristics of the workersor other social or economic characteristics of the workers And And within any group the labor-supply curves of individuals are within any group the labor-supply curves of individuals are likely to varylikely to vary

bull In principle In principle if we had a good statistical estimate of the typical if we had a good statistical estimate of the typical distribution of the wagesdistribution of the wages we could make a reasonable we could make a reasonable calculation But statisticians at the Bureau of Labor Statistics calculation But statisticians at the Bureau of Labor Statistics (BLS) do not try to calculate the labor supply in this way (BLS) do not try to calculate the labor supply in this way Instead they Instead they count the number of hours that workers actually count the number of hours that workers actually workwork and the average and the average wages and salaries they are paid wages and salaries they are paid

bull In USA the total hours of labor in 1998 was In USA the total hours of labor in 1998 was 236882236882 million million The average hours of work is The average hours of work is 17211721 hours per year = hours per year = 344344 hours hours per week (assuming a 50 week year) This number is 14 percent per week (assuming a 50 week year) This number is 14 percent below the full time 40-hour week which makes sense since it below the full time 40-hour week which makes sense since it averages over full-time part-time and overtime workers averages over full-time part-time and overtime workers

Labor Market EquilibriumLabor Market Equilibrium

bull MARKET CLEARINGMARKET CLEARING

bull When both demand and supply curves are plotted on the same When both demand and supply curves are plotted on the same diagram the crossing point defines the diagram the crossing point defines the equilibrium real-wage equilibrium real-wage rate and the rate and the equilibrium level of labor employedequilibrium level of labor employed

bull The real wage The real wage looks different looks different from the point of view of the firm from the point of view of the firm and the worker For the and the worker For the firmfirm the relevant real wage is the the relevant real wage is the product-real wage product-real wage defined as defined as the number of units of the good the number of units of the good the firm produces that the wage will purchase the firm produces that the wage will purchase ((price of price of productproduct = = w) w) For the For the workerworker the relevant real wage is the the relevant real wage is the consumption-consumption-real real wagewage defined as defined as the number of typical consumption baskets the number of typical consumption baskets that the wage will purchase that the wage will purchase ((price of price of consumption basket consumption basket = = w)w)

bull For aggregate analysis we might use the For aggregate analysis we might use the Producer Price IndexProducer Price Index or the GDP deflator to approximate the or the GDP deflator to approximate the product priceproduct price and the and the CPICPI to approximate the to approximate the consumption price consumption price

bull Suppose that the product-real wage and the consumption-real Suppose that the product-real wage and the consumption-real wage in the following figure start out with the identical value wage in the following figure start out with the identical value ((wp) at the market-clearing point Awp) at the market-clearing point A Now suppose that Now suppose that imported Japanese cars are a large portion of the typical imported Japanese cars are a large portion of the typical workerrsquos consumption basket workerrsquos consumption basket and that and that ceteris paribus ceteris paribus the price the price of Japanese cars rises sharply This means that the of Japanese cars rises sharply This means that the real wage real wage from the point of view of the from the point of view of the consumer falls to (consumer falls to (wpwpCPICPI ) )11 at point at point

B B on the labor-supply curve (LS) so that the worker would on the labor-supply curve (LS) so that the worker would want to supply less labor (want to supply less labor (LL11))

bull The rise in the price of Japanese cars has no effect on the price The rise in the price of Japanese cars has no effect on the price of their products Nevertheless they see a reduction of labor of their products Nevertheless they see a reduction of labor supply at the original market clearing wage It is as if the supply at the original market clearing wage It is as if the labor-supply curve labor-supply curve has shifted to the left to has shifted to the left to LSLSrsquo which passes rsquo which passes through ((through ((wp) L1) at point C wp) L1) at point C At the original wage rate labor At the original wage rate labor demand exceeds labor supply so firms raise wages in an effort demand exceeds labor supply so firms raise wages in an effort to attract workers until they reach the new market-clearing to attract workers until they reach the new market-clearing wage at point D where they pay (wage at point D where they pay (wpwpPPIPPI ) for labor of L ) for labor of L The The

rise in the price of Japanese cars has the effect of raising the rise in the price of Japanese cars has the effect of raising the wages that firms must pay and reducing labor employedwages that firms must pay and reducing labor employed Higher wages partly compensate workers for the higher costs Higher wages partly compensate workers for the higher costs of consumption but firms can afford to pay those higher wages of consumption but firms can afford to pay those higher wages only if marginal products rise as a result of their using less only if marginal products rise as a result of their using less labor labor

bull The rise in wage rates is not enough to compensate workers The rise in wage rates is not enough to compensate workers fully so the consumption-real wage in equilibrium is (wpfully so the consumption-real wage in equilibrium is (wpCPI CPI ) )

atat point E We can think of import prices as a tax levied on point E We can think of import prices as a tax levied on consumers and of an increase in import prices as widening the consumers and of an increase in import prices as widening the tax wedge Unless the issue that we want to analyze depends on tax wedge Unless the issue that we want to analyze depends on the difference between product- and consumption-real wages the difference between product- and consumption-real wages we will treat the real wage as the same for both labor supply we will treat the real wage as the same for both labor supply and labor demandand labor demand

An Increase in the Price of Consumption GoodsAn Increase in the Price of Consumption GoodsRelative to the Price of OutputRelative to the Price of Output

ANALYZING IDEAL LABOR MARKETSANALYZING IDEAL LABOR MARKETS

bull The aggregate labor-supplylabor-demand diagram provides us The aggregate labor-supplylabor-demand diagram provides us with a powerful tool We now analyze three important with a powerful tool We now analyze three important macroeconomic issues macroeconomic issues

(1) the effect of tax cuts on employment (1) the effect of tax cuts on employment

(2) the effect of technological progress on the well-being of (2) the effect of technological progress on the well-being of workers and workers and

(3) the effect of immigration on existing workers (3) the effect of immigration on existing workers

bull Issue 1 Tax Cuts Issue 1 Tax Cuts What are the effects of a cut in marginal What are the effects of a cut in marginal income-tax rates on employment and the level of GDP in the income-tax rates on employment and the level of GDP in the economyeconomy Recall from section that a lower marginal income-Recall from section that a lower marginal income-tax rate increases labor supply at each real wage (a rightward tax rate increases labor supply at each real wage (a rightward shift of the labor-supply) shift of the labor-supply)

bull Labor-market equilibrium moves from point A to point B in Labor-market equilibrium moves from point A to point B in the lower panel of the following Notice that the amount of the lower panel of the following Notice that the amount of labor available to firms increases so that firms move labor available to firms increases so that firms move production from Arsquo to Brsquo on the labor production function in production from Arsquo to Brsquo on the labor production function in the upper panel Also notice that the real wage falls from (the upper panel Also notice that the real wage falls from (wp)1 wp)1 to (wp)2 Since the cut in taxes increases the number of to (wp)2 Since the cut in taxes increases the number of workers workers willing to work at each wage Workers care about their take-willing to work at each wage Workers care about their take-home pay ndash that is about their home pay ndash that is about their after-tax real wage after-tax real wage This is This is perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 can be greater than the old after-tax real wage (1ndashcan be greater than the old after-tax real wage (1ndashτ1τ1)(wp)1 so )(wp)1 so long as the rise in the take-home share (1 ndash τ) is long as the rise in the take-home share (1 ndash τ) is proportionately greater than the fall in the before-tax real proportionately greater than the fall in the before-tax real wage (wp)wage (wp)

bull The analysis depends on substitution effects dominating The analysis depends on substitution effects dominating income effects which they probably do in aggregate if not for income effects which they probably do in aggregate if not for every worker So the supply-siders of the Reagan years are every worker So the supply-siders of the Reagan years are correct in principle How much output will increase depends on correct in principle How much output will increase depends on how large the substitution effect is If most people work a how large the substitution effect is If most people work a standard 40-hour week the effect could be quite small and the standard 40-hour week the effect could be quite small and the increase in output might also be very small in practiceincrease in output might also be very small in practice

Issue 1 The Effect of a Cut in Marginal Tax RatesIssue 1 The Effect of a Cut in Marginal Tax Rates

Issue 2 Technological Progress and Worker WelfareIssue 2 Technological Progress and Worker Welfare

bull Is technological progress and increasing use of machinery and Is technological progress and increasing use of machinery and other capital beneficial for workersother capital beneficial for workers

bull Technological change or capital accumulation have been Technological change or capital accumulation have been known as ldquoLudditesrdquo (known as ldquoLudditesrdquo (it negatively affects the demand for it negatively affects the demand for laborlabor) To see why the Luddites are wrong ndash at least for ) To see why the Luddites are wrong ndash at least for clearing labor markets ndash recall that technological progress or clearing labor markets ndash recall that technological progress or increased capital both increased capital both shift the labor-demand curve upwardshift the labor-demand curve upward The lower panel of the following figure shows that the effect of The lower panel of the following figure shows that the effect of the increased demand for labor is to increase total employment the increased demand for labor is to increase total employment and the real wage Firms and the real wage Firms can pay a higher real wage can pay a higher real wage because because the additional capital or technological progress the additional capital or technological progress increases the increases the marginal product of labormarginal product of labor

bull The The Ludditesrsquo mistake Ludditesrsquo mistake is most easily seen in the upper panel is most easily seen in the upper panel The Luddite argument assumes that fewer workers will The Luddite argument assumes that fewer workers will produce the same total output Production starts at Arsquo using produce the same total output Production starts at Arsquo using L1 L1 workers to produce Y1 After the upward shift in the production workers to produce Y1 After the upward shift in the production function the same output could be produced using less labor function the same output could be produced using less labor ((L3) at point Arsquorsquo The L3) at point Arsquorsquo The problem is that Arsquorsquo is not an equilibrium problem is that Arsquorsquo is not an equilibrium At that point the marginal product of labor is higher than the At that point the marginal product of labor is higher than the original real wage so a profit-maximizing firm would want to original real wage so a profit-maximizing firm would want to expand production To do this they must hire more labor than expand production To do this they must hire more labor than L3 and indeed they L3 and indeed they find it find it profitable profitable to hire more labor than to hire more labor than the original the original L1 The only way actually to increase labor L1 The only way actually to increase labor is to is to raise the real-wage raise the real-wage rate above its original level Technological rate above its original level Technological progress therefore favors progress therefore favors workers by increasing employment workers by increasing employment and wagesand wages

bull Early in the 19th century hand-woven cloth was very Early in the 19th century hand-woven cloth was very expensive and a worker was lucky to own the clothes on his expensive and a worker was lucky to own the clothes on his back and a spare set for church on Sunday Textiles were one of back and a spare set for church on Sunday Textiles were one of the first industries to benefit from the Industrial Revolution so the first industries to benefit from the Industrial Revolution so that by the end of the 19th century machine-made fabrics and that by the end of the 19th century machine-made fabrics and mass-production made decent clothing in larger quantities mass-production made decent clothing in larger quantities accessible to most of the population of the more developed accessible to most of the population of the more developed countries Similar progress has been made in most forms of countries Similar progress has been made in most forms of production Agricultural production which at the turn of the production Agricultural production which at the turn of the 20th century absorbed half the labor force now absorbs less 20th century absorbed half the labor force now absorbs less than 3 percent while producing more food more cheaply than than 3 percent while producing more food more cheaply than ever ever

bull We must be careful not to dismiss the Luddites as altogether We must be careful not to dismiss the Luddites as altogether foolish While new technology especially over decades has foolish While new technology especially over decades has proved to be a net gain for workers in general the Luddites proved to be a net gain for workers in general the Luddites were in fact correct that their way of life was threatened were in fact correct that their way of life was threatened Independent weavers became factory hands unskilled Independent weavers became factory hands unskilled workers increasingly women and often children replaced workers increasingly women and often children replaced skilled craftsmen and factory work often involved long hours skilled craftsmen and factory work often involved long hours in brutal conditions The wider society reaps the benefits of in brutal conditions The wider society reaps the benefits of technological change while a narrow group sometimes technological change while a narrow group sometimes disproportionately bears its costs Our analysis also assumes disproportionately bears its costs Our analysis also assumes that markets generally clear The implicit assumption is that that markets generally clear The implicit assumption is that displaced workers move on to new jobs possibly in other forms displaced workers move on to new jobs possibly in other forms of production Markets may have a tendency to clear in the of production Markets may have a tendency to clear in the long run yet workers may find themselves displaced in the long run yet workers may find themselves displaced in the short run say over the course of a business cycleshort run say over the course of a business cycle

Issue 3 Immigration Jobs and Real WagesIssue 3 Immigration Jobs and Real Wages

bull How does an increase in the labor force through immigration or How does an increase in the labor force through immigration or natural population growth affect labor and GDP natural population growth affect labor and GDP

bull One of the emotional issues associated with US immigration One of the emotional issues associated with US immigration policy ndash particularly towards low-wage workers from Mexico ndash policy ndash particularly towards low-wage workers from Mexico ndash is the idea that is the idea that immigrants take jobs away from native immigrants take jobs away from native workers workers We might be tempted to dismiss this fear as another We might be tempted to dismiss this fear as another example of the lump-of-labor fallacy Yet there is a sensible example of the lump-of-labor fallacy Yet there is a sensible intuition behind the argument An increase in the labor force ndash intuition behind the argument An increase in the labor force ndash due either to immigration or to higher population growth rates due either to immigration or to higher population growth rates ndash can be represented as an outward shift of the aggregate labor ndash can be represented as an outward shift of the aggregate labor supply curve as shown in the following Figure Employment supply curve as shown in the following Figure Employment increases but real wages fall It is not then that immigrants increases but real wages fall It is not then that immigrants take jobs away from natives take jobs away from natives Rather they compete for jobsRather they compete for jobs putting downward pressure on real wagesputting downward pressure on real wages

bull Again we must exercise care in interpreting the analysis Again we must exercise care in interpreting the analysis Remember that aggregate labor and average wage rates hide Remember that aggregate labor and average wage rates hide many details of the labor process The incomes of the new many details of the labor process The incomes of the new immigrants immigrants creates demand creates demand for the new production that they for the new production that they make possible Immigrant workers (at least those ndash whether make possible Immigrant workers (at least those ndash whether legal or illegal ndash who have become the focus of the most intense legal or illegal ndash who have become the focus of the most intense political debate) political debate) are likely to possess fewer skills than nativesare likely to possess fewer skills than natives The net effect is that the increased demand for goods and The net effect is that the increased demand for goods and services generated by immigrants is likely to increase the services generated by immigrants is likely to increase the demand for skilled (demand for skilled (and largely nativeand largely native) workers relative to ) workers relative to their supply and so to increase real wages of skilled workers their supply and so to increase real wages of skilled workers Low-skilled immigration may lower the real wage for farm Low-skilled immigration may lower the real wage for farm workers but if anything it would raise the real wage for workers but if anything it would raise the real wage for computer programmerscomputer programmers

Next Task Labor Market in Kuwait

Appendix Is Labor Supply Stable Over Time

bull Statistics on participation rates or average hours for a Statistics on participation rates or average hours for a particular month or year are snapshot of the labor market particular month or year are snapshot of the labor market Can we analyze the effects of that increase on the labor market Can we analyze the effects of that increase on the labor market under the assumption that the labor-supply curves of workers under the assumption that the labor-supply curves of workers remain essentially stableremain essentially stable

bull Data on participation rates in the United States appear to Data on participation rates in the United States appear to support this conjecture (see Figure 811) which shows the support this conjecture (see Figure 811) which shows the overall civilian participation rate trending upward ndash at least overall civilian participation rate trending upward ndash at least from the middle of the 1960sfrom the middle of the 1960s

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

bull The Labor-Leisure ChoiceThe Labor-Leisure Choice

bull Once we see leisure as a good and the real-wage rate as its Once we see leisure as a good and the real-wage rate as its price it is easier to understand the choices a worker faces price it is easier to understand the choices a worker faces There are 168 hours in a week If a worker chooses There are 168 hours in a week If a worker chooses not to work not to work at allat all he enjoys 168 hours of leisure but forgoes the income he enjoys 168 hours of leisure but forgoes the income needed to buy any other goods If the worker instead takes needed to buy any other goods If the worker instead takes fewer hours of leisure he supplies labor fewer hours of leisure he supplies labor l = 168 ndash hours of l = 168 ndash hours of leisure leisure and he gains the ability to purchase goods worth wp times l and he gains the ability to purchase goods worth wp times l The problem The problem for the worker for the worker is to choose is to choose the hours of labor (the hours of labor (l ) l ) that at the margin makes the psychic value of a small loss that at the margin makes the psychic value of a small loss further loss of leisure time (ie a small increase in labor time) further loss of leisure time (ie a small increase in labor time) exactly equal to the psychic value of the small gain in exactly equal to the psychic value of the small gain in consumption goods that would be purchased by that laborconsumption goods that would be purchased by that labor

bull INCOME EFFECT How would your supply of labor change if you could receive the income that results from the increased wage rate without facing a changed opportunity cost of leisure

bull As a general rule an increase in income ceteris paribus increases the demand for all goods The extra $20 per week would permit you to buy more goods including leisure without reducing your purchases of other goods The reduction in the supply of labor as the result of an increase in income is called the income effect

bull SUBSTITUTION EFFECTSUBSTITUTION EFFECT

bull If the wage rate rose If the wage rate rose would people work more or less As a would people work more or less As a general rule whenever general rule whenever ceteris paribus the price of anything rises ceteris paribus the price of anything rises relative to alternativesrelative to alternatives the demand for it decreases Here the the demand for it decreases Here the price of leisure price of leisure (its opportunity cost) has risen relative to the (its opportunity cost) has risen relative to the price of other goods the supply of price of other goods the supply of labor would riselabor would rise The change The change in the wage rate encourages people to substitute the now in the wage rate encourages people to substitute the now cheaper goods (what you buy using your wage) for the now cheaper goods (what you buy using your wage) for the now more expensive leisure more expensive leisure The increase in the supply of labor as The increase in the supply of labor as the result of an increase in the price (or opportunity cost) of the result of an increase in the price (or opportunity cost) of leisure is called theleisure is called the SUBSTITUTION EFFECT SUBSTITUTION EFFECT

bull The Labor-supply CurveThe Labor-supply Curve

bull The following figure represents the workerrsquos labor-supply The following figure represents the workerrsquos labor-supply decision Look first at panel (A) Suppose that at point A decision Look first at panel (A) Suppose that at point A where the real wage is (where the real wage is (wp)1 the worker decides that providing l wp)1 the worker decides that providing l hours of work balances the advantages of a little more hours of work balances the advantages of a little more consumption against a little more leisure at the margin Now consumption against a little more leisure at the margin Now consider what happens when the real wage rises to (consider what happens when the real wage rises to (wp)2 wp)2 There is a substitution effect shown by the arrow pointing to There is a substitution effect shown by the arrow pointing to the right which encourages the worker to supply more labor the right which encourages the worker to supply more labor The size of the substitution effect is measured by the length of The size of the substitution effect is measured by the length of the arrowthe arrow

bull There is also an income effect shown by the arrow pointing to There is also an income effect shown by the arrow pointing to the left which encourages the worker to supply less laborthe left which encourages the worker to supply less labor

The Slope of the Labor-Supply Curve

bull The net effect The net effect is measured by the difference between the is measured by the difference between the substitution and income effects shown at point B so that an substitution and income effects shown at point B so that an increase in the wage rate increases the workerrsquos supply of labor increase in the wage rate increases the workerrsquos supply of labor to to l2 to the right of l1 If the substitution effect is always stronger l2 to the right of l1 If the substitution effect is always stronger then the labor supply then the labor supply curve slopes upward curve slopes upward

bull Substitution effects are not necessarily stronger than income Substitution effects are not necessarily stronger than income effectseffects Panel (B) shows the construction of the labor-supply Panel (B) shows the construction of the labor-supply curve starting from point C when income effects are stronger curve starting from point C when income effects are stronger than substitution effects When the real-wage rate increases than substitution effects When the real-wage rate increases from (from (wp)1 to (wp)2 the dominant income effect overwhelms wp)1 to (wp)2 the dominant income effect overwhelms the substitution effect and labor the substitution effect and labor supply (point C) falls from supply (point C) falls from l1 to l1 to l2 If income effects are stronger for all wage rates above l2 If income effects are stronger for all wage rates above ((wp)1 wp)1 then the labor-supply curve will slope downward toward point C then the labor-supply curve will slope downward toward point C higher real wage higher real wage rates lower labor supplyrates lower labor supply

bull Although the labor-supply curve can slope downward towards Although the labor-supply curve can slope downward towards a point like A it is not reasonable to believe that it could slope a point like A it is not reasonable to believe that it could slope downward for every possible wage rate At very low wage rates downward for every possible wage rate At very low wage rates it is more reasonable to suppose that with very low incomes it is more reasonable to suppose that with very low incomes the workerrsquos need for food clothing shelter and other the workerrsquos need for food clothing shelter and other ldquoessentialrdquo goods the income effect is weak and the ldquoessentialrdquo goods the income effect is weak and the substitution effect is strong We should therefore expect the substitution effect is strong We should therefore expect the labor-supply curve to be upward sloping when wage rates are labor-supply curve to be upward sloping when wage rates are low Hence labor supply would be backward bending low Hence labor supply would be backward bending

Backward-bending Labor-supply Curve

Adding Realism TaxesAdding Realism Taxes

bull How does the tax affect the income from a little more or a little How does the tax affect the income from a little more or a little less work To answer this question we must know the less work To answer this question we must know the marginal marginal tax ratetax rate ((the fraction of an additional dollar of income that is the fraction of an additional dollar of income that is paid as taxes) paid as taxes) To keep things simple assume that all income is To keep things simple assume that all income is taxed at the same taxed at the same flatflat rate rate ττ In this case the marginal tax rate In this case the marginal tax rate must also be τ which takes a value between zero and one If a must also be τ which takes a value between zero and one If a worker earns worker earns wpwp for an hour of work the government takes for an hour of work the government takes τ(wp) τ(wp) as taxes and leaves the worker as taxes and leaves the worker (1ndashτ)(wp) (1ndashτ)(wp) as the after-as the after-tax real wagetax real wage

bull Since the worker actually receives the Since the worker actually receives the after-tax real wageafter-tax real wage it is it is the the true opportunity cost of leisure true opportunity cost of leisure Any increase in the Any increase in the marginal tax rate represents a decrease in the opportunity cost marginal tax rate represents a decrease in the opportunity cost of leisure If of leisure If substitution effectssubstitution effects are stronger than income are stronger than income effects then any increase in marginal tax rates effects then any increase in marginal tax rates reducesreduces the the supply of labor supply of labor as shown in the following figureas shown in the following figure

The Effect of a Tax Increase on Labor Supply

bull The labor-supply curve with no taxes is shown on the right of The labor-supply curve with no taxes is shown on the right of the figure At the figure At (wp)1(wp)1 the worker supplies labor the worker supplies labor l1l1 If a tax of If a tax of τ1τ1 is imposed the after-tax real wage is is imposed the after-tax real wage is (1ndashτ1)(wp)1(1ndashτ1)(wp)1 The worker The worker should react exactly as if he paid no taxes but suffered a cut in should react exactly as if he paid no taxes but suffered a cut in his wages This is shown as a movement from point A to point B his wages This is shown as a movement from point A to point B where labor supply has fallen to where labor supply has fallen to l2l2 But of course the wage rate But of course the wage rate did not really falldid not really fall the employer still pays (wp)1 This means the employer still pays (wp)1 This means that (l2 (wp)1) is the labor-supply (point C)that (l2 (wp)1) is the labor-supply (point C)

bull Since this would apply for any real-wage rate every point on Since this would apply for any real-wage rate every point on the original curve shifts to the left Because the the original curve shifts to the left Because the tax rate is tax rate is proportional its absolute effect is greaterproportional its absolute effect is greater as is the shift in the as is the shift in the labor-supply curve at high wage rates resulting in a labor-supply curve at high wage rates resulting in a steepening of the curve Any further increase in the tax rate to steepening of the curve Any further increase in the tax rate to say τ2 would shift the labor-supply curve further to the left say τ2 would shift the labor-supply curve further to the left

bull The length of the line segment BC measures the The length of the line segment BC measures the TAX WEDGETAX WEDGE between the real wage paid by employers and the after-tax real between the real wage paid by employers and the after-tax real wage received by workewage received by workersrs The The largerlarger the tax wedge the the tax wedge the largerlarger the leftward shift of the labor-supply curve and the the leftward shift of the labor-supply curve and the greater the greater the reductionreduction in labor supplied at any real wage in labor supplied at any real wage

bull The idea that tax increases lower labor supply and conversely The idea that tax increases lower labor supply and conversely that tax cuts increase labor supply was a major tenet of the so-that tax cuts increase labor supply was a major tenet of the so-called called supply-side economicssupply-side economics popular in the early 1980s popular in the early 1980s President Ronald Reagan and his advisors used it to argue that President Ronald Reagan and his advisors used it to argue that cuts in marginal tax rates cuts in marginal tax rates would stimulate people would stimulate people to to workwork harder and to harder and to earn larger earn larger incomesincomes

Adding Realism A Standard WorkweekAdding Realism A Standard Workweek

bull Another way in which the simple analysis of labor supply is Another way in which the simple analysis of labor supply is unrealistic is that many unrealistic is that many workers are not given an option about workers are not given an option about the number of hours they workthe number of hours they work Although people work part- Although people work part-time and overtime either may be voluntary or mandatory time and overtime either may be voluntary or mandatory

bull Assuming that workers are Assuming that workers are not permitted to work more than not permitted to work more than 40 hours a week40 hours a week the following figure includes a constraint of the following figure includes a constraint of 40 hours If the worker were permitted to choose freely then 40 hours If the worker were permitted to choose freely then the labor-supply curve would backward bending curve The the labor-supply curve would backward bending curve The overall effect is to of the standard work week is to reshape the overall effect is to of the standard work week is to reshape the labor-supply curve as indicated by the heavy curve with the labor-supply curve as indicated by the heavy curve with the vertical segment that runs through points A F G D and E vertical segment that runs through points A F G D and E Any worker on this vertical segment is constrainedAny worker on this vertical segment is constrained

The Individual Labor-Supply Curve in PracticeThe Individual Labor-Supply Curve in Practice

bull What does the individual labor-supply curve look like in What does the individual labor-supply curve look like in realityreality It is difficult to answer this question because in reality It is difficult to answer this question because in reality we can observe we can observe only one pointonly one point on the labor-supply curve for a on the labor-supply curve for a single worker single worker at a particular timeat a particular time All the other points are All the other points are conjecturesconjectures about what the worker would supply if faced with about what the worker would supply if faced with different wage rates If we imagine that on average workers are different wage rates If we imagine that on average workers are substantially substantially similarsimilar we might nonetheless get some idea of we might nonetheless get some idea of what the individual labor-supply curve might look likewhat the individual labor-supply curve might look like

bull The The National Longitudinal SurveyNational Longitudinal Survey (Youth) has catalogued the (Youth) has catalogued the work histories of a large sample of individuals starting at a work histories of a large sample of individuals starting at a young age The following figure plots the real-wage rates and young age The following figure plots the real-wage rates and average weekly hours of labor for about average weekly hours of labor for about 1000010000 male workers male workers from this survey for a from this survey for a single periodsingle period with the best fitting flexible with the best fitting flexible line through these points serves as our empirical estimate of the line through these points serves as our empirical estimate of the labor-supply curve for these workerslabor-supply curve for these workers

bull The regression line traces out a shape very The regression line traces out a shape very like the backward-like the backward-bendingbending labor-supply curve with a 40-hour constraint What labor-supply curve with a 40-hour constraint What looks like a vertical line above 40 hours is looks like a vertical line above 40 hours is not really a solid line not really a solid line at all but a reflection of the fact that about at all but a reflection of the fact that about 7500 7500 of the 10000 of the 10000 workers in the sample supply 40 hours per week at a variety of workers in the sample supply 40 hours per week at a variety of wage rates The labor-supply curve traces out a segment above wage rates The labor-supply curve traces out a segment above the 40-hour point that corresponds to the constraintthe 40-hour point that corresponds to the constraint

bull There are There are points to the rightpoints to the right of 40 hours This is reasonable of 40 hours This is reasonable since in the real world workers do since in the real world workers do work overtimework overtime ndash either ndash either because they are supervisors or professionals or because because they are supervisors or professionals or because employers offer them the required time-and-half wage rate employers offer them the required time-and-half wage rate The fit of the regression line is far from perfect points lie on The fit of the regression line is far from perfect points lie on both sides of the line We should interpret it as a both sides of the line We should interpret it as a snapshotsnapshot of of the behavior of the typical worker But ofthe behavior of the typical worker But of course the typical course the typical worker is not any actual worker in particularworker is not any actual worker in particular

THE WORKER CHOOSING TO PARTICIPATETHE WORKER CHOOSING TO PARTICIPATE

bull So far we have examined only one aspect of the workerrsquos So far we have examined only one aspect of the workerrsquos labor-supply decision labor-supply decision how many hours to work for given real how many hours to work for given real wagewage We now take up the second aspect We now take up the second aspect participationparticipation ndash that ndash that is is whether or not to work at allwhether or not to work at all A labor-supply curve that starts A labor-supply curve that starts at the origin and slopes upwards for at least a portion of its at the origin and slopes upwards for at least a portion of its length suggests that even length suggests that even if the wage were very lowif the wage were very low ndash say 1cent ndash say 1cent per hour ndash the worker would work a little bit That is clearly per hour ndash the worker would work a little bit That is clearly unrealisticunrealistic no one would work at all for 1cent per hour no one would work at all for 1cent per hour What What factors determine how high the wage factors determine how high the wage must be to induce a person must be to induce a person to participate in the labor marketto participate in the labor market

bull The labor force The labor force participationparticipation decision is a question of decision is a question of opportunity costopportunity cost Idleness has its charms Before anyone enters Idleness has its charms Before anyone enters the labor force the wage rate must be high enough to overcome the labor force the wage rate must be high enough to overcome them them The opportunity cost of participatingThe opportunity cost of participating in the labor force is in the labor force is sum of sum of

1048766 1048766 the implicit valuethe implicit value the worker places on complete idleness the worker places on complete idleness

1048766 1048766 the explicit coststhe explicit costs of working compared to not working such as of working compared to not working such as clothing transport childcare) andclothing transport childcare) and

1048766 1048766 the explicit losses the explicit losses from working (for instance housework not from working (for instance housework not done)done)

bull The opportunity cost is partly psychological and partly material The opportunity cost is partly psychological and partly material If people were completely If people were completely independentindependent of each other the worker of each other the worker might place a lower value on the opportunity cost of might place a lower value on the opportunity cost of participation because then the choice might be literally between participation because then the choice might be literally between work and starvationwork and starvation

bull But most people are not But most people are not completely independentcompletely independent Whether or Whether or not to participate in the labor force could be a not to participate in the labor force could be a genuine choicegenuine choice and would depend on the and would depend on the real wagereal wage

bull The The RESERVATION WAGE RESERVATION WAGE is defined to be is defined to be the opportunity the opportunity cost of working compared to not workingcost of working compared to not working ndash ndash that is the real wage that is the real wage that is high enough to make it just worthwhile for a worker to that is high enough to make it just worthwhile for a worker to participate in the labor forceparticipate in the labor force

bull Taking account of the opportunity costs of participation affects Taking account of the opportunity costs of participation affects the shape of the labor-supply curve As long as the the shape of the labor-supply curve As long as the real wage is real wage is below the reservationbelow the reservation wage ((wp)R) the worker supplies no wage ((wp)R) the worker supplies no labor at all Above the reservation wage there is a normal labor at all Above the reservation wage there is a normal labor-supply curvelabor-supply curve

bull The following captures the two stages of the labor supply The following captures the two stages of the labor supply decision decision FirstFirst at low wages the worker will at low wages the worker will notnot supply any supply any labor at all and small increases in wages have no effect But labor at all and small increases in wages have no effect But secondsecond as soon as the wage rises enough for the worker to bite as soon as the wage rises enough for the worker to bite the bullet and join the labor force the minimum labor supplied the bullet and join the labor force the minimum labor supplied will be well will be well above zeroabove zero and the worker will decide how many and the worker will decide how many hours to supply above this minimum through the usual process hours to supply above this minimum through the usual process of balancing the opportunity cost of leisure against the desire of balancing the opportunity cost of leisure against the desire for consumption goodsfor consumption goods

AGGREGATE LABOR SUPPLY

bull How can we moveHow can we move from the microeconomics of the labor supply from the microeconomics of the labor supply back to an aggregate relationship usable in macroeconomic back to an aggregate relationship usable in macroeconomic analysis analysis If workers were essentially alikeIf workers were essentially alike the problem would the problem would be easy be easy

bull As we have seen labor supply has two dimensions ndash As we have seen labor supply has two dimensions ndash participationparticipation in the labor force and in the labor force and choice of hourschoice of hours of labor of labor Take the participation decision first If all workers were alike Take the participation decision first If all workers were alike except for except for differences in their reservation wagedifferences in their reservation wage then we could then we could rank them from lowest to highest reservation wage The rank them from lowest to highest reservation wage The aggregate labor-supply (participation) curve is strictly aggregate labor-supply (participation) curve is strictly upwardslopingupwardsloping

bull Of course this is too easy Just as we observed in deriving the Of course this is too easy Just as we observed in deriving the aggregate labor demand curve workers are aggregate labor demand curve workers are not all alikenot all alike Once Once again we must interpret the vertical axis as measuring the again we must interpret the vertical axis as measuring the average real wageaverage real wage that at best provides a kind of index for the that at best provides a kind of index for the level of the wage structure level of the wage structure

bull The The problemproblem remains the remains the samesame when we turn to the choice of when we turn to the choice of hourshours Workers are all different and face a structure of wages Workers are all different and face a structure of wages For each worker individually there is a jump from supplying For each worker individually there is a jump from supplying zero to supplying some positive number of hours zero to supplying some positive number of hours when his own when his own wage rate surpasses their wage rate surpasses their reservation wagereservation wage But in aggregate But in aggregate we are we are unlikely to see such a jumpunlikely to see such a jump Not only are there a variety Not only are there a variety of wages offered at any time but reservation wages differof wages offered at any time but reservation wages differ

Derivation of the Aggregate Labor-supply Curve

bull A curve like the one in this figure can be used to display either A curve like the one in this figure can be used to display either the the participation participation decision or decision or the hoursthe hours The horizontal axis can The horizontal axis can either be used for workers either be used for workers or worker-hoursor worker-hours as measures of the as measures of the labor supply The two meanings are not completely labor supply The two meanings are not completely independent by definition independent by definition

bull workers equiv aggregate worker ndash hours average hours per worker workers equiv aggregate worker ndash hours average hours per worker

The Participation Rate and Average Hours

bull Let us look first at the aggregate participation decision The Let us look first at the aggregate participation decision The aggregate number of workers who have decided to participate aggregate number of workers who have decided to participate is known as the is known as the labor forcelabor force the the civilian labor force over 16 civilian labor force over 16 years of ageyears of age This number excludes uniformed members of the This number excludes uniformed members of the armed services and the small number of workers under 16 armed services and the small number of workers under 16 years old The labor force of course has grown right along years old The labor force of course has grown right along with population with population

bull The participation rateThe participation rate (PR) measures (PR) measures the labor force as its ratio the labor force as its ratio to the relevant populationto the relevant population

bull participation rate = labor forcerelevant population participation rate = labor forcerelevant population

bull ldquoldquonon-institutionalrdquo non-institutionalrdquo excludes people in prison or in homes for excludes people in prison or in homes for the aged) the aged)

bull The aggregate number of hours The aggregate number of hours worked is worked is not as easy not as easy as the as the participation rate to relate to the individual workerrsquos choices participation rate to relate to the individual workerrsquos choices If every worker had the same labor-supply curve we would If every worker had the same labor-supply curve we would have to know the wage offered to each one in order to calculate have to know the wage offered to each one in order to calculate the total number of labor hours supplied In reality workers the total number of labor hours supplied In reality workers are not all alike are not all alike Labor-supply curves may vary systematically Labor-supply curves may vary systematically according to the sex age ethnic group education experience according to the sex age ethnic group education experience or other social or economic characteristics of the workersor other social or economic characteristics of the workers And And within any group the labor-supply curves of individuals are within any group the labor-supply curves of individuals are likely to varylikely to vary

bull In principle In principle if we had a good statistical estimate of the typical if we had a good statistical estimate of the typical distribution of the wagesdistribution of the wages we could make a reasonable we could make a reasonable calculation But statisticians at the Bureau of Labor Statistics calculation But statisticians at the Bureau of Labor Statistics (BLS) do not try to calculate the labor supply in this way (BLS) do not try to calculate the labor supply in this way Instead they Instead they count the number of hours that workers actually count the number of hours that workers actually workwork and the average and the average wages and salaries they are paid wages and salaries they are paid

bull In USA the total hours of labor in 1998 was In USA the total hours of labor in 1998 was 236882236882 million million The average hours of work is The average hours of work is 17211721 hours per year = hours per year = 344344 hours hours per week (assuming a 50 week year) This number is 14 percent per week (assuming a 50 week year) This number is 14 percent below the full time 40-hour week which makes sense since it below the full time 40-hour week which makes sense since it averages over full-time part-time and overtime workers averages over full-time part-time and overtime workers

Labor Market EquilibriumLabor Market Equilibrium

bull MARKET CLEARINGMARKET CLEARING

bull When both demand and supply curves are plotted on the same When both demand and supply curves are plotted on the same diagram the crossing point defines the diagram the crossing point defines the equilibrium real-wage equilibrium real-wage rate and the rate and the equilibrium level of labor employedequilibrium level of labor employed

bull The real wage The real wage looks different looks different from the point of view of the firm from the point of view of the firm and the worker For the and the worker For the firmfirm the relevant real wage is the the relevant real wage is the product-real wage product-real wage defined as defined as the number of units of the good the number of units of the good the firm produces that the wage will purchase the firm produces that the wage will purchase ((price of price of productproduct = = w) w) For the For the workerworker the relevant real wage is the the relevant real wage is the consumption-consumption-real real wagewage defined as defined as the number of typical consumption baskets the number of typical consumption baskets that the wage will purchase that the wage will purchase ((price of price of consumption basket consumption basket = = w)w)

bull For aggregate analysis we might use the For aggregate analysis we might use the Producer Price IndexProducer Price Index or the GDP deflator to approximate the or the GDP deflator to approximate the product priceproduct price and the and the CPICPI to approximate the to approximate the consumption price consumption price

bull Suppose that the product-real wage and the consumption-real Suppose that the product-real wage and the consumption-real wage in the following figure start out with the identical value wage in the following figure start out with the identical value ((wp) at the market-clearing point Awp) at the market-clearing point A Now suppose that Now suppose that imported Japanese cars are a large portion of the typical imported Japanese cars are a large portion of the typical workerrsquos consumption basket workerrsquos consumption basket and that and that ceteris paribus ceteris paribus the price the price of Japanese cars rises sharply This means that the of Japanese cars rises sharply This means that the real wage real wage from the point of view of the from the point of view of the consumer falls to (consumer falls to (wpwpCPICPI ) )11 at point at point

B B on the labor-supply curve (LS) so that the worker would on the labor-supply curve (LS) so that the worker would want to supply less labor (want to supply less labor (LL11))

bull The rise in the price of Japanese cars has no effect on the price The rise in the price of Japanese cars has no effect on the price of their products Nevertheless they see a reduction of labor of their products Nevertheless they see a reduction of labor supply at the original market clearing wage It is as if the supply at the original market clearing wage It is as if the labor-supply curve labor-supply curve has shifted to the left to has shifted to the left to LSLSrsquo which passes rsquo which passes through ((through ((wp) L1) at point C wp) L1) at point C At the original wage rate labor At the original wage rate labor demand exceeds labor supply so firms raise wages in an effort demand exceeds labor supply so firms raise wages in an effort to attract workers until they reach the new market-clearing to attract workers until they reach the new market-clearing wage at point D where they pay (wage at point D where they pay (wpwpPPIPPI ) for labor of L ) for labor of L The The

rise in the price of Japanese cars has the effect of raising the rise in the price of Japanese cars has the effect of raising the wages that firms must pay and reducing labor employedwages that firms must pay and reducing labor employed Higher wages partly compensate workers for the higher costs Higher wages partly compensate workers for the higher costs of consumption but firms can afford to pay those higher wages of consumption but firms can afford to pay those higher wages only if marginal products rise as a result of their using less only if marginal products rise as a result of their using less labor labor

bull The rise in wage rates is not enough to compensate workers The rise in wage rates is not enough to compensate workers fully so the consumption-real wage in equilibrium is (wpfully so the consumption-real wage in equilibrium is (wpCPI CPI ) )

atat point E We can think of import prices as a tax levied on point E We can think of import prices as a tax levied on consumers and of an increase in import prices as widening the consumers and of an increase in import prices as widening the tax wedge Unless the issue that we want to analyze depends on tax wedge Unless the issue that we want to analyze depends on the difference between product- and consumption-real wages the difference between product- and consumption-real wages we will treat the real wage as the same for both labor supply we will treat the real wage as the same for both labor supply and labor demandand labor demand

An Increase in the Price of Consumption GoodsAn Increase in the Price of Consumption GoodsRelative to the Price of OutputRelative to the Price of Output

ANALYZING IDEAL LABOR MARKETSANALYZING IDEAL LABOR MARKETS

bull The aggregate labor-supplylabor-demand diagram provides us The aggregate labor-supplylabor-demand diagram provides us with a powerful tool We now analyze three important with a powerful tool We now analyze three important macroeconomic issues macroeconomic issues

(1) the effect of tax cuts on employment (1) the effect of tax cuts on employment

(2) the effect of technological progress on the well-being of (2) the effect of technological progress on the well-being of workers and workers and

(3) the effect of immigration on existing workers (3) the effect of immigration on existing workers

bull Issue 1 Tax Cuts Issue 1 Tax Cuts What are the effects of a cut in marginal What are the effects of a cut in marginal income-tax rates on employment and the level of GDP in the income-tax rates on employment and the level of GDP in the economyeconomy Recall from section that a lower marginal income-Recall from section that a lower marginal income-tax rate increases labor supply at each real wage (a rightward tax rate increases labor supply at each real wage (a rightward shift of the labor-supply) shift of the labor-supply)

bull Labor-market equilibrium moves from point A to point B in Labor-market equilibrium moves from point A to point B in the lower panel of the following Notice that the amount of the lower panel of the following Notice that the amount of labor available to firms increases so that firms move labor available to firms increases so that firms move production from Arsquo to Brsquo on the labor production function in production from Arsquo to Brsquo on the labor production function in the upper panel Also notice that the real wage falls from (the upper panel Also notice that the real wage falls from (wp)1 wp)1 to (wp)2 Since the cut in taxes increases the number of to (wp)2 Since the cut in taxes increases the number of workers workers willing to work at each wage Workers care about their take-willing to work at each wage Workers care about their take-home pay ndash that is about their home pay ndash that is about their after-tax real wage after-tax real wage This is This is perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 can be greater than the old after-tax real wage (1ndashcan be greater than the old after-tax real wage (1ndashτ1τ1)(wp)1 so )(wp)1 so long as the rise in the take-home share (1 ndash τ) is long as the rise in the take-home share (1 ndash τ) is proportionately greater than the fall in the before-tax real proportionately greater than the fall in the before-tax real wage (wp)wage (wp)

bull The analysis depends on substitution effects dominating The analysis depends on substitution effects dominating income effects which they probably do in aggregate if not for income effects which they probably do in aggregate if not for every worker So the supply-siders of the Reagan years are every worker So the supply-siders of the Reagan years are correct in principle How much output will increase depends on correct in principle How much output will increase depends on how large the substitution effect is If most people work a how large the substitution effect is If most people work a standard 40-hour week the effect could be quite small and the standard 40-hour week the effect could be quite small and the increase in output might also be very small in practiceincrease in output might also be very small in practice

Issue 1 The Effect of a Cut in Marginal Tax RatesIssue 1 The Effect of a Cut in Marginal Tax Rates

Issue 2 Technological Progress and Worker WelfareIssue 2 Technological Progress and Worker Welfare

bull Is technological progress and increasing use of machinery and Is technological progress and increasing use of machinery and other capital beneficial for workersother capital beneficial for workers

bull Technological change or capital accumulation have been Technological change or capital accumulation have been known as ldquoLudditesrdquo (known as ldquoLudditesrdquo (it negatively affects the demand for it negatively affects the demand for laborlabor) To see why the Luddites are wrong ndash at least for ) To see why the Luddites are wrong ndash at least for clearing labor markets ndash recall that technological progress or clearing labor markets ndash recall that technological progress or increased capital both increased capital both shift the labor-demand curve upwardshift the labor-demand curve upward The lower panel of the following figure shows that the effect of The lower panel of the following figure shows that the effect of the increased demand for labor is to increase total employment the increased demand for labor is to increase total employment and the real wage Firms and the real wage Firms can pay a higher real wage can pay a higher real wage because because the additional capital or technological progress the additional capital or technological progress increases the increases the marginal product of labormarginal product of labor

bull The The Ludditesrsquo mistake Ludditesrsquo mistake is most easily seen in the upper panel is most easily seen in the upper panel The Luddite argument assumes that fewer workers will The Luddite argument assumes that fewer workers will produce the same total output Production starts at Arsquo using produce the same total output Production starts at Arsquo using L1 L1 workers to produce Y1 After the upward shift in the production workers to produce Y1 After the upward shift in the production function the same output could be produced using less labor function the same output could be produced using less labor ((L3) at point Arsquorsquo The L3) at point Arsquorsquo The problem is that Arsquorsquo is not an equilibrium problem is that Arsquorsquo is not an equilibrium At that point the marginal product of labor is higher than the At that point the marginal product of labor is higher than the original real wage so a profit-maximizing firm would want to original real wage so a profit-maximizing firm would want to expand production To do this they must hire more labor than expand production To do this they must hire more labor than L3 and indeed they L3 and indeed they find it find it profitable profitable to hire more labor than to hire more labor than the original the original L1 The only way actually to increase labor L1 The only way actually to increase labor is to is to raise the real-wage raise the real-wage rate above its original level Technological rate above its original level Technological progress therefore favors progress therefore favors workers by increasing employment workers by increasing employment and wagesand wages

bull Early in the 19th century hand-woven cloth was very Early in the 19th century hand-woven cloth was very expensive and a worker was lucky to own the clothes on his expensive and a worker was lucky to own the clothes on his back and a spare set for church on Sunday Textiles were one of back and a spare set for church on Sunday Textiles were one of the first industries to benefit from the Industrial Revolution so the first industries to benefit from the Industrial Revolution so that by the end of the 19th century machine-made fabrics and that by the end of the 19th century machine-made fabrics and mass-production made decent clothing in larger quantities mass-production made decent clothing in larger quantities accessible to most of the population of the more developed accessible to most of the population of the more developed countries Similar progress has been made in most forms of countries Similar progress has been made in most forms of production Agricultural production which at the turn of the production Agricultural production which at the turn of the 20th century absorbed half the labor force now absorbs less 20th century absorbed half the labor force now absorbs less than 3 percent while producing more food more cheaply than than 3 percent while producing more food more cheaply than ever ever

bull We must be careful not to dismiss the Luddites as altogether We must be careful not to dismiss the Luddites as altogether foolish While new technology especially over decades has foolish While new technology especially over decades has proved to be a net gain for workers in general the Luddites proved to be a net gain for workers in general the Luddites were in fact correct that their way of life was threatened were in fact correct that their way of life was threatened Independent weavers became factory hands unskilled Independent weavers became factory hands unskilled workers increasingly women and often children replaced workers increasingly women and often children replaced skilled craftsmen and factory work often involved long hours skilled craftsmen and factory work often involved long hours in brutal conditions The wider society reaps the benefits of in brutal conditions The wider society reaps the benefits of technological change while a narrow group sometimes technological change while a narrow group sometimes disproportionately bears its costs Our analysis also assumes disproportionately bears its costs Our analysis also assumes that markets generally clear The implicit assumption is that that markets generally clear The implicit assumption is that displaced workers move on to new jobs possibly in other forms displaced workers move on to new jobs possibly in other forms of production Markets may have a tendency to clear in the of production Markets may have a tendency to clear in the long run yet workers may find themselves displaced in the long run yet workers may find themselves displaced in the short run say over the course of a business cycleshort run say over the course of a business cycle

Issue 3 Immigration Jobs and Real WagesIssue 3 Immigration Jobs and Real Wages

bull How does an increase in the labor force through immigration or How does an increase in the labor force through immigration or natural population growth affect labor and GDP natural population growth affect labor and GDP

bull One of the emotional issues associated with US immigration One of the emotional issues associated with US immigration policy ndash particularly towards low-wage workers from Mexico ndash policy ndash particularly towards low-wage workers from Mexico ndash is the idea that is the idea that immigrants take jobs away from native immigrants take jobs away from native workers workers We might be tempted to dismiss this fear as another We might be tempted to dismiss this fear as another example of the lump-of-labor fallacy Yet there is a sensible example of the lump-of-labor fallacy Yet there is a sensible intuition behind the argument An increase in the labor force ndash intuition behind the argument An increase in the labor force ndash due either to immigration or to higher population growth rates due either to immigration or to higher population growth rates ndash can be represented as an outward shift of the aggregate labor ndash can be represented as an outward shift of the aggregate labor supply curve as shown in the following Figure Employment supply curve as shown in the following Figure Employment increases but real wages fall It is not then that immigrants increases but real wages fall It is not then that immigrants take jobs away from natives take jobs away from natives Rather they compete for jobsRather they compete for jobs putting downward pressure on real wagesputting downward pressure on real wages

bull Again we must exercise care in interpreting the analysis Again we must exercise care in interpreting the analysis Remember that aggregate labor and average wage rates hide Remember that aggregate labor and average wage rates hide many details of the labor process The incomes of the new many details of the labor process The incomes of the new immigrants immigrants creates demand creates demand for the new production that they for the new production that they make possible Immigrant workers (at least those ndash whether make possible Immigrant workers (at least those ndash whether legal or illegal ndash who have become the focus of the most intense legal or illegal ndash who have become the focus of the most intense political debate) political debate) are likely to possess fewer skills than nativesare likely to possess fewer skills than natives The net effect is that the increased demand for goods and The net effect is that the increased demand for goods and services generated by immigrants is likely to increase the services generated by immigrants is likely to increase the demand for skilled (demand for skilled (and largely nativeand largely native) workers relative to ) workers relative to their supply and so to increase real wages of skilled workers their supply and so to increase real wages of skilled workers Low-skilled immigration may lower the real wage for farm Low-skilled immigration may lower the real wage for farm workers but if anything it would raise the real wage for workers but if anything it would raise the real wage for computer programmerscomputer programmers

Next Task Labor Market in Kuwait

Appendix Is Labor Supply Stable Over Time

bull Statistics on participation rates or average hours for a Statistics on participation rates or average hours for a particular month or year are snapshot of the labor market particular month or year are snapshot of the labor market Can we analyze the effects of that increase on the labor market Can we analyze the effects of that increase on the labor market under the assumption that the labor-supply curves of workers under the assumption that the labor-supply curves of workers remain essentially stableremain essentially stable

bull Data on participation rates in the United States appear to Data on participation rates in the United States appear to support this conjecture (see Figure 811) which shows the support this conjecture (see Figure 811) which shows the overall civilian participation rate trending upward ndash at least overall civilian participation rate trending upward ndash at least from the middle of the 1960sfrom the middle of the 1960s

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

bull INCOME EFFECT How would your supply of labor change if you could receive the income that results from the increased wage rate without facing a changed opportunity cost of leisure

bull As a general rule an increase in income ceteris paribus increases the demand for all goods The extra $20 per week would permit you to buy more goods including leisure without reducing your purchases of other goods The reduction in the supply of labor as the result of an increase in income is called the income effect

bull SUBSTITUTION EFFECTSUBSTITUTION EFFECT

bull If the wage rate rose If the wage rate rose would people work more or less As a would people work more or less As a general rule whenever general rule whenever ceteris paribus the price of anything rises ceteris paribus the price of anything rises relative to alternativesrelative to alternatives the demand for it decreases Here the the demand for it decreases Here the price of leisure price of leisure (its opportunity cost) has risen relative to the (its opportunity cost) has risen relative to the price of other goods the supply of price of other goods the supply of labor would riselabor would rise The change The change in the wage rate encourages people to substitute the now in the wage rate encourages people to substitute the now cheaper goods (what you buy using your wage) for the now cheaper goods (what you buy using your wage) for the now more expensive leisure more expensive leisure The increase in the supply of labor as The increase in the supply of labor as the result of an increase in the price (or opportunity cost) of the result of an increase in the price (or opportunity cost) of leisure is called theleisure is called the SUBSTITUTION EFFECT SUBSTITUTION EFFECT

bull The Labor-supply CurveThe Labor-supply Curve

bull The following figure represents the workerrsquos labor-supply The following figure represents the workerrsquos labor-supply decision Look first at panel (A) Suppose that at point A decision Look first at panel (A) Suppose that at point A where the real wage is (where the real wage is (wp)1 the worker decides that providing l wp)1 the worker decides that providing l hours of work balances the advantages of a little more hours of work balances the advantages of a little more consumption against a little more leisure at the margin Now consumption against a little more leisure at the margin Now consider what happens when the real wage rises to (consider what happens when the real wage rises to (wp)2 wp)2 There is a substitution effect shown by the arrow pointing to There is a substitution effect shown by the arrow pointing to the right which encourages the worker to supply more labor the right which encourages the worker to supply more labor The size of the substitution effect is measured by the length of The size of the substitution effect is measured by the length of the arrowthe arrow

bull There is also an income effect shown by the arrow pointing to There is also an income effect shown by the arrow pointing to the left which encourages the worker to supply less laborthe left which encourages the worker to supply less labor

The Slope of the Labor-Supply Curve

bull The net effect The net effect is measured by the difference between the is measured by the difference between the substitution and income effects shown at point B so that an substitution and income effects shown at point B so that an increase in the wage rate increases the workerrsquos supply of labor increase in the wage rate increases the workerrsquos supply of labor to to l2 to the right of l1 If the substitution effect is always stronger l2 to the right of l1 If the substitution effect is always stronger then the labor supply then the labor supply curve slopes upward curve slopes upward

bull Substitution effects are not necessarily stronger than income Substitution effects are not necessarily stronger than income effectseffects Panel (B) shows the construction of the labor-supply Panel (B) shows the construction of the labor-supply curve starting from point C when income effects are stronger curve starting from point C when income effects are stronger than substitution effects When the real-wage rate increases than substitution effects When the real-wage rate increases from (from (wp)1 to (wp)2 the dominant income effect overwhelms wp)1 to (wp)2 the dominant income effect overwhelms the substitution effect and labor the substitution effect and labor supply (point C) falls from supply (point C) falls from l1 to l1 to l2 If income effects are stronger for all wage rates above l2 If income effects are stronger for all wage rates above ((wp)1 wp)1 then the labor-supply curve will slope downward toward point C then the labor-supply curve will slope downward toward point C higher real wage higher real wage rates lower labor supplyrates lower labor supply

bull Although the labor-supply curve can slope downward towards Although the labor-supply curve can slope downward towards a point like A it is not reasonable to believe that it could slope a point like A it is not reasonable to believe that it could slope downward for every possible wage rate At very low wage rates downward for every possible wage rate At very low wage rates it is more reasonable to suppose that with very low incomes it is more reasonable to suppose that with very low incomes the workerrsquos need for food clothing shelter and other the workerrsquos need for food clothing shelter and other ldquoessentialrdquo goods the income effect is weak and the ldquoessentialrdquo goods the income effect is weak and the substitution effect is strong We should therefore expect the substitution effect is strong We should therefore expect the labor-supply curve to be upward sloping when wage rates are labor-supply curve to be upward sloping when wage rates are low Hence labor supply would be backward bending low Hence labor supply would be backward bending

Backward-bending Labor-supply Curve

Adding Realism TaxesAdding Realism Taxes

bull How does the tax affect the income from a little more or a little How does the tax affect the income from a little more or a little less work To answer this question we must know the less work To answer this question we must know the marginal marginal tax ratetax rate ((the fraction of an additional dollar of income that is the fraction of an additional dollar of income that is paid as taxes) paid as taxes) To keep things simple assume that all income is To keep things simple assume that all income is taxed at the same taxed at the same flatflat rate rate ττ In this case the marginal tax rate In this case the marginal tax rate must also be τ which takes a value between zero and one If a must also be τ which takes a value between zero and one If a worker earns worker earns wpwp for an hour of work the government takes for an hour of work the government takes τ(wp) τ(wp) as taxes and leaves the worker as taxes and leaves the worker (1ndashτ)(wp) (1ndashτ)(wp) as the after-as the after-tax real wagetax real wage

bull Since the worker actually receives the Since the worker actually receives the after-tax real wageafter-tax real wage it is it is the the true opportunity cost of leisure true opportunity cost of leisure Any increase in the Any increase in the marginal tax rate represents a decrease in the opportunity cost marginal tax rate represents a decrease in the opportunity cost of leisure If of leisure If substitution effectssubstitution effects are stronger than income are stronger than income effects then any increase in marginal tax rates effects then any increase in marginal tax rates reducesreduces the the supply of labor supply of labor as shown in the following figureas shown in the following figure

The Effect of a Tax Increase on Labor Supply

bull The labor-supply curve with no taxes is shown on the right of The labor-supply curve with no taxes is shown on the right of the figure At the figure At (wp)1(wp)1 the worker supplies labor the worker supplies labor l1l1 If a tax of If a tax of τ1τ1 is imposed the after-tax real wage is is imposed the after-tax real wage is (1ndashτ1)(wp)1(1ndashτ1)(wp)1 The worker The worker should react exactly as if he paid no taxes but suffered a cut in should react exactly as if he paid no taxes but suffered a cut in his wages This is shown as a movement from point A to point B his wages This is shown as a movement from point A to point B where labor supply has fallen to where labor supply has fallen to l2l2 But of course the wage rate But of course the wage rate did not really falldid not really fall the employer still pays (wp)1 This means the employer still pays (wp)1 This means that (l2 (wp)1) is the labor-supply (point C)that (l2 (wp)1) is the labor-supply (point C)

bull Since this would apply for any real-wage rate every point on Since this would apply for any real-wage rate every point on the original curve shifts to the left Because the the original curve shifts to the left Because the tax rate is tax rate is proportional its absolute effect is greaterproportional its absolute effect is greater as is the shift in the as is the shift in the labor-supply curve at high wage rates resulting in a labor-supply curve at high wage rates resulting in a steepening of the curve Any further increase in the tax rate to steepening of the curve Any further increase in the tax rate to say τ2 would shift the labor-supply curve further to the left say τ2 would shift the labor-supply curve further to the left

bull The length of the line segment BC measures the The length of the line segment BC measures the TAX WEDGETAX WEDGE between the real wage paid by employers and the after-tax real between the real wage paid by employers and the after-tax real wage received by workewage received by workersrs The The largerlarger the tax wedge the the tax wedge the largerlarger the leftward shift of the labor-supply curve and the the leftward shift of the labor-supply curve and the greater the greater the reductionreduction in labor supplied at any real wage in labor supplied at any real wage

bull The idea that tax increases lower labor supply and conversely The idea that tax increases lower labor supply and conversely that tax cuts increase labor supply was a major tenet of the so-that tax cuts increase labor supply was a major tenet of the so-called called supply-side economicssupply-side economics popular in the early 1980s popular in the early 1980s President Ronald Reagan and his advisors used it to argue that President Ronald Reagan and his advisors used it to argue that cuts in marginal tax rates cuts in marginal tax rates would stimulate people would stimulate people to to workwork harder and to harder and to earn larger earn larger incomesincomes

Adding Realism A Standard WorkweekAdding Realism A Standard Workweek

bull Another way in which the simple analysis of labor supply is Another way in which the simple analysis of labor supply is unrealistic is that many unrealistic is that many workers are not given an option about workers are not given an option about the number of hours they workthe number of hours they work Although people work part- Although people work part-time and overtime either may be voluntary or mandatory time and overtime either may be voluntary or mandatory

bull Assuming that workers are Assuming that workers are not permitted to work more than not permitted to work more than 40 hours a week40 hours a week the following figure includes a constraint of the following figure includes a constraint of 40 hours If the worker were permitted to choose freely then 40 hours If the worker were permitted to choose freely then the labor-supply curve would backward bending curve The the labor-supply curve would backward bending curve The overall effect is to of the standard work week is to reshape the overall effect is to of the standard work week is to reshape the labor-supply curve as indicated by the heavy curve with the labor-supply curve as indicated by the heavy curve with the vertical segment that runs through points A F G D and E vertical segment that runs through points A F G D and E Any worker on this vertical segment is constrainedAny worker on this vertical segment is constrained

The Individual Labor-Supply Curve in PracticeThe Individual Labor-Supply Curve in Practice

bull What does the individual labor-supply curve look like in What does the individual labor-supply curve look like in realityreality It is difficult to answer this question because in reality It is difficult to answer this question because in reality we can observe we can observe only one pointonly one point on the labor-supply curve for a on the labor-supply curve for a single worker single worker at a particular timeat a particular time All the other points are All the other points are conjecturesconjectures about what the worker would supply if faced with about what the worker would supply if faced with different wage rates If we imagine that on average workers are different wage rates If we imagine that on average workers are substantially substantially similarsimilar we might nonetheless get some idea of we might nonetheless get some idea of what the individual labor-supply curve might look likewhat the individual labor-supply curve might look like

bull The The National Longitudinal SurveyNational Longitudinal Survey (Youth) has catalogued the (Youth) has catalogued the work histories of a large sample of individuals starting at a work histories of a large sample of individuals starting at a young age The following figure plots the real-wage rates and young age The following figure plots the real-wage rates and average weekly hours of labor for about average weekly hours of labor for about 1000010000 male workers male workers from this survey for a from this survey for a single periodsingle period with the best fitting flexible with the best fitting flexible line through these points serves as our empirical estimate of the line through these points serves as our empirical estimate of the labor-supply curve for these workerslabor-supply curve for these workers

bull The regression line traces out a shape very The regression line traces out a shape very like the backward-like the backward-bendingbending labor-supply curve with a 40-hour constraint What labor-supply curve with a 40-hour constraint What looks like a vertical line above 40 hours is looks like a vertical line above 40 hours is not really a solid line not really a solid line at all but a reflection of the fact that about at all but a reflection of the fact that about 7500 7500 of the 10000 of the 10000 workers in the sample supply 40 hours per week at a variety of workers in the sample supply 40 hours per week at a variety of wage rates The labor-supply curve traces out a segment above wage rates The labor-supply curve traces out a segment above the 40-hour point that corresponds to the constraintthe 40-hour point that corresponds to the constraint

bull There are There are points to the rightpoints to the right of 40 hours This is reasonable of 40 hours This is reasonable since in the real world workers do since in the real world workers do work overtimework overtime ndash either ndash either because they are supervisors or professionals or because because they are supervisors or professionals or because employers offer them the required time-and-half wage rate employers offer them the required time-and-half wage rate The fit of the regression line is far from perfect points lie on The fit of the regression line is far from perfect points lie on both sides of the line We should interpret it as a both sides of the line We should interpret it as a snapshotsnapshot of of the behavior of the typical worker But ofthe behavior of the typical worker But of course the typical course the typical worker is not any actual worker in particularworker is not any actual worker in particular

THE WORKER CHOOSING TO PARTICIPATETHE WORKER CHOOSING TO PARTICIPATE

bull So far we have examined only one aspect of the workerrsquos So far we have examined only one aspect of the workerrsquos labor-supply decision labor-supply decision how many hours to work for given real how many hours to work for given real wagewage We now take up the second aspect We now take up the second aspect participationparticipation ndash that ndash that is is whether or not to work at allwhether or not to work at all A labor-supply curve that starts A labor-supply curve that starts at the origin and slopes upwards for at least a portion of its at the origin and slopes upwards for at least a portion of its length suggests that even length suggests that even if the wage were very lowif the wage were very low ndash say 1cent ndash say 1cent per hour ndash the worker would work a little bit That is clearly per hour ndash the worker would work a little bit That is clearly unrealisticunrealistic no one would work at all for 1cent per hour no one would work at all for 1cent per hour What What factors determine how high the wage factors determine how high the wage must be to induce a person must be to induce a person to participate in the labor marketto participate in the labor market

bull The labor force The labor force participationparticipation decision is a question of decision is a question of opportunity costopportunity cost Idleness has its charms Before anyone enters Idleness has its charms Before anyone enters the labor force the wage rate must be high enough to overcome the labor force the wage rate must be high enough to overcome them them The opportunity cost of participatingThe opportunity cost of participating in the labor force is in the labor force is sum of sum of

1048766 1048766 the implicit valuethe implicit value the worker places on complete idleness the worker places on complete idleness

1048766 1048766 the explicit coststhe explicit costs of working compared to not working such as of working compared to not working such as clothing transport childcare) andclothing transport childcare) and

1048766 1048766 the explicit losses the explicit losses from working (for instance housework not from working (for instance housework not done)done)

bull The opportunity cost is partly psychological and partly material The opportunity cost is partly psychological and partly material If people were completely If people were completely independentindependent of each other the worker of each other the worker might place a lower value on the opportunity cost of might place a lower value on the opportunity cost of participation because then the choice might be literally between participation because then the choice might be literally between work and starvationwork and starvation

bull But most people are not But most people are not completely independentcompletely independent Whether or Whether or not to participate in the labor force could be a not to participate in the labor force could be a genuine choicegenuine choice and would depend on the and would depend on the real wagereal wage

bull The The RESERVATION WAGE RESERVATION WAGE is defined to be is defined to be the opportunity the opportunity cost of working compared to not workingcost of working compared to not working ndash ndash that is the real wage that is the real wage that is high enough to make it just worthwhile for a worker to that is high enough to make it just worthwhile for a worker to participate in the labor forceparticipate in the labor force

bull Taking account of the opportunity costs of participation affects Taking account of the opportunity costs of participation affects the shape of the labor-supply curve As long as the the shape of the labor-supply curve As long as the real wage is real wage is below the reservationbelow the reservation wage ((wp)R) the worker supplies no wage ((wp)R) the worker supplies no labor at all Above the reservation wage there is a normal labor at all Above the reservation wage there is a normal labor-supply curvelabor-supply curve

bull The following captures the two stages of the labor supply The following captures the two stages of the labor supply decision decision FirstFirst at low wages the worker will at low wages the worker will notnot supply any supply any labor at all and small increases in wages have no effect But labor at all and small increases in wages have no effect But secondsecond as soon as the wage rises enough for the worker to bite as soon as the wage rises enough for the worker to bite the bullet and join the labor force the minimum labor supplied the bullet and join the labor force the minimum labor supplied will be well will be well above zeroabove zero and the worker will decide how many and the worker will decide how many hours to supply above this minimum through the usual process hours to supply above this minimum through the usual process of balancing the opportunity cost of leisure against the desire of balancing the opportunity cost of leisure against the desire for consumption goodsfor consumption goods

AGGREGATE LABOR SUPPLY

bull How can we moveHow can we move from the microeconomics of the labor supply from the microeconomics of the labor supply back to an aggregate relationship usable in macroeconomic back to an aggregate relationship usable in macroeconomic analysis analysis If workers were essentially alikeIf workers were essentially alike the problem would the problem would be easy be easy

bull As we have seen labor supply has two dimensions ndash As we have seen labor supply has two dimensions ndash participationparticipation in the labor force and in the labor force and choice of hourschoice of hours of labor of labor Take the participation decision first If all workers were alike Take the participation decision first If all workers were alike except for except for differences in their reservation wagedifferences in their reservation wage then we could then we could rank them from lowest to highest reservation wage The rank them from lowest to highest reservation wage The aggregate labor-supply (participation) curve is strictly aggregate labor-supply (participation) curve is strictly upwardslopingupwardsloping

bull Of course this is too easy Just as we observed in deriving the Of course this is too easy Just as we observed in deriving the aggregate labor demand curve workers are aggregate labor demand curve workers are not all alikenot all alike Once Once again we must interpret the vertical axis as measuring the again we must interpret the vertical axis as measuring the average real wageaverage real wage that at best provides a kind of index for the that at best provides a kind of index for the level of the wage structure level of the wage structure

bull The The problemproblem remains the remains the samesame when we turn to the choice of when we turn to the choice of hourshours Workers are all different and face a structure of wages Workers are all different and face a structure of wages For each worker individually there is a jump from supplying For each worker individually there is a jump from supplying zero to supplying some positive number of hours zero to supplying some positive number of hours when his own when his own wage rate surpasses their wage rate surpasses their reservation wagereservation wage But in aggregate But in aggregate we are we are unlikely to see such a jumpunlikely to see such a jump Not only are there a variety Not only are there a variety of wages offered at any time but reservation wages differof wages offered at any time but reservation wages differ

Derivation of the Aggregate Labor-supply Curve

bull A curve like the one in this figure can be used to display either A curve like the one in this figure can be used to display either the the participation participation decision or decision or the hoursthe hours The horizontal axis can The horizontal axis can either be used for workers either be used for workers or worker-hoursor worker-hours as measures of the as measures of the labor supply The two meanings are not completely labor supply The two meanings are not completely independent by definition independent by definition

bull workers equiv aggregate worker ndash hours average hours per worker workers equiv aggregate worker ndash hours average hours per worker

The Participation Rate and Average Hours

bull Let us look first at the aggregate participation decision The Let us look first at the aggregate participation decision The aggregate number of workers who have decided to participate aggregate number of workers who have decided to participate is known as the is known as the labor forcelabor force the the civilian labor force over 16 civilian labor force over 16 years of ageyears of age This number excludes uniformed members of the This number excludes uniformed members of the armed services and the small number of workers under 16 armed services and the small number of workers under 16 years old The labor force of course has grown right along years old The labor force of course has grown right along with population with population

bull The participation rateThe participation rate (PR) measures (PR) measures the labor force as its ratio the labor force as its ratio to the relevant populationto the relevant population

bull participation rate = labor forcerelevant population participation rate = labor forcerelevant population

bull ldquoldquonon-institutionalrdquo non-institutionalrdquo excludes people in prison or in homes for excludes people in prison or in homes for the aged) the aged)

bull The aggregate number of hours The aggregate number of hours worked is worked is not as easy not as easy as the as the participation rate to relate to the individual workerrsquos choices participation rate to relate to the individual workerrsquos choices If every worker had the same labor-supply curve we would If every worker had the same labor-supply curve we would have to know the wage offered to each one in order to calculate have to know the wage offered to each one in order to calculate the total number of labor hours supplied In reality workers the total number of labor hours supplied In reality workers are not all alike are not all alike Labor-supply curves may vary systematically Labor-supply curves may vary systematically according to the sex age ethnic group education experience according to the sex age ethnic group education experience or other social or economic characteristics of the workersor other social or economic characteristics of the workers And And within any group the labor-supply curves of individuals are within any group the labor-supply curves of individuals are likely to varylikely to vary

bull In principle In principle if we had a good statistical estimate of the typical if we had a good statistical estimate of the typical distribution of the wagesdistribution of the wages we could make a reasonable we could make a reasonable calculation But statisticians at the Bureau of Labor Statistics calculation But statisticians at the Bureau of Labor Statistics (BLS) do not try to calculate the labor supply in this way (BLS) do not try to calculate the labor supply in this way Instead they Instead they count the number of hours that workers actually count the number of hours that workers actually workwork and the average and the average wages and salaries they are paid wages and salaries they are paid

bull In USA the total hours of labor in 1998 was In USA the total hours of labor in 1998 was 236882236882 million million The average hours of work is The average hours of work is 17211721 hours per year = hours per year = 344344 hours hours per week (assuming a 50 week year) This number is 14 percent per week (assuming a 50 week year) This number is 14 percent below the full time 40-hour week which makes sense since it below the full time 40-hour week which makes sense since it averages over full-time part-time and overtime workers averages over full-time part-time and overtime workers

Labor Market EquilibriumLabor Market Equilibrium

bull MARKET CLEARINGMARKET CLEARING

bull When both demand and supply curves are plotted on the same When both demand and supply curves are plotted on the same diagram the crossing point defines the diagram the crossing point defines the equilibrium real-wage equilibrium real-wage rate and the rate and the equilibrium level of labor employedequilibrium level of labor employed

bull The real wage The real wage looks different looks different from the point of view of the firm from the point of view of the firm and the worker For the and the worker For the firmfirm the relevant real wage is the the relevant real wage is the product-real wage product-real wage defined as defined as the number of units of the good the number of units of the good the firm produces that the wage will purchase the firm produces that the wage will purchase ((price of price of productproduct = = w) w) For the For the workerworker the relevant real wage is the the relevant real wage is the consumption-consumption-real real wagewage defined as defined as the number of typical consumption baskets the number of typical consumption baskets that the wage will purchase that the wage will purchase ((price of price of consumption basket consumption basket = = w)w)

bull For aggregate analysis we might use the For aggregate analysis we might use the Producer Price IndexProducer Price Index or the GDP deflator to approximate the or the GDP deflator to approximate the product priceproduct price and the and the CPICPI to approximate the to approximate the consumption price consumption price

bull Suppose that the product-real wage and the consumption-real Suppose that the product-real wage and the consumption-real wage in the following figure start out with the identical value wage in the following figure start out with the identical value ((wp) at the market-clearing point Awp) at the market-clearing point A Now suppose that Now suppose that imported Japanese cars are a large portion of the typical imported Japanese cars are a large portion of the typical workerrsquos consumption basket workerrsquos consumption basket and that and that ceteris paribus ceteris paribus the price the price of Japanese cars rises sharply This means that the of Japanese cars rises sharply This means that the real wage real wage from the point of view of the from the point of view of the consumer falls to (consumer falls to (wpwpCPICPI ) )11 at point at point

B B on the labor-supply curve (LS) so that the worker would on the labor-supply curve (LS) so that the worker would want to supply less labor (want to supply less labor (LL11))

bull The rise in the price of Japanese cars has no effect on the price The rise in the price of Japanese cars has no effect on the price of their products Nevertheless they see a reduction of labor of their products Nevertheless they see a reduction of labor supply at the original market clearing wage It is as if the supply at the original market clearing wage It is as if the labor-supply curve labor-supply curve has shifted to the left to has shifted to the left to LSLSrsquo which passes rsquo which passes through ((through ((wp) L1) at point C wp) L1) at point C At the original wage rate labor At the original wage rate labor demand exceeds labor supply so firms raise wages in an effort demand exceeds labor supply so firms raise wages in an effort to attract workers until they reach the new market-clearing to attract workers until they reach the new market-clearing wage at point D where they pay (wage at point D where they pay (wpwpPPIPPI ) for labor of L ) for labor of L The The

rise in the price of Japanese cars has the effect of raising the rise in the price of Japanese cars has the effect of raising the wages that firms must pay and reducing labor employedwages that firms must pay and reducing labor employed Higher wages partly compensate workers for the higher costs Higher wages partly compensate workers for the higher costs of consumption but firms can afford to pay those higher wages of consumption but firms can afford to pay those higher wages only if marginal products rise as a result of their using less only if marginal products rise as a result of their using less labor labor

bull The rise in wage rates is not enough to compensate workers The rise in wage rates is not enough to compensate workers fully so the consumption-real wage in equilibrium is (wpfully so the consumption-real wage in equilibrium is (wpCPI CPI ) )

atat point E We can think of import prices as a tax levied on point E We can think of import prices as a tax levied on consumers and of an increase in import prices as widening the consumers and of an increase in import prices as widening the tax wedge Unless the issue that we want to analyze depends on tax wedge Unless the issue that we want to analyze depends on the difference between product- and consumption-real wages the difference between product- and consumption-real wages we will treat the real wage as the same for both labor supply we will treat the real wage as the same for both labor supply and labor demandand labor demand

An Increase in the Price of Consumption GoodsAn Increase in the Price of Consumption GoodsRelative to the Price of OutputRelative to the Price of Output

ANALYZING IDEAL LABOR MARKETSANALYZING IDEAL LABOR MARKETS

bull The aggregate labor-supplylabor-demand diagram provides us The aggregate labor-supplylabor-demand diagram provides us with a powerful tool We now analyze three important with a powerful tool We now analyze three important macroeconomic issues macroeconomic issues

(1) the effect of tax cuts on employment (1) the effect of tax cuts on employment

(2) the effect of technological progress on the well-being of (2) the effect of technological progress on the well-being of workers and workers and

(3) the effect of immigration on existing workers (3) the effect of immigration on existing workers

bull Issue 1 Tax Cuts Issue 1 Tax Cuts What are the effects of a cut in marginal What are the effects of a cut in marginal income-tax rates on employment and the level of GDP in the income-tax rates on employment and the level of GDP in the economyeconomy Recall from section that a lower marginal income-Recall from section that a lower marginal income-tax rate increases labor supply at each real wage (a rightward tax rate increases labor supply at each real wage (a rightward shift of the labor-supply) shift of the labor-supply)

bull Labor-market equilibrium moves from point A to point B in Labor-market equilibrium moves from point A to point B in the lower panel of the following Notice that the amount of the lower panel of the following Notice that the amount of labor available to firms increases so that firms move labor available to firms increases so that firms move production from Arsquo to Brsquo on the labor production function in production from Arsquo to Brsquo on the labor production function in the upper panel Also notice that the real wage falls from (the upper panel Also notice that the real wage falls from (wp)1 wp)1 to (wp)2 Since the cut in taxes increases the number of to (wp)2 Since the cut in taxes increases the number of workers workers willing to work at each wage Workers care about their take-willing to work at each wage Workers care about their take-home pay ndash that is about their home pay ndash that is about their after-tax real wage after-tax real wage This is This is perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 can be greater than the old after-tax real wage (1ndashcan be greater than the old after-tax real wage (1ndashτ1τ1)(wp)1 so )(wp)1 so long as the rise in the take-home share (1 ndash τ) is long as the rise in the take-home share (1 ndash τ) is proportionately greater than the fall in the before-tax real proportionately greater than the fall in the before-tax real wage (wp)wage (wp)

bull The analysis depends on substitution effects dominating The analysis depends on substitution effects dominating income effects which they probably do in aggregate if not for income effects which they probably do in aggregate if not for every worker So the supply-siders of the Reagan years are every worker So the supply-siders of the Reagan years are correct in principle How much output will increase depends on correct in principle How much output will increase depends on how large the substitution effect is If most people work a how large the substitution effect is If most people work a standard 40-hour week the effect could be quite small and the standard 40-hour week the effect could be quite small and the increase in output might also be very small in practiceincrease in output might also be very small in practice

Issue 1 The Effect of a Cut in Marginal Tax RatesIssue 1 The Effect of a Cut in Marginal Tax Rates

Issue 2 Technological Progress and Worker WelfareIssue 2 Technological Progress and Worker Welfare

bull Is technological progress and increasing use of machinery and Is technological progress and increasing use of machinery and other capital beneficial for workersother capital beneficial for workers

bull Technological change or capital accumulation have been Technological change or capital accumulation have been known as ldquoLudditesrdquo (known as ldquoLudditesrdquo (it negatively affects the demand for it negatively affects the demand for laborlabor) To see why the Luddites are wrong ndash at least for ) To see why the Luddites are wrong ndash at least for clearing labor markets ndash recall that technological progress or clearing labor markets ndash recall that technological progress or increased capital both increased capital both shift the labor-demand curve upwardshift the labor-demand curve upward The lower panel of the following figure shows that the effect of The lower panel of the following figure shows that the effect of the increased demand for labor is to increase total employment the increased demand for labor is to increase total employment and the real wage Firms and the real wage Firms can pay a higher real wage can pay a higher real wage because because the additional capital or technological progress the additional capital or technological progress increases the increases the marginal product of labormarginal product of labor

bull The The Ludditesrsquo mistake Ludditesrsquo mistake is most easily seen in the upper panel is most easily seen in the upper panel The Luddite argument assumes that fewer workers will The Luddite argument assumes that fewer workers will produce the same total output Production starts at Arsquo using produce the same total output Production starts at Arsquo using L1 L1 workers to produce Y1 After the upward shift in the production workers to produce Y1 After the upward shift in the production function the same output could be produced using less labor function the same output could be produced using less labor ((L3) at point Arsquorsquo The L3) at point Arsquorsquo The problem is that Arsquorsquo is not an equilibrium problem is that Arsquorsquo is not an equilibrium At that point the marginal product of labor is higher than the At that point the marginal product of labor is higher than the original real wage so a profit-maximizing firm would want to original real wage so a profit-maximizing firm would want to expand production To do this they must hire more labor than expand production To do this they must hire more labor than L3 and indeed they L3 and indeed they find it find it profitable profitable to hire more labor than to hire more labor than the original the original L1 The only way actually to increase labor L1 The only way actually to increase labor is to is to raise the real-wage raise the real-wage rate above its original level Technological rate above its original level Technological progress therefore favors progress therefore favors workers by increasing employment workers by increasing employment and wagesand wages

bull Early in the 19th century hand-woven cloth was very Early in the 19th century hand-woven cloth was very expensive and a worker was lucky to own the clothes on his expensive and a worker was lucky to own the clothes on his back and a spare set for church on Sunday Textiles were one of back and a spare set for church on Sunday Textiles were one of the first industries to benefit from the Industrial Revolution so the first industries to benefit from the Industrial Revolution so that by the end of the 19th century machine-made fabrics and that by the end of the 19th century machine-made fabrics and mass-production made decent clothing in larger quantities mass-production made decent clothing in larger quantities accessible to most of the population of the more developed accessible to most of the population of the more developed countries Similar progress has been made in most forms of countries Similar progress has been made in most forms of production Agricultural production which at the turn of the production Agricultural production which at the turn of the 20th century absorbed half the labor force now absorbs less 20th century absorbed half the labor force now absorbs less than 3 percent while producing more food more cheaply than than 3 percent while producing more food more cheaply than ever ever

bull We must be careful not to dismiss the Luddites as altogether We must be careful not to dismiss the Luddites as altogether foolish While new technology especially over decades has foolish While new technology especially over decades has proved to be a net gain for workers in general the Luddites proved to be a net gain for workers in general the Luddites were in fact correct that their way of life was threatened were in fact correct that their way of life was threatened Independent weavers became factory hands unskilled Independent weavers became factory hands unskilled workers increasingly women and often children replaced workers increasingly women and often children replaced skilled craftsmen and factory work often involved long hours skilled craftsmen and factory work often involved long hours in brutal conditions The wider society reaps the benefits of in brutal conditions The wider society reaps the benefits of technological change while a narrow group sometimes technological change while a narrow group sometimes disproportionately bears its costs Our analysis also assumes disproportionately bears its costs Our analysis also assumes that markets generally clear The implicit assumption is that that markets generally clear The implicit assumption is that displaced workers move on to new jobs possibly in other forms displaced workers move on to new jobs possibly in other forms of production Markets may have a tendency to clear in the of production Markets may have a tendency to clear in the long run yet workers may find themselves displaced in the long run yet workers may find themselves displaced in the short run say over the course of a business cycleshort run say over the course of a business cycle

Issue 3 Immigration Jobs and Real WagesIssue 3 Immigration Jobs and Real Wages

bull How does an increase in the labor force through immigration or How does an increase in the labor force through immigration or natural population growth affect labor and GDP natural population growth affect labor and GDP

bull One of the emotional issues associated with US immigration One of the emotional issues associated with US immigration policy ndash particularly towards low-wage workers from Mexico ndash policy ndash particularly towards low-wage workers from Mexico ndash is the idea that is the idea that immigrants take jobs away from native immigrants take jobs away from native workers workers We might be tempted to dismiss this fear as another We might be tempted to dismiss this fear as another example of the lump-of-labor fallacy Yet there is a sensible example of the lump-of-labor fallacy Yet there is a sensible intuition behind the argument An increase in the labor force ndash intuition behind the argument An increase in the labor force ndash due either to immigration or to higher population growth rates due either to immigration or to higher population growth rates ndash can be represented as an outward shift of the aggregate labor ndash can be represented as an outward shift of the aggregate labor supply curve as shown in the following Figure Employment supply curve as shown in the following Figure Employment increases but real wages fall It is not then that immigrants increases but real wages fall It is not then that immigrants take jobs away from natives take jobs away from natives Rather they compete for jobsRather they compete for jobs putting downward pressure on real wagesputting downward pressure on real wages

bull Again we must exercise care in interpreting the analysis Again we must exercise care in interpreting the analysis Remember that aggregate labor and average wage rates hide Remember that aggregate labor and average wage rates hide many details of the labor process The incomes of the new many details of the labor process The incomes of the new immigrants immigrants creates demand creates demand for the new production that they for the new production that they make possible Immigrant workers (at least those ndash whether make possible Immigrant workers (at least those ndash whether legal or illegal ndash who have become the focus of the most intense legal or illegal ndash who have become the focus of the most intense political debate) political debate) are likely to possess fewer skills than nativesare likely to possess fewer skills than natives The net effect is that the increased demand for goods and The net effect is that the increased demand for goods and services generated by immigrants is likely to increase the services generated by immigrants is likely to increase the demand for skilled (demand for skilled (and largely nativeand largely native) workers relative to ) workers relative to their supply and so to increase real wages of skilled workers their supply and so to increase real wages of skilled workers Low-skilled immigration may lower the real wage for farm Low-skilled immigration may lower the real wage for farm workers but if anything it would raise the real wage for workers but if anything it would raise the real wage for computer programmerscomputer programmers

Next Task Labor Market in Kuwait

Appendix Is Labor Supply Stable Over Time

bull Statistics on participation rates or average hours for a Statistics on participation rates or average hours for a particular month or year are snapshot of the labor market particular month or year are snapshot of the labor market Can we analyze the effects of that increase on the labor market Can we analyze the effects of that increase on the labor market under the assumption that the labor-supply curves of workers under the assumption that the labor-supply curves of workers remain essentially stableremain essentially stable

bull Data on participation rates in the United States appear to Data on participation rates in the United States appear to support this conjecture (see Figure 811) which shows the support this conjecture (see Figure 811) which shows the overall civilian participation rate trending upward ndash at least overall civilian participation rate trending upward ndash at least from the middle of the 1960sfrom the middle of the 1960s

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

bull SUBSTITUTION EFFECTSUBSTITUTION EFFECT

bull If the wage rate rose If the wage rate rose would people work more or less As a would people work more or less As a general rule whenever general rule whenever ceteris paribus the price of anything rises ceteris paribus the price of anything rises relative to alternativesrelative to alternatives the demand for it decreases Here the the demand for it decreases Here the price of leisure price of leisure (its opportunity cost) has risen relative to the (its opportunity cost) has risen relative to the price of other goods the supply of price of other goods the supply of labor would riselabor would rise The change The change in the wage rate encourages people to substitute the now in the wage rate encourages people to substitute the now cheaper goods (what you buy using your wage) for the now cheaper goods (what you buy using your wage) for the now more expensive leisure more expensive leisure The increase in the supply of labor as The increase in the supply of labor as the result of an increase in the price (or opportunity cost) of the result of an increase in the price (or opportunity cost) of leisure is called theleisure is called the SUBSTITUTION EFFECT SUBSTITUTION EFFECT

bull The Labor-supply CurveThe Labor-supply Curve

bull The following figure represents the workerrsquos labor-supply The following figure represents the workerrsquos labor-supply decision Look first at panel (A) Suppose that at point A decision Look first at panel (A) Suppose that at point A where the real wage is (where the real wage is (wp)1 the worker decides that providing l wp)1 the worker decides that providing l hours of work balances the advantages of a little more hours of work balances the advantages of a little more consumption against a little more leisure at the margin Now consumption against a little more leisure at the margin Now consider what happens when the real wage rises to (consider what happens when the real wage rises to (wp)2 wp)2 There is a substitution effect shown by the arrow pointing to There is a substitution effect shown by the arrow pointing to the right which encourages the worker to supply more labor the right which encourages the worker to supply more labor The size of the substitution effect is measured by the length of The size of the substitution effect is measured by the length of the arrowthe arrow

bull There is also an income effect shown by the arrow pointing to There is also an income effect shown by the arrow pointing to the left which encourages the worker to supply less laborthe left which encourages the worker to supply less labor

The Slope of the Labor-Supply Curve

bull The net effect The net effect is measured by the difference between the is measured by the difference between the substitution and income effects shown at point B so that an substitution and income effects shown at point B so that an increase in the wage rate increases the workerrsquos supply of labor increase in the wage rate increases the workerrsquos supply of labor to to l2 to the right of l1 If the substitution effect is always stronger l2 to the right of l1 If the substitution effect is always stronger then the labor supply then the labor supply curve slopes upward curve slopes upward

bull Substitution effects are not necessarily stronger than income Substitution effects are not necessarily stronger than income effectseffects Panel (B) shows the construction of the labor-supply Panel (B) shows the construction of the labor-supply curve starting from point C when income effects are stronger curve starting from point C when income effects are stronger than substitution effects When the real-wage rate increases than substitution effects When the real-wage rate increases from (from (wp)1 to (wp)2 the dominant income effect overwhelms wp)1 to (wp)2 the dominant income effect overwhelms the substitution effect and labor the substitution effect and labor supply (point C) falls from supply (point C) falls from l1 to l1 to l2 If income effects are stronger for all wage rates above l2 If income effects are stronger for all wage rates above ((wp)1 wp)1 then the labor-supply curve will slope downward toward point C then the labor-supply curve will slope downward toward point C higher real wage higher real wage rates lower labor supplyrates lower labor supply

bull Although the labor-supply curve can slope downward towards Although the labor-supply curve can slope downward towards a point like A it is not reasonable to believe that it could slope a point like A it is not reasonable to believe that it could slope downward for every possible wage rate At very low wage rates downward for every possible wage rate At very low wage rates it is more reasonable to suppose that with very low incomes it is more reasonable to suppose that with very low incomes the workerrsquos need for food clothing shelter and other the workerrsquos need for food clothing shelter and other ldquoessentialrdquo goods the income effect is weak and the ldquoessentialrdquo goods the income effect is weak and the substitution effect is strong We should therefore expect the substitution effect is strong We should therefore expect the labor-supply curve to be upward sloping when wage rates are labor-supply curve to be upward sloping when wage rates are low Hence labor supply would be backward bending low Hence labor supply would be backward bending

Backward-bending Labor-supply Curve

Adding Realism TaxesAdding Realism Taxes

bull How does the tax affect the income from a little more or a little How does the tax affect the income from a little more or a little less work To answer this question we must know the less work To answer this question we must know the marginal marginal tax ratetax rate ((the fraction of an additional dollar of income that is the fraction of an additional dollar of income that is paid as taxes) paid as taxes) To keep things simple assume that all income is To keep things simple assume that all income is taxed at the same taxed at the same flatflat rate rate ττ In this case the marginal tax rate In this case the marginal tax rate must also be τ which takes a value between zero and one If a must also be τ which takes a value between zero and one If a worker earns worker earns wpwp for an hour of work the government takes for an hour of work the government takes τ(wp) τ(wp) as taxes and leaves the worker as taxes and leaves the worker (1ndashτ)(wp) (1ndashτ)(wp) as the after-as the after-tax real wagetax real wage

bull Since the worker actually receives the Since the worker actually receives the after-tax real wageafter-tax real wage it is it is the the true opportunity cost of leisure true opportunity cost of leisure Any increase in the Any increase in the marginal tax rate represents a decrease in the opportunity cost marginal tax rate represents a decrease in the opportunity cost of leisure If of leisure If substitution effectssubstitution effects are stronger than income are stronger than income effects then any increase in marginal tax rates effects then any increase in marginal tax rates reducesreduces the the supply of labor supply of labor as shown in the following figureas shown in the following figure

The Effect of a Tax Increase on Labor Supply

bull The labor-supply curve with no taxes is shown on the right of The labor-supply curve with no taxes is shown on the right of the figure At the figure At (wp)1(wp)1 the worker supplies labor the worker supplies labor l1l1 If a tax of If a tax of τ1τ1 is imposed the after-tax real wage is is imposed the after-tax real wage is (1ndashτ1)(wp)1(1ndashτ1)(wp)1 The worker The worker should react exactly as if he paid no taxes but suffered a cut in should react exactly as if he paid no taxes but suffered a cut in his wages This is shown as a movement from point A to point B his wages This is shown as a movement from point A to point B where labor supply has fallen to where labor supply has fallen to l2l2 But of course the wage rate But of course the wage rate did not really falldid not really fall the employer still pays (wp)1 This means the employer still pays (wp)1 This means that (l2 (wp)1) is the labor-supply (point C)that (l2 (wp)1) is the labor-supply (point C)

bull Since this would apply for any real-wage rate every point on Since this would apply for any real-wage rate every point on the original curve shifts to the left Because the the original curve shifts to the left Because the tax rate is tax rate is proportional its absolute effect is greaterproportional its absolute effect is greater as is the shift in the as is the shift in the labor-supply curve at high wage rates resulting in a labor-supply curve at high wage rates resulting in a steepening of the curve Any further increase in the tax rate to steepening of the curve Any further increase in the tax rate to say τ2 would shift the labor-supply curve further to the left say τ2 would shift the labor-supply curve further to the left

bull The length of the line segment BC measures the The length of the line segment BC measures the TAX WEDGETAX WEDGE between the real wage paid by employers and the after-tax real between the real wage paid by employers and the after-tax real wage received by workewage received by workersrs The The largerlarger the tax wedge the the tax wedge the largerlarger the leftward shift of the labor-supply curve and the the leftward shift of the labor-supply curve and the greater the greater the reductionreduction in labor supplied at any real wage in labor supplied at any real wage

bull The idea that tax increases lower labor supply and conversely The idea that tax increases lower labor supply and conversely that tax cuts increase labor supply was a major tenet of the so-that tax cuts increase labor supply was a major tenet of the so-called called supply-side economicssupply-side economics popular in the early 1980s popular in the early 1980s President Ronald Reagan and his advisors used it to argue that President Ronald Reagan and his advisors used it to argue that cuts in marginal tax rates cuts in marginal tax rates would stimulate people would stimulate people to to workwork harder and to harder and to earn larger earn larger incomesincomes

Adding Realism A Standard WorkweekAdding Realism A Standard Workweek

bull Another way in which the simple analysis of labor supply is Another way in which the simple analysis of labor supply is unrealistic is that many unrealistic is that many workers are not given an option about workers are not given an option about the number of hours they workthe number of hours they work Although people work part- Although people work part-time and overtime either may be voluntary or mandatory time and overtime either may be voluntary or mandatory

bull Assuming that workers are Assuming that workers are not permitted to work more than not permitted to work more than 40 hours a week40 hours a week the following figure includes a constraint of the following figure includes a constraint of 40 hours If the worker were permitted to choose freely then 40 hours If the worker were permitted to choose freely then the labor-supply curve would backward bending curve The the labor-supply curve would backward bending curve The overall effect is to of the standard work week is to reshape the overall effect is to of the standard work week is to reshape the labor-supply curve as indicated by the heavy curve with the labor-supply curve as indicated by the heavy curve with the vertical segment that runs through points A F G D and E vertical segment that runs through points A F G D and E Any worker on this vertical segment is constrainedAny worker on this vertical segment is constrained

The Individual Labor-Supply Curve in PracticeThe Individual Labor-Supply Curve in Practice

bull What does the individual labor-supply curve look like in What does the individual labor-supply curve look like in realityreality It is difficult to answer this question because in reality It is difficult to answer this question because in reality we can observe we can observe only one pointonly one point on the labor-supply curve for a on the labor-supply curve for a single worker single worker at a particular timeat a particular time All the other points are All the other points are conjecturesconjectures about what the worker would supply if faced with about what the worker would supply if faced with different wage rates If we imagine that on average workers are different wage rates If we imagine that on average workers are substantially substantially similarsimilar we might nonetheless get some idea of we might nonetheless get some idea of what the individual labor-supply curve might look likewhat the individual labor-supply curve might look like

bull The The National Longitudinal SurveyNational Longitudinal Survey (Youth) has catalogued the (Youth) has catalogued the work histories of a large sample of individuals starting at a work histories of a large sample of individuals starting at a young age The following figure plots the real-wage rates and young age The following figure plots the real-wage rates and average weekly hours of labor for about average weekly hours of labor for about 1000010000 male workers male workers from this survey for a from this survey for a single periodsingle period with the best fitting flexible with the best fitting flexible line through these points serves as our empirical estimate of the line through these points serves as our empirical estimate of the labor-supply curve for these workerslabor-supply curve for these workers

bull The regression line traces out a shape very The regression line traces out a shape very like the backward-like the backward-bendingbending labor-supply curve with a 40-hour constraint What labor-supply curve with a 40-hour constraint What looks like a vertical line above 40 hours is looks like a vertical line above 40 hours is not really a solid line not really a solid line at all but a reflection of the fact that about at all but a reflection of the fact that about 7500 7500 of the 10000 of the 10000 workers in the sample supply 40 hours per week at a variety of workers in the sample supply 40 hours per week at a variety of wage rates The labor-supply curve traces out a segment above wage rates The labor-supply curve traces out a segment above the 40-hour point that corresponds to the constraintthe 40-hour point that corresponds to the constraint

bull There are There are points to the rightpoints to the right of 40 hours This is reasonable of 40 hours This is reasonable since in the real world workers do since in the real world workers do work overtimework overtime ndash either ndash either because they are supervisors or professionals or because because they are supervisors or professionals or because employers offer them the required time-and-half wage rate employers offer them the required time-and-half wage rate The fit of the regression line is far from perfect points lie on The fit of the regression line is far from perfect points lie on both sides of the line We should interpret it as a both sides of the line We should interpret it as a snapshotsnapshot of of the behavior of the typical worker But ofthe behavior of the typical worker But of course the typical course the typical worker is not any actual worker in particularworker is not any actual worker in particular

THE WORKER CHOOSING TO PARTICIPATETHE WORKER CHOOSING TO PARTICIPATE

bull So far we have examined only one aspect of the workerrsquos So far we have examined only one aspect of the workerrsquos labor-supply decision labor-supply decision how many hours to work for given real how many hours to work for given real wagewage We now take up the second aspect We now take up the second aspect participationparticipation ndash that ndash that is is whether or not to work at allwhether or not to work at all A labor-supply curve that starts A labor-supply curve that starts at the origin and slopes upwards for at least a portion of its at the origin and slopes upwards for at least a portion of its length suggests that even length suggests that even if the wage were very lowif the wage were very low ndash say 1cent ndash say 1cent per hour ndash the worker would work a little bit That is clearly per hour ndash the worker would work a little bit That is clearly unrealisticunrealistic no one would work at all for 1cent per hour no one would work at all for 1cent per hour What What factors determine how high the wage factors determine how high the wage must be to induce a person must be to induce a person to participate in the labor marketto participate in the labor market

bull The labor force The labor force participationparticipation decision is a question of decision is a question of opportunity costopportunity cost Idleness has its charms Before anyone enters Idleness has its charms Before anyone enters the labor force the wage rate must be high enough to overcome the labor force the wage rate must be high enough to overcome them them The opportunity cost of participatingThe opportunity cost of participating in the labor force is in the labor force is sum of sum of

1048766 1048766 the implicit valuethe implicit value the worker places on complete idleness the worker places on complete idleness

1048766 1048766 the explicit coststhe explicit costs of working compared to not working such as of working compared to not working such as clothing transport childcare) andclothing transport childcare) and

1048766 1048766 the explicit losses the explicit losses from working (for instance housework not from working (for instance housework not done)done)

bull The opportunity cost is partly psychological and partly material The opportunity cost is partly psychological and partly material If people were completely If people were completely independentindependent of each other the worker of each other the worker might place a lower value on the opportunity cost of might place a lower value on the opportunity cost of participation because then the choice might be literally between participation because then the choice might be literally between work and starvationwork and starvation

bull But most people are not But most people are not completely independentcompletely independent Whether or Whether or not to participate in the labor force could be a not to participate in the labor force could be a genuine choicegenuine choice and would depend on the and would depend on the real wagereal wage

bull The The RESERVATION WAGE RESERVATION WAGE is defined to be is defined to be the opportunity the opportunity cost of working compared to not workingcost of working compared to not working ndash ndash that is the real wage that is the real wage that is high enough to make it just worthwhile for a worker to that is high enough to make it just worthwhile for a worker to participate in the labor forceparticipate in the labor force

bull Taking account of the opportunity costs of participation affects Taking account of the opportunity costs of participation affects the shape of the labor-supply curve As long as the the shape of the labor-supply curve As long as the real wage is real wage is below the reservationbelow the reservation wage ((wp)R) the worker supplies no wage ((wp)R) the worker supplies no labor at all Above the reservation wage there is a normal labor at all Above the reservation wage there is a normal labor-supply curvelabor-supply curve

bull The following captures the two stages of the labor supply The following captures the two stages of the labor supply decision decision FirstFirst at low wages the worker will at low wages the worker will notnot supply any supply any labor at all and small increases in wages have no effect But labor at all and small increases in wages have no effect But secondsecond as soon as the wage rises enough for the worker to bite as soon as the wage rises enough for the worker to bite the bullet and join the labor force the minimum labor supplied the bullet and join the labor force the minimum labor supplied will be well will be well above zeroabove zero and the worker will decide how many and the worker will decide how many hours to supply above this minimum through the usual process hours to supply above this minimum through the usual process of balancing the opportunity cost of leisure against the desire of balancing the opportunity cost of leisure against the desire for consumption goodsfor consumption goods

AGGREGATE LABOR SUPPLY

bull How can we moveHow can we move from the microeconomics of the labor supply from the microeconomics of the labor supply back to an aggregate relationship usable in macroeconomic back to an aggregate relationship usable in macroeconomic analysis analysis If workers were essentially alikeIf workers were essentially alike the problem would the problem would be easy be easy

bull As we have seen labor supply has two dimensions ndash As we have seen labor supply has two dimensions ndash participationparticipation in the labor force and in the labor force and choice of hourschoice of hours of labor of labor Take the participation decision first If all workers were alike Take the participation decision first If all workers were alike except for except for differences in their reservation wagedifferences in their reservation wage then we could then we could rank them from lowest to highest reservation wage The rank them from lowest to highest reservation wage The aggregate labor-supply (participation) curve is strictly aggregate labor-supply (participation) curve is strictly upwardslopingupwardsloping

bull Of course this is too easy Just as we observed in deriving the Of course this is too easy Just as we observed in deriving the aggregate labor demand curve workers are aggregate labor demand curve workers are not all alikenot all alike Once Once again we must interpret the vertical axis as measuring the again we must interpret the vertical axis as measuring the average real wageaverage real wage that at best provides a kind of index for the that at best provides a kind of index for the level of the wage structure level of the wage structure

bull The The problemproblem remains the remains the samesame when we turn to the choice of when we turn to the choice of hourshours Workers are all different and face a structure of wages Workers are all different and face a structure of wages For each worker individually there is a jump from supplying For each worker individually there is a jump from supplying zero to supplying some positive number of hours zero to supplying some positive number of hours when his own when his own wage rate surpasses their wage rate surpasses their reservation wagereservation wage But in aggregate But in aggregate we are we are unlikely to see such a jumpunlikely to see such a jump Not only are there a variety Not only are there a variety of wages offered at any time but reservation wages differof wages offered at any time but reservation wages differ

Derivation of the Aggregate Labor-supply Curve

bull A curve like the one in this figure can be used to display either A curve like the one in this figure can be used to display either the the participation participation decision or decision or the hoursthe hours The horizontal axis can The horizontal axis can either be used for workers either be used for workers or worker-hoursor worker-hours as measures of the as measures of the labor supply The two meanings are not completely labor supply The two meanings are not completely independent by definition independent by definition

bull workers equiv aggregate worker ndash hours average hours per worker workers equiv aggregate worker ndash hours average hours per worker

The Participation Rate and Average Hours

bull Let us look first at the aggregate participation decision The Let us look first at the aggregate participation decision The aggregate number of workers who have decided to participate aggregate number of workers who have decided to participate is known as the is known as the labor forcelabor force the the civilian labor force over 16 civilian labor force over 16 years of ageyears of age This number excludes uniformed members of the This number excludes uniformed members of the armed services and the small number of workers under 16 armed services and the small number of workers under 16 years old The labor force of course has grown right along years old The labor force of course has grown right along with population with population

bull The participation rateThe participation rate (PR) measures (PR) measures the labor force as its ratio the labor force as its ratio to the relevant populationto the relevant population

bull participation rate = labor forcerelevant population participation rate = labor forcerelevant population

bull ldquoldquonon-institutionalrdquo non-institutionalrdquo excludes people in prison or in homes for excludes people in prison or in homes for the aged) the aged)

bull The aggregate number of hours The aggregate number of hours worked is worked is not as easy not as easy as the as the participation rate to relate to the individual workerrsquos choices participation rate to relate to the individual workerrsquos choices If every worker had the same labor-supply curve we would If every worker had the same labor-supply curve we would have to know the wage offered to each one in order to calculate have to know the wage offered to each one in order to calculate the total number of labor hours supplied In reality workers the total number of labor hours supplied In reality workers are not all alike are not all alike Labor-supply curves may vary systematically Labor-supply curves may vary systematically according to the sex age ethnic group education experience according to the sex age ethnic group education experience or other social or economic characteristics of the workersor other social or economic characteristics of the workers And And within any group the labor-supply curves of individuals are within any group the labor-supply curves of individuals are likely to varylikely to vary

bull In principle In principle if we had a good statistical estimate of the typical if we had a good statistical estimate of the typical distribution of the wagesdistribution of the wages we could make a reasonable we could make a reasonable calculation But statisticians at the Bureau of Labor Statistics calculation But statisticians at the Bureau of Labor Statistics (BLS) do not try to calculate the labor supply in this way (BLS) do not try to calculate the labor supply in this way Instead they Instead they count the number of hours that workers actually count the number of hours that workers actually workwork and the average and the average wages and salaries they are paid wages and salaries they are paid

bull In USA the total hours of labor in 1998 was In USA the total hours of labor in 1998 was 236882236882 million million The average hours of work is The average hours of work is 17211721 hours per year = hours per year = 344344 hours hours per week (assuming a 50 week year) This number is 14 percent per week (assuming a 50 week year) This number is 14 percent below the full time 40-hour week which makes sense since it below the full time 40-hour week which makes sense since it averages over full-time part-time and overtime workers averages over full-time part-time and overtime workers

Labor Market EquilibriumLabor Market Equilibrium

bull MARKET CLEARINGMARKET CLEARING

bull When both demand and supply curves are plotted on the same When both demand and supply curves are plotted on the same diagram the crossing point defines the diagram the crossing point defines the equilibrium real-wage equilibrium real-wage rate and the rate and the equilibrium level of labor employedequilibrium level of labor employed

bull The real wage The real wage looks different looks different from the point of view of the firm from the point of view of the firm and the worker For the and the worker For the firmfirm the relevant real wage is the the relevant real wage is the product-real wage product-real wage defined as defined as the number of units of the good the number of units of the good the firm produces that the wage will purchase the firm produces that the wage will purchase ((price of price of productproduct = = w) w) For the For the workerworker the relevant real wage is the the relevant real wage is the consumption-consumption-real real wagewage defined as defined as the number of typical consumption baskets the number of typical consumption baskets that the wage will purchase that the wage will purchase ((price of price of consumption basket consumption basket = = w)w)

bull For aggregate analysis we might use the For aggregate analysis we might use the Producer Price IndexProducer Price Index or the GDP deflator to approximate the or the GDP deflator to approximate the product priceproduct price and the and the CPICPI to approximate the to approximate the consumption price consumption price

bull Suppose that the product-real wage and the consumption-real Suppose that the product-real wage and the consumption-real wage in the following figure start out with the identical value wage in the following figure start out with the identical value ((wp) at the market-clearing point Awp) at the market-clearing point A Now suppose that Now suppose that imported Japanese cars are a large portion of the typical imported Japanese cars are a large portion of the typical workerrsquos consumption basket workerrsquos consumption basket and that and that ceteris paribus ceteris paribus the price the price of Japanese cars rises sharply This means that the of Japanese cars rises sharply This means that the real wage real wage from the point of view of the from the point of view of the consumer falls to (consumer falls to (wpwpCPICPI ) )11 at point at point

B B on the labor-supply curve (LS) so that the worker would on the labor-supply curve (LS) so that the worker would want to supply less labor (want to supply less labor (LL11))

bull The rise in the price of Japanese cars has no effect on the price The rise in the price of Japanese cars has no effect on the price of their products Nevertheless they see a reduction of labor of their products Nevertheless they see a reduction of labor supply at the original market clearing wage It is as if the supply at the original market clearing wage It is as if the labor-supply curve labor-supply curve has shifted to the left to has shifted to the left to LSLSrsquo which passes rsquo which passes through ((through ((wp) L1) at point C wp) L1) at point C At the original wage rate labor At the original wage rate labor demand exceeds labor supply so firms raise wages in an effort demand exceeds labor supply so firms raise wages in an effort to attract workers until they reach the new market-clearing to attract workers until they reach the new market-clearing wage at point D where they pay (wage at point D where they pay (wpwpPPIPPI ) for labor of L ) for labor of L The The

rise in the price of Japanese cars has the effect of raising the rise in the price of Japanese cars has the effect of raising the wages that firms must pay and reducing labor employedwages that firms must pay and reducing labor employed Higher wages partly compensate workers for the higher costs Higher wages partly compensate workers for the higher costs of consumption but firms can afford to pay those higher wages of consumption but firms can afford to pay those higher wages only if marginal products rise as a result of their using less only if marginal products rise as a result of their using less labor labor

bull The rise in wage rates is not enough to compensate workers The rise in wage rates is not enough to compensate workers fully so the consumption-real wage in equilibrium is (wpfully so the consumption-real wage in equilibrium is (wpCPI CPI ) )

atat point E We can think of import prices as a tax levied on point E We can think of import prices as a tax levied on consumers and of an increase in import prices as widening the consumers and of an increase in import prices as widening the tax wedge Unless the issue that we want to analyze depends on tax wedge Unless the issue that we want to analyze depends on the difference between product- and consumption-real wages the difference between product- and consumption-real wages we will treat the real wage as the same for both labor supply we will treat the real wage as the same for both labor supply and labor demandand labor demand

An Increase in the Price of Consumption GoodsAn Increase in the Price of Consumption GoodsRelative to the Price of OutputRelative to the Price of Output

ANALYZING IDEAL LABOR MARKETSANALYZING IDEAL LABOR MARKETS

bull The aggregate labor-supplylabor-demand diagram provides us The aggregate labor-supplylabor-demand diagram provides us with a powerful tool We now analyze three important with a powerful tool We now analyze three important macroeconomic issues macroeconomic issues

(1) the effect of tax cuts on employment (1) the effect of tax cuts on employment

(2) the effect of technological progress on the well-being of (2) the effect of technological progress on the well-being of workers and workers and

(3) the effect of immigration on existing workers (3) the effect of immigration on existing workers

bull Issue 1 Tax Cuts Issue 1 Tax Cuts What are the effects of a cut in marginal What are the effects of a cut in marginal income-tax rates on employment and the level of GDP in the income-tax rates on employment and the level of GDP in the economyeconomy Recall from section that a lower marginal income-Recall from section that a lower marginal income-tax rate increases labor supply at each real wage (a rightward tax rate increases labor supply at each real wage (a rightward shift of the labor-supply) shift of the labor-supply)

bull Labor-market equilibrium moves from point A to point B in Labor-market equilibrium moves from point A to point B in the lower panel of the following Notice that the amount of the lower panel of the following Notice that the amount of labor available to firms increases so that firms move labor available to firms increases so that firms move production from Arsquo to Brsquo on the labor production function in production from Arsquo to Brsquo on the labor production function in the upper panel Also notice that the real wage falls from (the upper panel Also notice that the real wage falls from (wp)1 wp)1 to (wp)2 Since the cut in taxes increases the number of to (wp)2 Since the cut in taxes increases the number of workers workers willing to work at each wage Workers care about their take-willing to work at each wage Workers care about their take-home pay ndash that is about their home pay ndash that is about their after-tax real wage after-tax real wage This is This is perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 can be greater than the old after-tax real wage (1ndashcan be greater than the old after-tax real wage (1ndashτ1τ1)(wp)1 so )(wp)1 so long as the rise in the take-home share (1 ndash τ) is long as the rise in the take-home share (1 ndash τ) is proportionately greater than the fall in the before-tax real proportionately greater than the fall in the before-tax real wage (wp)wage (wp)

bull The analysis depends on substitution effects dominating The analysis depends on substitution effects dominating income effects which they probably do in aggregate if not for income effects which they probably do in aggregate if not for every worker So the supply-siders of the Reagan years are every worker So the supply-siders of the Reagan years are correct in principle How much output will increase depends on correct in principle How much output will increase depends on how large the substitution effect is If most people work a how large the substitution effect is If most people work a standard 40-hour week the effect could be quite small and the standard 40-hour week the effect could be quite small and the increase in output might also be very small in practiceincrease in output might also be very small in practice

Issue 1 The Effect of a Cut in Marginal Tax RatesIssue 1 The Effect of a Cut in Marginal Tax Rates

Issue 2 Technological Progress and Worker WelfareIssue 2 Technological Progress and Worker Welfare

bull Is technological progress and increasing use of machinery and Is technological progress and increasing use of machinery and other capital beneficial for workersother capital beneficial for workers

bull Technological change or capital accumulation have been Technological change or capital accumulation have been known as ldquoLudditesrdquo (known as ldquoLudditesrdquo (it negatively affects the demand for it negatively affects the demand for laborlabor) To see why the Luddites are wrong ndash at least for ) To see why the Luddites are wrong ndash at least for clearing labor markets ndash recall that technological progress or clearing labor markets ndash recall that technological progress or increased capital both increased capital both shift the labor-demand curve upwardshift the labor-demand curve upward The lower panel of the following figure shows that the effect of The lower panel of the following figure shows that the effect of the increased demand for labor is to increase total employment the increased demand for labor is to increase total employment and the real wage Firms and the real wage Firms can pay a higher real wage can pay a higher real wage because because the additional capital or technological progress the additional capital or technological progress increases the increases the marginal product of labormarginal product of labor

bull The The Ludditesrsquo mistake Ludditesrsquo mistake is most easily seen in the upper panel is most easily seen in the upper panel The Luddite argument assumes that fewer workers will The Luddite argument assumes that fewer workers will produce the same total output Production starts at Arsquo using produce the same total output Production starts at Arsquo using L1 L1 workers to produce Y1 After the upward shift in the production workers to produce Y1 After the upward shift in the production function the same output could be produced using less labor function the same output could be produced using less labor ((L3) at point Arsquorsquo The L3) at point Arsquorsquo The problem is that Arsquorsquo is not an equilibrium problem is that Arsquorsquo is not an equilibrium At that point the marginal product of labor is higher than the At that point the marginal product of labor is higher than the original real wage so a profit-maximizing firm would want to original real wage so a profit-maximizing firm would want to expand production To do this they must hire more labor than expand production To do this they must hire more labor than L3 and indeed they L3 and indeed they find it find it profitable profitable to hire more labor than to hire more labor than the original the original L1 The only way actually to increase labor L1 The only way actually to increase labor is to is to raise the real-wage raise the real-wage rate above its original level Technological rate above its original level Technological progress therefore favors progress therefore favors workers by increasing employment workers by increasing employment and wagesand wages

bull Early in the 19th century hand-woven cloth was very Early in the 19th century hand-woven cloth was very expensive and a worker was lucky to own the clothes on his expensive and a worker was lucky to own the clothes on his back and a spare set for church on Sunday Textiles were one of back and a spare set for church on Sunday Textiles were one of the first industries to benefit from the Industrial Revolution so the first industries to benefit from the Industrial Revolution so that by the end of the 19th century machine-made fabrics and that by the end of the 19th century machine-made fabrics and mass-production made decent clothing in larger quantities mass-production made decent clothing in larger quantities accessible to most of the population of the more developed accessible to most of the population of the more developed countries Similar progress has been made in most forms of countries Similar progress has been made in most forms of production Agricultural production which at the turn of the production Agricultural production which at the turn of the 20th century absorbed half the labor force now absorbs less 20th century absorbed half the labor force now absorbs less than 3 percent while producing more food more cheaply than than 3 percent while producing more food more cheaply than ever ever

bull We must be careful not to dismiss the Luddites as altogether We must be careful not to dismiss the Luddites as altogether foolish While new technology especially over decades has foolish While new technology especially over decades has proved to be a net gain for workers in general the Luddites proved to be a net gain for workers in general the Luddites were in fact correct that their way of life was threatened were in fact correct that their way of life was threatened Independent weavers became factory hands unskilled Independent weavers became factory hands unskilled workers increasingly women and often children replaced workers increasingly women and often children replaced skilled craftsmen and factory work often involved long hours skilled craftsmen and factory work often involved long hours in brutal conditions The wider society reaps the benefits of in brutal conditions The wider society reaps the benefits of technological change while a narrow group sometimes technological change while a narrow group sometimes disproportionately bears its costs Our analysis also assumes disproportionately bears its costs Our analysis also assumes that markets generally clear The implicit assumption is that that markets generally clear The implicit assumption is that displaced workers move on to new jobs possibly in other forms displaced workers move on to new jobs possibly in other forms of production Markets may have a tendency to clear in the of production Markets may have a tendency to clear in the long run yet workers may find themselves displaced in the long run yet workers may find themselves displaced in the short run say over the course of a business cycleshort run say over the course of a business cycle

Issue 3 Immigration Jobs and Real WagesIssue 3 Immigration Jobs and Real Wages

bull How does an increase in the labor force through immigration or How does an increase in the labor force through immigration or natural population growth affect labor and GDP natural population growth affect labor and GDP

bull One of the emotional issues associated with US immigration One of the emotional issues associated with US immigration policy ndash particularly towards low-wage workers from Mexico ndash policy ndash particularly towards low-wage workers from Mexico ndash is the idea that is the idea that immigrants take jobs away from native immigrants take jobs away from native workers workers We might be tempted to dismiss this fear as another We might be tempted to dismiss this fear as another example of the lump-of-labor fallacy Yet there is a sensible example of the lump-of-labor fallacy Yet there is a sensible intuition behind the argument An increase in the labor force ndash intuition behind the argument An increase in the labor force ndash due either to immigration or to higher population growth rates due either to immigration or to higher population growth rates ndash can be represented as an outward shift of the aggregate labor ndash can be represented as an outward shift of the aggregate labor supply curve as shown in the following Figure Employment supply curve as shown in the following Figure Employment increases but real wages fall It is not then that immigrants increases but real wages fall It is not then that immigrants take jobs away from natives take jobs away from natives Rather they compete for jobsRather they compete for jobs putting downward pressure on real wagesputting downward pressure on real wages

bull Again we must exercise care in interpreting the analysis Again we must exercise care in interpreting the analysis Remember that aggregate labor and average wage rates hide Remember that aggregate labor and average wage rates hide many details of the labor process The incomes of the new many details of the labor process The incomes of the new immigrants immigrants creates demand creates demand for the new production that they for the new production that they make possible Immigrant workers (at least those ndash whether make possible Immigrant workers (at least those ndash whether legal or illegal ndash who have become the focus of the most intense legal or illegal ndash who have become the focus of the most intense political debate) political debate) are likely to possess fewer skills than nativesare likely to possess fewer skills than natives The net effect is that the increased demand for goods and The net effect is that the increased demand for goods and services generated by immigrants is likely to increase the services generated by immigrants is likely to increase the demand for skilled (demand for skilled (and largely nativeand largely native) workers relative to ) workers relative to their supply and so to increase real wages of skilled workers their supply and so to increase real wages of skilled workers Low-skilled immigration may lower the real wage for farm Low-skilled immigration may lower the real wage for farm workers but if anything it would raise the real wage for workers but if anything it would raise the real wage for computer programmerscomputer programmers

Next Task Labor Market in Kuwait

Appendix Is Labor Supply Stable Over Time

bull Statistics on participation rates or average hours for a Statistics on participation rates or average hours for a particular month or year are snapshot of the labor market particular month or year are snapshot of the labor market Can we analyze the effects of that increase on the labor market Can we analyze the effects of that increase on the labor market under the assumption that the labor-supply curves of workers under the assumption that the labor-supply curves of workers remain essentially stableremain essentially stable

bull Data on participation rates in the United States appear to Data on participation rates in the United States appear to support this conjecture (see Figure 811) which shows the support this conjecture (see Figure 811) which shows the overall civilian participation rate trending upward ndash at least overall civilian participation rate trending upward ndash at least from the middle of the 1960sfrom the middle of the 1960s

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

bull The Labor-supply CurveThe Labor-supply Curve

bull The following figure represents the workerrsquos labor-supply The following figure represents the workerrsquos labor-supply decision Look first at panel (A) Suppose that at point A decision Look first at panel (A) Suppose that at point A where the real wage is (where the real wage is (wp)1 the worker decides that providing l wp)1 the worker decides that providing l hours of work balances the advantages of a little more hours of work balances the advantages of a little more consumption against a little more leisure at the margin Now consumption against a little more leisure at the margin Now consider what happens when the real wage rises to (consider what happens when the real wage rises to (wp)2 wp)2 There is a substitution effect shown by the arrow pointing to There is a substitution effect shown by the arrow pointing to the right which encourages the worker to supply more labor the right which encourages the worker to supply more labor The size of the substitution effect is measured by the length of The size of the substitution effect is measured by the length of the arrowthe arrow

bull There is also an income effect shown by the arrow pointing to There is also an income effect shown by the arrow pointing to the left which encourages the worker to supply less laborthe left which encourages the worker to supply less labor

The Slope of the Labor-Supply Curve

bull The net effect The net effect is measured by the difference between the is measured by the difference between the substitution and income effects shown at point B so that an substitution and income effects shown at point B so that an increase in the wage rate increases the workerrsquos supply of labor increase in the wage rate increases the workerrsquos supply of labor to to l2 to the right of l1 If the substitution effect is always stronger l2 to the right of l1 If the substitution effect is always stronger then the labor supply then the labor supply curve slopes upward curve slopes upward

bull Substitution effects are not necessarily stronger than income Substitution effects are not necessarily stronger than income effectseffects Panel (B) shows the construction of the labor-supply Panel (B) shows the construction of the labor-supply curve starting from point C when income effects are stronger curve starting from point C when income effects are stronger than substitution effects When the real-wage rate increases than substitution effects When the real-wage rate increases from (from (wp)1 to (wp)2 the dominant income effect overwhelms wp)1 to (wp)2 the dominant income effect overwhelms the substitution effect and labor the substitution effect and labor supply (point C) falls from supply (point C) falls from l1 to l1 to l2 If income effects are stronger for all wage rates above l2 If income effects are stronger for all wage rates above ((wp)1 wp)1 then the labor-supply curve will slope downward toward point C then the labor-supply curve will slope downward toward point C higher real wage higher real wage rates lower labor supplyrates lower labor supply

bull Although the labor-supply curve can slope downward towards Although the labor-supply curve can slope downward towards a point like A it is not reasonable to believe that it could slope a point like A it is not reasonable to believe that it could slope downward for every possible wage rate At very low wage rates downward for every possible wage rate At very low wage rates it is more reasonable to suppose that with very low incomes it is more reasonable to suppose that with very low incomes the workerrsquos need for food clothing shelter and other the workerrsquos need for food clothing shelter and other ldquoessentialrdquo goods the income effect is weak and the ldquoessentialrdquo goods the income effect is weak and the substitution effect is strong We should therefore expect the substitution effect is strong We should therefore expect the labor-supply curve to be upward sloping when wage rates are labor-supply curve to be upward sloping when wage rates are low Hence labor supply would be backward bending low Hence labor supply would be backward bending

Backward-bending Labor-supply Curve

Adding Realism TaxesAdding Realism Taxes

bull How does the tax affect the income from a little more or a little How does the tax affect the income from a little more or a little less work To answer this question we must know the less work To answer this question we must know the marginal marginal tax ratetax rate ((the fraction of an additional dollar of income that is the fraction of an additional dollar of income that is paid as taxes) paid as taxes) To keep things simple assume that all income is To keep things simple assume that all income is taxed at the same taxed at the same flatflat rate rate ττ In this case the marginal tax rate In this case the marginal tax rate must also be τ which takes a value between zero and one If a must also be τ which takes a value between zero and one If a worker earns worker earns wpwp for an hour of work the government takes for an hour of work the government takes τ(wp) τ(wp) as taxes and leaves the worker as taxes and leaves the worker (1ndashτ)(wp) (1ndashτ)(wp) as the after-as the after-tax real wagetax real wage

bull Since the worker actually receives the Since the worker actually receives the after-tax real wageafter-tax real wage it is it is the the true opportunity cost of leisure true opportunity cost of leisure Any increase in the Any increase in the marginal tax rate represents a decrease in the opportunity cost marginal tax rate represents a decrease in the opportunity cost of leisure If of leisure If substitution effectssubstitution effects are stronger than income are stronger than income effects then any increase in marginal tax rates effects then any increase in marginal tax rates reducesreduces the the supply of labor supply of labor as shown in the following figureas shown in the following figure

The Effect of a Tax Increase on Labor Supply

bull The labor-supply curve with no taxes is shown on the right of The labor-supply curve with no taxes is shown on the right of the figure At the figure At (wp)1(wp)1 the worker supplies labor the worker supplies labor l1l1 If a tax of If a tax of τ1τ1 is imposed the after-tax real wage is is imposed the after-tax real wage is (1ndashτ1)(wp)1(1ndashτ1)(wp)1 The worker The worker should react exactly as if he paid no taxes but suffered a cut in should react exactly as if he paid no taxes but suffered a cut in his wages This is shown as a movement from point A to point B his wages This is shown as a movement from point A to point B where labor supply has fallen to where labor supply has fallen to l2l2 But of course the wage rate But of course the wage rate did not really falldid not really fall the employer still pays (wp)1 This means the employer still pays (wp)1 This means that (l2 (wp)1) is the labor-supply (point C)that (l2 (wp)1) is the labor-supply (point C)

bull Since this would apply for any real-wage rate every point on Since this would apply for any real-wage rate every point on the original curve shifts to the left Because the the original curve shifts to the left Because the tax rate is tax rate is proportional its absolute effect is greaterproportional its absolute effect is greater as is the shift in the as is the shift in the labor-supply curve at high wage rates resulting in a labor-supply curve at high wage rates resulting in a steepening of the curve Any further increase in the tax rate to steepening of the curve Any further increase in the tax rate to say τ2 would shift the labor-supply curve further to the left say τ2 would shift the labor-supply curve further to the left

bull The length of the line segment BC measures the The length of the line segment BC measures the TAX WEDGETAX WEDGE between the real wage paid by employers and the after-tax real between the real wage paid by employers and the after-tax real wage received by workewage received by workersrs The The largerlarger the tax wedge the the tax wedge the largerlarger the leftward shift of the labor-supply curve and the the leftward shift of the labor-supply curve and the greater the greater the reductionreduction in labor supplied at any real wage in labor supplied at any real wage

bull The idea that tax increases lower labor supply and conversely The idea that tax increases lower labor supply and conversely that tax cuts increase labor supply was a major tenet of the so-that tax cuts increase labor supply was a major tenet of the so-called called supply-side economicssupply-side economics popular in the early 1980s popular in the early 1980s President Ronald Reagan and his advisors used it to argue that President Ronald Reagan and his advisors used it to argue that cuts in marginal tax rates cuts in marginal tax rates would stimulate people would stimulate people to to workwork harder and to harder and to earn larger earn larger incomesincomes

Adding Realism A Standard WorkweekAdding Realism A Standard Workweek

bull Another way in which the simple analysis of labor supply is Another way in which the simple analysis of labor supply is unrealistic is that many unrealistic is that many workers are not given an option about workers are not given an option about the number of hours they workthe number of hours they work Although people work part- Although people work part-time and overtime either may be voluntary or mandatory time and overtime either may be voluntary or mandatory

bull Assuming that workers are Assuming that workers are not permitted to work more than not permitted to work more than 40 hours a week40 hours a week the following figure includes a constraint of the following figure includes a constraint of 40 hours If the worker were permitted to choose freely then 40 hours If the worker were permitted to choose freely then the labor-supply curve would backward bending curve The the labor-supply curve would backward bending curve The overall effect is to of the standard work week is to reshape the overall effect is to of the standard work week is to reshape the labor-supply curve as indicated by the heavy curve with the labor-supply curve as indicated by the heavy curve with the vertical segment that runs through points A F G D and E vertical segment that runs through points A F G D and E Any worker on this vertical segment is constrainedAny worker on this vertical segment is constrained

The Individual Labor-Supply Curve in PracticeThe Individual Labor-Supply Curve in Practice

bull What does the individual labor-supply curve look like in What does the individual labor-supply curve look like in realityreality It is difficult to answer this question because in reality It is difficult to answer this question because in reality we can observe we can observe only one pointonly one point on the labor-supply curve for a on the labor-supply curve for a single worker single worker at a particular timeat a particular time All the other points are All the other points are conjecturesconjectures about what the worker would supply if faced with about what the worker would supply if faced with different wage rates If we imagine that on average workers are different wage rates If we imagine that on average workers are substantially substantially similarsimilar we might nonetheless get some idea of we might nonetheless get some idea of what the individual labor-supply curve might look likewhat the individual labor-supply curve might look like

bull The The National Longitudinal SurveyNational Longitudinal Survey (Youth) has catalogued the (Youth) has catalogued the work histories of a large sample of individuals starting at a work histories of a large sample of individuals starting at a young age The following figure plots the real-wage rates and young age The following figure plots the real-wage rates and average weekly hours of labor for about average weekly hours of labor for about 1000010000 male workers male workers from this survey for a from this survey for a single periodsingle period with the best fitting flexible with the best fitting flexible line through these points serves as our empirical estimate of the line through these points serves as our empirical estimate of the labor-supply curve for these workerslabor-supply curve for these workers

bull The regression line traces out a shape very The regression line traces out a shape very like the backward-like the backward-bendingbending labor-supply curve with a 40-hour constraint What labor-supply curve with a 40-hour constraint What looks like a vertical line above 40 hours is looks like a vertical line above 40 hours is not really a solid line not really a solid line at all but a reflection of the fact that about at all but a reflection of the fact that about 7500 7500 of the 10000 of the 10000 workers in the sample supply 40 hours per week at a variety of workers in the sample supply 40 hours per week at a variety of wage rates The labor-supply curve traces out a segment above wage rates The labor-supply curve traces out a segment above the 40-hour point that corresponds to the constraintthe 40-hour point that corresponds to the constraint

bull There are There are points to the rightpoints to the right of 40 hours This is reasonable of 40 hours This is reasonable since in the real world workers do since in the real world workers do work overtimework overtime ndash either ndash either because they are supervisors or professionals or because because they are supervisors or professionals or because employers offer them the required time-and-half wage rate employers offer them the required time-and-half wage rate The fit of the regression line is far from perfect points lie on The fit of the regression line is far from perfect points lie on both sides of the line We should interpret it as a both sides of the line We should interpret it as a snapshotsnapshot of of the behavior of the typical worker But ofthe behavior of the typical worker But of course the typical course the typical worker is not any actual worker in particularworker is not any actual worker in particular

THE WORKER CHOOSING TO PARTICIPATETHE WORKER CHOOSING TO PARTICIPATE

bull So far we have examined only one aspect of the workerrsquos So far we have examined only one aspect of the workerrsquos labor-supply decision labor-supply decision how many hours to work for given real how many hours to work for given real wagewage We now take up the second aspect We now take up the second aspect participationparticipation ndash that ndash that is is whether or not to work at allwhether or not to work at all A labor-supply curve that starts A labor-supply curve that starts at the origin and slopes upwards for at least a portion of its at the origin and slopes upwards for at least a portion of its length suggests that even length suggests that even if the wage were very lowif the wage were very low ndash say 1cent ndash say 1cent per hour ndash the worker would work a little bit That is clearly per hour ndash the worker would work a little bit That is clearly unrealisticunrealistic no one would work at all for 1cent per hour no one would work at all for 1cent per hour What What factors determine how high the wage factors determine how high the wage must be to induce a person must be to induce a person to participate in the labor marketto participate in the labor market

bull The labor force The labor force participationparticipation decision is a question of decision is a question of opportunity costopportunity cost Idleness has its charms Before anyone enters Idleness has its charms Before anyone enters the labor force the wage rate must be high enough to overcome the labor force the wage rate must be high enough to overcome them them The opportunity cost of participatingThe opportunity cost of participating in the labor force is in the labor force is sum of sum of

1048766 1048766 the implicit valuethe implicit value the worker places on complete idleness the worker places on complete idleness

1048766 1048766 the explicit coststhe explicit costs of working compared to not working such as of working compared to not working such as clothing transport childcare) andclothing transport childcare) and

1048766 1048766 the explicit losses the explicit losses from working (for instance housework not from working (for instance housework not done)done)

bull The opportunity cost is partly psychological and partly material The opportunity cost is partly psychological and partly material If people were completely If people were completely independentindependent of each other the worker of each other the worker might place a lower value on the opportunity cost of might place a lower value on the opportunity cost of participation because then the choice might be literally between participation because then the choice might be literally between work and starvationwork and starvation

bull But most people are not But most people are not completely independentcompletely independent Whether or Whether or not to participate in the labor force could be a not to participate in the labor force could be a genuine choicegenuine choice and would depend on the and would depend on the real wagereal wage

bull The The RESERVATION WAGE RESERVATION WAGE is defined to be is defined to be the opportunity the opportunity cost of working compared to not workingcost of working compared to not working ndash ndash that is the real wage that is the real wage that is high enough to make it just worthwhile for a worker to that is high enough to make it just worthwhile for a worker to participate in the labor forceparticipate in the labor force

bull Taking account of the opportunity costs of participation affects Taking account of the opportunity costs of participation affects the shape of the labor-supply curve As long as the the shape of the labor-supply curve As long as the real wage is real wage is below the reservationbelow the reservation wage ((wp)R) the worker supplies no wage ((wp)R) the worker supplies no labor at all Above the reservation wage there is a normal labor at all Above the reservation wage there is a normal labor-supply curvelabor-supply curve

bull The following captures the two stages of the labor supply The following captures the two stages of the labor supply decision decision FirstFirst at low wages the worker will at low wages the worker will notnot supply any supply any labor at all and small increases in wages have no effect But labor at all and small increases in wages have no effect But secondsecond as soon as the wage rises enough for the worker to bite as soon as the wage rises enough for the worker to bite the bullet and join the labor force the minimum labor supplied the bullet and join the labor force the minimum labor supplied will be well will be well above zeroabove zero and the worker will decide how many and the worker will decide how many hours to supply above this minimum through the usual process hours to supply above this minimum through the usual process of balancing the opportunity cost of leisure against the desire of balancing the opportunity cost of leisure against the desire for consumption goodsfor consumption goods

AGGREGATE LABOR SUPPLY

bull How can we moveHow can we move from the microeconomics of the labor supply from the microeconomics of the labor supply back to an aggregate relationship usable in macroeconomic back to an aggregate relationship usable in macroeconomic analysis analysis If workers were essentially alikeIf workers were essentially alike the problem would the problem would be easy be easy

bull As we have seen labor supply has two dimensions ndash As we have seen labor supply has two dimensions ndash participationparticipation in the labor force and in the labor force and choice of hourschoice of hours of labor of labor Take the participation decision first If all workers were alike Take the participation decision first If all workers were alike except for except for differences in their reservation wagedifferences in their reservation wage then we could then we could rank them from lowest to highest reservation wage The rank them from lowest to highest reservation wage The aggregate labor-supply (participation) curve is strictly aggregate labor-supply (participation) curve is strictly upwardslopingupwardsloping

bull Of course this is too easy Just as we observed in deriving the Of course this is too easy Just as we observed in deriving the aggregate labor demand curve workers are aggregate labor demand curve workers are not all alikenot all alike Once Once again we must interpret the vertical axis as measuring the again we must interpret the vertical axis as measuring the average real wageaverage real wage that at best provides a kind of index for the that at best provides a kind of index for the level of the wage structure level of the wage structure

bull The The problemproblem remains the remains the samesame when we turn to the choice of when we turn to the choice of hourshours Workers are all different and face a structure of wages Workers are all different and face a structure of wages For each worker individually there is a jump from supplying For each worker individually there is a jump from supplying zero to supplying some positive number of hours zero to supplying some positive number of hours when his own when his own wage rate surpasses their wage rate surpasses their reservation wagereservation wage But in aggregate But in aggregate we are we are unlikely to see such a jumpunlikely to see such a jump Not only are there a variety Not only are there a variety of wages offered at any time but reservation wages differof wages offered at any time but reservation wages differ

Derivation of the Aggregate Labor-supply Curve

bull A curve like the one in this figure can be used to display either A curve like the one in this figure can be used to display either the the participation participation decision or decision or the hoursthe hours The horizontal axis can The horizontal axis can either be used for workers either be used for workers or worker-hoursor worker-hours as measures of the as measures of the labor supply The two meanings are not completely labor supply The two meanings are not completely independent by definition independent by definition

bull workers equiv aggregate worker ndash hours average hours per worker workers equiv aggregate worker ndash hours average hours per worker

The Participation Rate and Average Hours

bull Let us look first at the aggregate participation decision The Let us look first at the aggregate participation decision The aggregate number of workers who have decided to participate aggregate number of workers who have decided to participate is known as the is known as the labor forcelabor force the the civilian labor force over 16 civilian labor force over 16 years of ageyears of age This number excludes uniformed members of the This number excludes uniformed members of the armed services and the small number of workers under 16 armed services and the small number of workers under 16 years old The labor force of course has grown right along years old The labor force of course has grown right along with population with population

bull The participation rateThe participation rate (PR) measures (PR) measures the labor force as its ratio the labor force as its ratio to the relevant populationto the relevant population

bull participation rate = labor forcerelevant population participation rate = labor forcerelevant population

bull ldquoldquonon-institutionalrdquo non-institutionalrdquo excludes people in prison or in homes for excludes people in prison or in homes for the aged) the aged)

bull The aggregate number of hours The aggregate number of hours worked is worked is not as easy not as easy as the as the participation rate to relate to the individual workerrsquos choices participation rate to relate to the individual workerrsquos choices If every worker had the same labor-supply curve we would If every worker had the same labor-supply curve we would have to know the wage offered to each one in order to calculate have to know the wage offered to each one in order to calculate the total number of labor hours supplied In reality workers the total number of labor hours supplied In reality workers are not all alike are not all alike Labor-supply curves may vary systematically Labor-supply curves may vary systematically according to the sex age ethnic group education experience according to the sex age ethnic group education experience or other social or economic characteristics of the workersor other social or economic characteristics of the workers And And within any group the labor-supply curves of individuals are within any group the labor-supply curves of individuals are likely to varylikely to vary

bull In principle In principle if we had a good statistical estimate of the typical if we had a good statistical estimate of the typical distribution of the wagesdistribution of the wages we could make a reasonable we could make a reasonable calculation But statisticians at the Bureau of Labor Statistics calculation But statisticians at the Bureau of Labor Statistics (BLS) do not try to calculate the labor supply in this way (BLS) do not try to calculate the labor supply in this way Instead they Instead they count the number of hours that workers actually count the number of hours that workers actually workwork and the average and the average wages and salaries they are paid wages and salaries they are paid

bull In USA the total hours of labor in 1998 was In USA the total hours of labor in 1998 was 236882236882 million million The average hours of work is The average hours of work is 17211721 hours per year = hours per year = 344344 hours hours per week (assuming a 50 week year) This number is 14 percent per week (assuming a 50 week year) This number is 14 percent below the full time 40-hour week which makes sense since it below the full time 40-hour week which makes sense since it averages over full-time part-time and overtime workers averages over full-time part-time and overtime workers

Labor Market EquilibriumLabor Market Equilibrium

bull MARKET CLEARINGMARKET CLEARING

bull When both demand and supply curves are plotted on the same When both demand and supply curves are plotted on the same diagram the crossing point defines the diagram the crossing point defines the equilibrium real-wage equilibrium real-wage rate and the rate and the equilibrium level of labor employedequilibrium level of labor employed

bull The real wage The real wage looks different looks different from the point of view of the firm from the point of view of the firm and the worker For the and the worker For the firmfirm the relevant real wage is the the relevant real wage is the product-real wage product-real wage defined as defined as the number of units of the good the number of units of the good the firm produces that the wage will purchase the firm produces that the wage will purchase ((price of price of productproduct = = w) w) For the For the workerworker the relevant real wage is the the relevant real wage is the consumption-consumption-real real wagewage defined as defined as the number of typical consumption baskets the number of typical consumption baskets that the wage will purchase that the wage will purchase ((price of price of consumption basket consumption basket = = w)w)

bull For aggregate analysis we might use the For aggregate analysis we might use the Producer Price IndexProducer Price Index or the GDP deflator to approximate the or the GDP deflator to approximate the product priceproduct price and the and the CPICPI to approximate the to approximate the consumption price consumption price

bull Suppose that the product-real wage and the consumption-real Suppose that the product-real wage and the consumption-real wage in the following figure start out with the identical value wage in the following figure start out with the identical value ((wp) at the market-clearing point Awp) at the market-clearing point A Now suppose that Now suppose that imported Japanese cars are a large portion of the typical imported Japanese cars are a large portion of the typical workerrsquos consumption basket workerrsquos consumption basket and that and that ceteris paribus ceteris paribus the price the price of Japanese cars rises sharply This means that the of Japanese cars rises sharply This means that the real wage real wage from the point of view of the from the point of view of the consumer falls to (consumer falls to (wpwpCPICPI ) )11 at point at point

B B on the labor-supply curve (LS) so that the worker would on the labor-supply curve (LS) so that the worker would want to supply less labor (want to supply less labor (LL11))

bull The rise in the price of Japanese cars has no effect on the price The rise in the price of Japanese cars has no effect on the price of their products Nevertheless they see a reduction of labor of their products Nevertheless they see a reduction of labor supply at the original market clearing wage It is as if the supply at the original market clearing wage It is as if the labor-supply curve labor-supply curve has shifted to the left to has shifted to the left to LSLSrsquo which passes rsquo which passes through ((through ((wp) L1) at point C wp) L1) at point C At the original wage rate labor At the original wage rate labor demand exceeds labor supply so firms raise wages in an effort demand exceeds labor supply so firms raise wages in an effort to attract workers until they reach the new market-clearing to attract workers until they reach the new market-clearing wage at point D where they pay (wage at point D where they pay (wpwpPPIPPI ) for labor of L ) for labor of L The The

rise in the price of Japanese cars has the effect of raising the rise in the price of Japanese cars has the effect of raising the wages that firms must pay and reducing labor employedwages that firms must pay and reducing labor employed Higher wages partly compensate workers for the higher costs Higher wages partly compensate workers for the higher costs of consumption but firms can afford to pay those higher wages of consumption but firms can afford to pay those higher wages only if marginal products rise as a result of their using less only if marginal products rise as a result of their using less labor labor

bull The rise in wage rates is not enough to compensate workers The rise in wage rates is not enough to compensate workers fully so the consumption-real wage in equilibrium is (wpfully so the consumption-real wage in equilibrium is (wpCPI CPI ) )

atat point E We can think of import prices as a tax levied on point E We can think of import prices as a tax levied on consumers and of an increase in import prices as widening the consumers and of an increase in import prices as widening the tax wedge Unless the issue that we want to analyze depends on tax wedge Unless the issue that we want to analyze depends on the difference between product- and consumption-real wages the difference between product- and consumption-real wages we will treat the real wage as the same for both labor supply we will treat the real wage as the same for both labor supply and labor demandand labor demand

An Increase in the Price of Consumption GoodsAn Increase in the Price of Consumption GoodsRelative to the Price of OutputRelative to the Price of Output

ANALYZING IDEAL LABOR MARKETSANALYZING IDEAL LABOR MARKETS

bull The aggregate labor-supplylabor-demand diagram provides us The aggregate labor-supplylabor-demand diagram provides us with a powerful tool We now analyze three important with a powerful tool We now analyze three important macroeconomic issues macroeconomic issues

(1) the effect of tax cuts on employment (1) the effect of tax cuts on employment

(2) the effect of technological progress on the well-being of (2) the effect of technological progress on the well-being of workers and workers and

(3) the effect of immigration on existing workers (3) the effect of immigration on existing workers

bull Issue 1 Tax Cuts Issue 1 Tax Cuts What are the effects of a cut in marginal What are the effects of a cut in marginal income-tax rates on employment and the level of GDP in the income-tax rates on employment and the level of GDP in the economyeconomy Recall from section that a lower marginal income-Recall from section that a lower marginal income-tax rate increases labor supply at each real wage (a rightward tax rate increases labor supply at each real wage (a rightward shift of the labor-supply) shift of the labor-supply)

bull Labor-market equilibrium moves from point A to point B in Labor-market equilibrium moves from point A to point B in the lower panel of the following Notice that the amount of the lower panel of the following Notice that the amount of labor available to firms increases so that firms move labor available to firms increases so that firms move production from Arsquo to Brsquo on the labor production function in production from Arsquo to Brsquo on the labor production function in the upper panel Also notice that the real wage falls from (the upper panel Also notice that the real wage falls from (wp)1 wp)1 to (wp)2 Since the cut in taxes increases the number of to (wp)2 Since the cut in taxes increases the number of workers workers willing to work at each wage Workers care about their take-willing to work at each wage Workers care about their take-home pay ndash that is about their home pay ndash that is about their after-tax real wage after-tax real wage This is This is perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 can be greater than the old after-tax real wage (1ndashcan be greater than the old after-tax real wage (1ndashτ1τ1)(wp)1 so )(wp)1 so long as the rise in the take-home share (1 ndash τ) is long as the rise in the take-home share (1 ndash τ) is proportionately greater than the fall in the before-tax real proportionately greater than the fall in the before-tax real wage (wp)wage (wp)

bull The analysis depends on substitution effects dominating The analysis depends on substitution effects dominating income effects which they probably do in aggregate if not for income effects which they probably do in aggregate if not for every worker So the supply-siders of the Reagan years are every worker So the supply-siders of the Reagan years are correct in principle How much output will increase depends on correct in principle How much output will increase depends on how large the substitution effect is If most people work a how large the substitution effect is If most people work a standard 40-hour week the effect could be quite small and the standard 40-hour week the effect could be quite small and the increase in output might also be very small in practiceincrease in output might also be very small in practice

Issue 1 The Effect of a Cut in Marginal Tax RatesIssue 1 The Effect of a Cut in Marginal Tax Rates

Issue 2 Technological Progress and Worker WelfareIssue 2 Technological Progress and Worker Welfare

bull Is technological progress and increasing use of machinery and Is technological progress and increasing use of machinery and other capital beneficial for workersother capital beneficial for workers

bull Technological change or capital accumulation have been Technological change or capital accumulation have been known as ldquoLudditesrdquo (known as ldquoLudditesrdquo (it negatively affects the demand for it negatively affects the demand for laborlabor) To see why the Luddites are wrong ndash at least for ) To see why the Luddites are wrong ndash at least for clearing labor markets ndash recall that technological progress or clearing labor markets ndash recall that technological progress or increased capital both increased capital both shift the labor-demand curve upwardshift the labor-demand curve upward The lower panel of the following figure shows that the effect of The lower panel of the following figure shows that the effect of the increased demand for labor is to increase total employment the increased demand for labor is to increase total employment and the real wage Firms and the real wage Firms can pay a higher real wage can pay a higher real wage because because the additional capital or technological progress the additional capital or technological progress increases the increases the marginal product of labormarginal product of labor

bull The The Ludditesrsquo mistake Ludditesrsquo mistake is most easily seen in the upper panel is most easily seen in the upper panel The Luddite argument assumes that fewer workers will The Luddite argument assumes that fewer workers will produce the same total output Production starts at Arsquo using produce the same total output Production starts at Arsquo using L1 L1 workers to produce Y1 After the upward shift in the production workers to produce Y1 After the upward shift in the production function the same output could be produced using less labor function the same output could be produced using less labor ((L3) at point Arsquorsquo The L3) at point Arsquorsquo The problem is that Arsquorsquo is not an equilibrium problem is that Arsquorsquo is not an equilibrium At that point the marginal product of labor is higher than the At that point the marginal product of labor is higher than the original real wage so a profit-maximizing firm would want to original real wage so a profit-maximizing firm would want to expand production To do this they must hire more labor than expand production To do this they must hire more labor than L3 and indeed they L3 and indeed they find it find it profitable profitable to hire more labor than to hire more labor than the original the original L1 The only way actually to increase labor L1 The only way actually to increase labor is to is to raise the real-wage raise the real-wage rate above its original level Technological rate above its original level Technological progress therefore favors progress therefore favors workers by increasing employment workers by increasing employment and wagesand wages

bull Early in the 19th century hand-woven cloth was very Early in the 19th century hand-woven cloth was very expensive and a worker was lucky to own the clothes on his expensive and a worker was lucky to own the clothes on his back and a spare set for church on Sunday Textiles were one of back and a spare set for church on Sunday Textiles were one of the first industries to benefit from the Industrial Revolution so the first industries to benefit from the Industrial Revolution so that by the end of the 19th century machine-made fabrics and that by the end of the 19th century machine-made fabrics and mass-production made decent clothing in larger quantities mass-production made decent clothing in larger quantities accessible to most of the population of the more developed accessible to most of the population of the more developed countries Similar progress has been made in most forms of countries Similar progress has been made in most forms of production Agricultural production which at the turn of the production Agricultural production which at the turn of the 20th century absorbed half the labor force now absorbs less 20th century absorbed half the labor force now absorbs less than 3 percent while producing more food more cheaply than than 3 percent while producing more food more cheaply than ever ever

bull We must be careful not to dismiss the Luddites as altogether We must be careful not to dismiss the Luddites as altogether foolish While new technology especially over decades has foolish While new technology especially over decades has proved to be a net gain for workers in general the Luddites proved to be a net gain for workers in general the Luddites were in fact correct that their way of life was threatened were in fact correct that their way of life was threatened Independent weavers became factory hands unskilled Independent weavers became factory hands unskilled workers increasingly women and often children replaced workers increasingly women and often children replaced skilled craftsmen and factory work often involved long hours skilled craftsmen and factory work often involved long hours in brutal conditions The wider society reaps the benefits of in brutal conditions The wider society reaps the benefits of technological change while a narrow group sometimes technological change while a narrow group sometimes disproportionately bears its costs Our analysis also assumes disproportionately bears its costs Our analysis also assumes that markets generally clear The implicit assumption is that that markets generally clear The implicit assumption is that displaced workers move on to new jobs possibly in other forms displaced workers move on to new jobs possibly in other forms of production Markets may have a tendency to clear in the of production Markets may have a tendency to clear in the long run yet workers may find themselves displaced in the long run yet workers may find themselves displaced in the short run say over the course of a business cycleshort run say over the course of a business cycle

Issue 3 Immigration Jobs and Real WagesIssue 3 Immigration Jobs and Real Wages

bull How does an increase in the labor force through immigration or How does an increase in the labor force through immigration or natural population growth affect labor and GDP natural population growth affect labor and GDP

bull One of the emotional issues associated with US immigration One of the emotional issues associated with US immigration policy ndash particularly towards low-wage workers from Mexico ndash policy ndash particularly towards low-wage workers from Mexico ndash is the idea that is the idea that immigrants take jobs away from native immigrants take jobs away from native workers workers We might be tempted to dismiss this fear as another We might be tempted to dismiss this fear as another example of the lump-of-labor fallacy Yet there is a sensible example of the lump-of-labor fallacy Yet there is a sensible intuition behind the argument An increase in the labor force ndash intuition behind the argument An increase in the labor force ndash due either to immigration or to higher population growth rates due either to immigration or to higher population growth rates ndash can be represented as an outward shift of the aggregate labor ndash can be represented as an outward shift of the aggregate labor supply curve as shown in the following Figure Employment supply curve as shown in the following Figure Employment increases but real wages fall It is not then that immigrants increases but real wages fall It is not then that immigrants take jobs away from natives take jobs away from natives Rather they compete for jobsRather they compete for jobs putting downward pressure on real wagesputting downward pressure on real wages

bull Again we must exercise care in interpreting the analysis Again we must exercise care in interpreting the analysis Remember that aggregate labor and average wage rates hide Remember that aggregate labor and average wage rates hide many details of the labor process The incomes of the new many details of the labor process The incomes of the new immigrants immigrants creates demand creates demand for the new production that they for the new production that they make possible Immigrant workers (at least those ndash whether make possible Immigrant workers (at least those ndash whether legal or illegal ndash who have become the focus of the most intense legal or illegal ndash who have become the focus of the most intense political debate) political debate) are likely to possess fewer skills than nativesare likely to possess fewer skills than natives The net effect is that the increased demand for goods and The net effect is that the increased demand for goods and services generated by immigrants is likely to increase the services generated by immigrants is likely to increase the demand for skilled (demand for skilled (and largely nativeand largely native) workers relative to ) workers relative to their supply and so to increase real wages of skilled workers their supply and so to increase real wages of skilled workers Low-skilled immigration may lower the real wage for farm Low-skilled immigration may lower the real wage for farm workers but if anything it would raise the real wage for workers but if anything it would raise the real wage for computer programmerscomputer programmers

Next Task Labor Market in Kuwait

Appendix Is Labor Supply Stable Over Time

bull Statistics on participation rates or average hours for a Statistics on participation rates or average hours for a particular month or year are snapshot of the labor market particular month or year are snapshot of the labor market Can we analyze the effects of that increase on the labor market Can we analyze the effects of that increase on the labor market under the assumption that the labor-supply curves of workers under the assumption that the labor-supply curves of workers remain essentially stableremain essentially stable

bull Data on participation rates in the United States appear to Data on participation rates in the United States appear to support this conjecture (see Figure 811) which shows the support this conjecture (see Figure 811) which shows the overall civilian participation rate trending upward ndash at least overall civilian participation rate trending upward ndash at least from the middle of the 1960sfrom the middle of the 1960s

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

The Slope of the Labor-Supply Curve

bull The net effect The net effect is measured by the difference between the is measured by the difference between the substitution and income effects shown at point B so that an substitution and income effects shown at point B so that an increase in the wage rate increases the workerrsquos supply of labor increase in the wage rate increases the workerrsquos supply of labor to to l2 to the right of l1 If the substitution effect is always stronger l2 to the right of l1 If the substitution effect is always stronger then the labor supply then the labor supply curve slopes upward curve slopes upward

bull Substitution effects are not necessarily stronger than income Substitution effects are not necessarily stronger than income effectseffects Panel (B) shows the construction of the labor-supply Panel (B) shows the construction of the labor-supply curve starting from point C when income effects are stronger curve starting from point C when income effects are stronger than substitution effects When the real-wage rate increases than substitution effects When the real-wage rate increases from (from (wp)1 to (wp)2 the dominant income effect overwhelms wp)1 to (wp)2 the dominant income effect overwhelms the substitution effect and labor the substitution effect and labor supply (point C) falls from supply (point C) falls from l1 to l1 to l2 If income effects are stronger for all wage rates above l2 If income effects are stronger for all wage rates above ((wp)1 wp)1 then the labor-supply curve will slope downward toward point C then the labor-supply curve will slope downward toward point C higher real wage higher real wage rates lower labor supplyrates lower labor supply

bull Although the labor-supply curve can slope downward towards Although the labor-supply curve can slope downward towards a point like A it is not reasonable to believe that it could slope a point like A it is not reasonable to believe that it could slope downward for every possible wage rate At very low wage rates downward for every possible wage rate At very low wage rates it is more reasonable to suppose that with very low incomes it is more reasonable to suppose that with very low incomes the workerrsquos need for food clothing shelter and other the workerrsquos need for food clothing shelter and other ldquoessentialrdquo goods the income effect is weak and the ldquoessentialrdquo goods the income effect is weak and the substitution effect is strong We should therefore expect the substitution effect is strong We should therefore expect the labor-supply curve to be upward sloping when wage rates are labor-supply curve to be upward sloping when wage rates are low Hence labor supply would be backward bending low Hence labor supply would be backward bending

Backward-bending Labor-supply Curve

Adding Realism TaxesAdding Realism Taxes

bull How does the tax affect the income from a little more or a little How does the tax affect the income from a little more or a little less work To answer this question we must know the less work To answer this question we must know the marginal marginal tax ratetax rate ((the fraction of an additional dollar of income that is the fraction of an additional dollar of income that is paid as taxes) paid as taxes) To keep things simple assume that all income is To keep things simple assume that all income is taxed at the same taxed at the same flatflat rate rate ττ In this case the marginal tax rate In this case the marginal tax rate must also be τ which takes a value between zero and one If a must also be τ which takes a value between zero and one If a worker earns worker earns wpwp for an hour of work the government takes for an hour of work the government takes τ(wp) τ(wp) as taxes and leaves the worker as taxes and leaves the worker (1ndashτ)(wp) (1ndashτ)(wp) as the after-as the after-tax real wagetax real wage

bull Since the worker actually receives the Since the worker actually receives the after-tax real wageafter-tax real wage it is it is the the true opportunity cost of leisure true opportunity cost of leisure Any increase in the Any increase in the marginal tax rate represents a decrease in the opportunity cost marginal tax rate represents a decrease in the opportunity cost of leisure If of leisure If substitution effectssubstitution effects are stronger than income are stronger than income effects then any increase in marginal tax rates effects then any increase in marginal tax rates reducesreduces the the supply of labor supply of labor as shown in the following figureas shown in the following figure

The Effect of a Tax Increase on Labor Supply

bull The labor-supply curve with no taxes is shown on the right of The labor-supply curve with no taxes is shown on the right of the figure At the figure At (wp)1(wp)1 the worker supplies labor the worker supplies labor l1l1 If a tax of If a tax of τ1τ1 is imposed the after-tax real wage is is imposed the after-tax real wage is (1ndashτ1)(wp)1(1ndashτ1)(wp)1 The worker The worker should react exactly as if he paid no taxes but suffered a cut in should react exactly as if he paid no taxes but suffered a cut in his wages This is shown as a movement from point A to point B his wages This is shown as a movement from point A to point B where labor supply has fallen to where labor supply has fallen to l2l2 But of course the wage rate But of course the wage rate did not really falldid not really fall the employer still pays (wp)1 This means the employer still pays (wp)1 This means that (l2 (wp)1) is the labor-supply (point C)that (l2 (wp)1) is the labor-supply (point C)

bull Since this would apply for any real-wage rate every point on Since this would apply for any real-wage rate every point on the original curve shifts to the left Because the the original curve shifts to the left Because the tax rate is tax rate is proportional its absolute effect is greaterproportional its absolute effect is greater as is the shift in the as is the shift in the labor-supply curve at high wage rates resulting in a labor-supply curve at high wage rates resulting in a steepening of the curve Any further increase in the tax rate to steepening of the curve Any further increase in the tax rate to say τ2 would shift the labor-supply curve further to the left say τ2 would shift the labor-supply curve further to the left

bull The length of the line segment BC measures the The length of the line segment BC measures the TAX WEDGETAX WEDGE between the real wage paid by employers and the after-tax real between the real wage paid by employers and the after-tax real wage received by workewage received by workersrs The The largerlarger the tax wedge the the tax wedge the largerlarger the leftward shift of the labor-supply curve and the the leftward shift of the labor-supply curve and the greater the greater the reductionreduction in labor supplied at any real wage in labor supplied at any real wage

bull The idea that tax increases lower labor supply and conversely The idea that tax increases lower labor supply and conversely that tax cuts increase labor supply was a major tenet of the so-that tax cuts increase labor supply was a major tenet of the so-called called supply-side economicssupply-side economics popular in the early 1980s popular in the early 1980s President Ronald Reagan and his advisors used it to argue that President Ronald Reagan and his advisors used it to argue that cuts in marginal tax rates cuts in marginal tax rates would stimulate people would stimulate people to to workwork harder and to harder and to earn larger earn larger incomesincomes

Adding Realism A Standard WorkweekAdding Realism A Standard Workweek

bull Another way in which the simple analysis of labor supply is Another way in which the simple analysis of labor supply is unrealistic is that many unrealistic is that many workers are not given an option about workers are not given an option about the number of hours they workthe number of hours they work Although people work part- Although people work part-time and overtime either may be voluntary or mandatory time and overtime either may be voluntary or mandatory

bull Assuming that workers are Assuming that workers are not permitted to work more than not permitted to work more than 40 hours a week40 hours a week the following figure includes a constraint of the following figure includes a constraint of 40 hours If the worker were permitted to choose freely then 40 hours If the worker were permitted to choose freely then the labor-supply curve would backward bending curve The the labor-supply curve would backward bending curve The overall effect is to of the standard work week is to reshape the overall effect is to of the standard work week is to reshape the labor-supply curve as indicated by the heavy curve with the labor-supply curve as indicated by the heavy curve with the vertical segment that runs through points A F G D and E vertical segment that runs through points A F G D and E Any worker on this vertical segment is constrainedAny worker on this vertical segment is constrained

The Individual Labor-Supply Curve in PracticeThe Individual Labor-Supply Curve in Practice

bull What does the individual labor-supply curve look like in What does the individual labor-supply curve look like in realityreality It is difficult to answer this question because in reality It is difficult to answer this question because in reality we can observe we can observe only one pointonly one point on the labor-supply curve for a on the labor-supply curve for a single worker single worker at a particular timeat a particular time All the other points are All the other points are conjecturesconjectures about what the worker would supply if faced with about what the worker would supply if faced with different wage rates If we imagine that on average workers are different wage rates If we imagine that on average workers are substantially substantially similarsimilar we might nonetheless get some idea of we might nonetheless get some idea of what the individual labor-supply curve might look likewhat the individual labor-supply curve might look like

bull The The National Longitudinal SurveyNational Longitudinal Survey (Youth) has catalogued the (Youth) has catalogued the work histories of a large sample of individuals starting at a work histories of a large sample of individuals starting at a young age The following figure plots the real-wage rates and young age The following figure plots the real-wage rates and average weekly hours of labor for about average weekly hours of labor for about 1000010000 male workers male workers from this survey for a from this survey for a single periodsingle period with the best fitting flexible with the best fitting flexible line through these points serves as our empirical estimate of the line through these points serves as our empirical estimate of the labor-supply curve for these workerslabor-supply curve for these workers

bull The regression line traces out a shape very The regression line traces out a shape very like the backward-like the backward-bendingbending labor-supply curve with a 40-hour constraint What labor-supply curve with a 40-hour constraint What looks like a vertical line above 40 hours is looks like a vertical line above 40 hours is not really a solid line not really a solid line at all but a reflection of the fact that about at all but a reflection of the fact that about 7500 7500 of the 10000 of the 10000 workers in the sample supply 40 hours per week at a variety of workers in the sample supply 40 hours per week at a variety of wage rates The labor-supply curve traces out a segment above wage rates The labor-supply curve traces out a segment above the 40-hour point that corresponds to the constraintthe 40-hour point that corresponds to the constraint

bull There are There are points to the rightpoints to the right of 40 hours This is reasonable of 40 hours This is reasonable since in the real world workers do since in the real world workers do work overtimework overtime ndash either ndash either because they are supervisors or professionals or because because they are supervisors or professionals or because employers offer them the required time-and-half wage rate employers offer them the required time-and-half wage rate The fit of the regression line is far from perfect points lie on The fit of the regression line is far from perfect points lie on both sides of the line We should interpret it as a both sides of the line We should interpret it as a snapshotsnapshot of of the behavior of the typical worker But ofthe behavior of the typical worker But of course the typical course the typical worker is not any actual worker in particularworker is not any actual worker in particular

THE WORKER CHOOSING TO PARTICIPATETHE WORKER CHOOSING TO PARTICIPATE

bull So far we have examined only one aspect of the workerrsquos So far we have examined only one aspect of the workerrsquos labor-supply decision labor-supply decision how many hours to work for given real how many hours to work for given real wagewage We now take up the second aspect We now take up the second aspect participationparticipation ndash that ndash that is is whether or not to work at allwhether or not to work at all A labor-supply curve that starts A labor-supply curve that starts at the origin and slopes upwards for at least a portion of its at the origin and slopes upwards for at least a portion of its length suggests that even length suggests that even if the wage were very lowif the wage were very low ndash say 1cent ndash say 1cent per hour ndash the worker would work a little bit That is clearly per hour ndash the worker would work a little bit That is clearly unrealisticunrealistic no one would work at all for 1cent per hour no one would work at all for 1cent per hour What What factors determine how high the wage factors determine how high the wage must be to induce a person must be to induce a person to participate in the labor marketto participate in the labor market

bull The labor force The labor force participationparticipation decision is a question of decision is a question of opportunity costopportunity cost Idleness has its charms Before anyone enters Idleness has its charms Before anyone enters the labor force the wage rate must be high enough to overcome the labor force the wage rate must be high enough to overcome them them The opportunity cost of participatingThe opportunity cost of participating in the labor force is in the labor force is sum of sum of

1048766 1048766 the implicit valuethe implicit value the worker places on complete idleness the worker places on complete idleness

1048766 1048766 the explicit coststhe explicit costs of working compared to not working such as of working compared to not working such as clothing transport childcare) andclothing transport childcare) and

1048766 1048766 the explicit losses the explicit losses from working (for instance housework not from working (for instance housework not done)done)

bull The opportunity cost is partly psychological and partly material The opportunity cost is partly psychological and partly material If people were completely If people were completely independentindependent of each other the worker of each other the worker might place a lower value on the opportunity cost of might place a lower value on the opportunity cost of participation because then the choice might be literally between participation because then the choice might be literally between work and starvationwork and starvation

bull But most people are not But most people are not completely independentcompletely independent Whether or Whether or not to participate in the labor force could be a not to participate in the labor force could be a genuine choicegenuine choice and would depend on the and would depend on the real wagereal wage

bull The The RESERVATION WAGE RESERVATION WAGE is defined to be is defined to be the opportunity the opportunity cost of working compared to not workingcost of working compared to not working ndash ndash that is the real wage that is the real wage that is high enough to make it just worthwhile for a worker to that is high enough to make it just worthwhile for a worker to participate in the labor forceparticipate in the labor force

bull Taking account of the opportunity costs of participation affects Taking account of the opportunity costs of participation affects the shape of the labor-supply curve As long as the the shape of the labor-supply curve As long as the real wage is real wage is below the reservationbelow the reservation wage ((wp)R) the worker supplies no wage ((wp)R) the worker supplies no labor at all Above the reservation wage there is a normal labor at all Above the reservation wage there is a normal labor-supply curvelabor-supply curve

bull The following captures the two stages of the labor supply The following captures the two stages of the labor supply decision decision FirstFirst at low wages the worker will at low wages the worker will notnot supply any supply any labor at all and small increases in wages have no effect But labor at all and small increases in wages have no effect But secondsecond as soon as the wage rises enough for the worker to bite as soon as the wage rises enough for the worker to bite the bullet and join the labor force the minimum labor supplied the bullet and join the labor force the minimum labor supplied will be well will be well above zeroabove zero and the worker will decide how many and the worker will decide how many hours to supply above this minimum through the usual process hours to supply above this minimum through the usual process of balancing the opportunity cost of leisure against the desire of balancing the opportunity cost of leisure against the desire for consumption goodsfor consumption goods

AGGREGATE LABOR SUPPLY

bull How can we moveHow can we move from the microeconomics of the labor supply from the microeconomics of the labor supply back to an aggregate relationship usable in macroeconomic back to an aggregate relationship usable in macroeconomic analysis analysis If workers were essentially alikeIf workers were essentially alike the problem would the problem would be easy be easy

bull As we have seen labor supply has two dimensions ndash As we have seen labor supply has two dimensions ndash participationparticipation in the labor force and in the labor force and choice of hourschoice of hours of labor of labor Take the participation decision first If all workers were alike Take the participation decision first If all workers were alike except for except for differences in their reservation wagedifferences in their reservation wage then we could then we could rank them from lowest to highest reservation wage The rank them from lowest to highest reservation wage The aggregate labor-supply (participation) curve is strictly aggregate labor-supply (participation) curve is strictly upwardslopingupwardsloping

bull Of course this is too easy Just as we observed in deriving the Of course this is too easy Just as we observed in deriving the aggregate labor demand curve workers are aggregate labor demand curve workers are not all alikenot all alike Once Once again we must interpret the vertical axis as measuring the again we must interpret the vertical axis as measuring the average real wageaverage real wage that at best provides a kind of index for the that at best provides a kind of index for the level of the wage structure level of the wage structure

bull The The problemproblem remains the remains the samesame when we turn to the choice of when we turn to the choice of hourshours Workers are all different and face a structure of wages Workers are all different and face a structure of wages For each worker individually there is a jump from supplying For each worker individually there is a jump from supplying zero to supplying some positive number of hours zero to supplying some positive number of hours when his own when his own wage rate surpasses their wage rate surpasses their reservation wagereservation wage But in aggregate But in aggregate we are we are unlikely to see such a jumpunlikely to see such a jump Not only are there a variety Not only are there a variety of wages offered at any time but reservation wages differof wages offered at any time but reservation wages differ

Derivation of the Aggregate Labor-supply Curve

bull A curve like the one in this figure can be used to display either A curve like the one in this figure can be used to display either the the participation participation decision or decision or the hoursthe hours The horizontal axis can The horizontal axis can either be used for workers either be used for workers or worker-hoursor worker-hours as measures of the as measures of the labor supply The two meanings are not completely labor supply The two meanings are not completely independent by definition independent by definition

bull workers equiv aggregate worker ndash hours average hours per worker workers equiv aggregate worker ndash hours average hours per worker

The Participation Rate and Average Hours

bull Let us look first at the aggregate participation decision The Let us look first at the aggregate participation decision The aggregate number of workers who have decided to participate aggregate number of workers who have decided to participate is known as the is known as the labor forcelabor force the the civilian labor force over 16 civilian labor force over 16 years of ageyears of age This number excludes uniformed members of the This number excludes uniformed members of the armed services and the small number of workers under 16 armed services and the small number of workers under 16 years old The labor force of course has grown right along years old The labor force of course has grown right along with population with population

bull The participation rateThe participation rate (PR) measures (PR) measures the labor force as its ratio the labor force as its ratio to the relevant populationto the relevant population

bull participation rate = labor forcerelevant population participation rate = labor forcerelevant population

bull ldquoldquonon-institutionalrdquo non-institutionalrdquo excludes people in prison or in homes for excludes people in prison or in homes for the aged) the aged)

bull The aggregate number of hours The aggregate number of hours worked is worked is not as easy not as easy as the as the participation rate to relate to the individual workerrsquos choices participation rate to relate to the individual workerrsquos choices If every worker had the same labor-supply curve we would If every worker had the same labor-supply curve we would have to know the wage offered to each one in order to calculate have to know the wage offered to each one in order to calculate the total number of labor hours supplied In reality workers the total number of labor hours supplied In reality workers are not all alike are not all alike Labor-supply curves may vary systematically Labor-supply curves may vary systematically according to the sex age ethnic group education experience according to the sex age ethnic group education experience or other social or economic characteristics of the workersor other social or economic characteristics of the workers And And within any group the labor-supply curves of individuals are within any group the labor-supply curves of individuals are likely to varylikely to vary

bull In principle In principle if we had a good statistical estimate of the typical if we had a good statistical estimate of the typical distribution of the wagesdistribution of the wages we could make a reasonable we could make a reasonable calculation But statisticians at the Bureau of Labor Statistics calculation But statisticians at the Bureau of Labor Statistics (BLS) do not try to calculate the labor supply in this way (BLS) do not try to calculate the labor supply in this way Instead they Instead they count the number of hours that workers actually count the number of hours that workers actually workwork and the average and the average wages and salaries they are paid wages and salaries they are paid

bull In USA the total hours of labor in 1998 was In USA the total hours of labor in 1998 was 236882236882 million million The average hours of work is The average hours of work is 17211721 hours per year = hours per year = 344344 hours hours per week (assuming a 50 week year) This number is 14 percent per week (assuming a 50 week year) This number is 14 percent below the full time 40-hour week which makes sense since it below the full time 40-hour week which makes sense since it averages over full-time part-time and overtime workers averages over full-time part-time and overtime workers

Labor Market EquilibriumLabor Market Equilibrium

bull MARKET CLEARINGMARKET CLEARING

bull When both demand and supply curves are plotted on the same When both demand and supply curves are plotted on the same diagram the crossing point defines the diagram the crossing point defines the equilibrium real-wage equilibrium real-wage rate and the rate and the equilibrium level of labor employedequilibrium level of labor employed

bull The real wage The real wage looks different looks different from the point of view of the firm from the point of view of the firm and the worker For the and the worker For the firmfirm the relevant real wage is the the relevant real wage is the product-real wage product-real wage defined as defined as the number of units of the good the number of units of the good the firm produces that the wage will purchase the firm produces that the wage will purchase ((price of price of productproduct = = w) w) For the For the workerworker the relevant real wage is the the relevant real wage is the consumption-consumption-real real wagewage defined as defined as the number of typical consumption baskets the number of typical consumption baskets that the wage will purchase that the wage will purchase ((price of price of consumption basket consumption basket = = w)w)

bull For aggregate analysis we might use the For aggregate analysis we might use the Producer Price IndexProducer Price Index or the GDP deflator to approximate the or the GDP deflator to approximate the product priceproduct price and the and the CPICPI to approximate the to approximate the consumption price consumption price

bull Suppose that the product-real wage and the consumption-real Suppose that the product-real wage and the consumption-real wage in the following figure start out with the identical value wage in the following figure start out with the identical value ((wp) at the market-clearing point Awp) at the market-clearing point A Now suppose that Now suppose that imported Japanese cars are a large portion of the typical imported Japanese cars are a large portion of the typical workerrsquos consumption basket workerrsquos consumption basket and that and that ceteris paribus ceteris paribus the price the price of Japanese cars rises sharply This means that the of Japanese cars rises sharply This means that the real wage real wage from the point of view of the from the point of view of the consumer falls to (consumer falls to (wpwpCPICPI ) )11 at point at point

B B on the labor-supply curve (LS) so that the worker would on the labor-supply curve (LS) so that the worker would want to supply less labor (want to supply less labor (LL11))

bull The rise in the price of Japanese cars has no effect on the price The rise in the price of Japanese cars has no effect on the price of their products Nevertheless they see a reduction of labor of their products Nevertheless they see a reduction of labor supply at the original market clearing wage It is as if the supply at the original market clearing wage It is as if the labor-supply curve labor-supply curve has shifted to the left to has shifted to the left to LSLSrsquo which passes rsquo which passes through ((through ((wp) L1) at point C wp) L1) at point C At the original wage rate labor At the original wage rate labor demand exceeds labor supply so firms raise wages in an effort demand exceeds labor supply so firms raise wages in an effort to attract workers until they reach the new market-clearing to attract workers until they reach the new market-clearing wage at point D where they pay (wage at point D where they pay (wpwpPPIPPI ) for labor of L ) for labor of L The The

rise in the price of Japanese cars has the effect of raising the rise in the price of Japanese cars has the effect of raising the wages that firms must pay and reducing labor employedwages that firms must pay and reducing labor employed Higher wages partly compensate workers for the higher costs Higher wages partly compensate workers for the higher costs of consumption but firms can afford to pay those higher wages of consumption but firms can afford to pay those higher wages only if marginal products rise as a result of their using less only if marginal products rise as a result of their using less labor labor

bull The rise in wage rates is not enough to compensate workers The rise in wage rates is not enough to compensate workers fully so the consumption-real wage in equilibrium is (wpfully so the consumption-real wage in equilibrium is (wpCPI CPI ) )

atat point E We can think of import prices as a tax levied on point E We can think of import prices as a tax levied on consumers and of an increase in import prices as widening the consumers and of an increase in import prices as widening the tax wedge Unless the issue that we want to analyze depends on tax wedge Unless the issue that we want to analyze depends on the difference between product- and consumption-real wages the difference between product- and consumption-real wages we will treat the real wage as the same for both labor supply we will treat the real wage as the same for both labor supply and labor demandand labor demand

An Increase in the Price of Consumption GoodsAn Increase in the Price of Consumption GoodsRelative to the Price of OutputRelative to the Price of Output

ANALYZING IDEAL LABOR MARKETSANALYZING IDEAL LABOR MARKETS

bull The aggregate labor-supplylabor-demand diagram provides us The aggregate labor-supplylabor-demand diagram provides us with a powerful tool We now analyze three important with a powerful tool We now analyze three important macroeconomic issues macroeconomic issues

(1) the effect of tax cuts on employment (1) the effect of tax cuts on employment

(2) the effect of technological progress on the well-being of (2) the effect of technological progress on the well-being of workers and workers and

(3) the effect of immigration on existing workers (3) the effect of immigration on existing workers

bull Issue 1 Tax Cuts Issue 1 Tax Cuts What are the effects of a cut in marginal What are the effects of a cut in marginal income-tax rates on employment and the level of GDP in the income-tax rates on employment and the level of GDP in the economyeconomy Recall from section that a lower marginal income-Recall from section that a lower marginal income-tax rate increases labor supply at each real wage (a rightward tax rate increases labor supply at each real wage (a rightward shift of the labor-supply) shift of the labor-supply)

bull Labor-market equilibrium moves from point A to point B in Labor-market equilibrium moves from point A to point B in the lower panel of the following Notice that the amount of the lower panel of the following Notice that the amount of labor available to firms increases so that firms move labor available to firms increases so that firms move production from Arsquo to Brsquo on the labor production function in production from Arsquo to Brsquo on the labor production function in the upper panel Also notice that the real wage falls from (the upper panel Also notice that the real wage falls from (wp)1 wp)1 to (wp)2 Since the cut in taxes increases the number of to (wp)2 Since the cut in taxes increases the number of workers workers willing to work at each wage Workers care about their take-willing to work at each wage Workers care about their take-home pay ndash that is about their home pay ndash that is about their after-tax real wage after-tax real wage This is This is perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 can be greater than the old after-tax real wage (1ndashcan be greater than the old after-tax real wage (1ndashτ1τ1)(wp)1 so )(wp)1 so long as the rise in the take-home share (1 ndash τ) is long as the rise in the take-home share (1 ndash τ) is proportionately greater than the fall in the before-tax real proportionately greater than the fall in the before-tax real wage (wp)wage (wp)

bull The analysis depends on substitution effects dominating The analysis depends on substitution effects dominating income effects which they probably do in aggregate if not for income effects which they probably do in aggregate if not for every worker So the supply-siders of the Reagan years are every worker So the supply-siders of the Reagan years are correct in principle How much output will increase depends on correct in principle How much output will increase depends on how large the substitution effect is If most people work a how large the substitution effect is If most people work a standard 40-hour week the effect could be quite small and the standard 40-hour week the effect could be quite small and the increase in output might also be very small in practiceincrease in output might also be very small in practice

Issue 1 The Effect of a Cut in Marginal Tax RatesIssue 1 The Effect of a Cut in Marginal Tax Rates

Issue 2 Technological Progress and Worker WelfareIssue 2 Technological Progress and Worker Welfare

bull Is technological progress and increasing use of machinery and Is technological progress and increasing use of machinery and other capital beneficial for workersother capital beneficial for workers

bull Technological change or capital accumulation have been Technological change or capital accumulation have been known as ldquoLudditesrdquo (known as ldquoLudditesrdquo (it negatively affects the demand for it negatively affects the demand for laborlabor) To see why the Luddites are wrong ndash at least for ) To see why the Luddites are wrong ndash at least for clearing labor markets ndash recall that technological progress or clearing labor markets ndash recall that technological progress or increased capital both increased capital both shift the labor-demand curve upwardshift the labor-demand curve upward The lower panel of the following figure shows that the effect of The lower panel of the following figure shows that the effect of the increased demand for labor is to increase total employment the increased demand for labor is to increase total employment and the real wage Firms and the real wage Firms can pay a higher real wage can pay a higher real wage because because the additional capital or technological progress the additional capital or technological progress increases the increases the marginal product of labormarginal product of labor

bull The The Ludditesrsquo mistake Ludditesrsquo mistake is most easily seen in the upper panel is most easily seen in the upper panel The Luddite argument assumes that fewer workers will The Luddite argument assumes that fewer workers will produce the same total output Production starts at Arsquo using produce the same total output Production starts at Arsquo using L1 L1 workers to produce Y1 After the upward shift in the production workers to produce Y1 After the upward shift in the production function the same output could be produced using less labor function the same output could be produced using less labor ((L3) at point Arsquorsquo The L3) at point Arsquorsquo The problem is that Arsquorsquo is not an equilibrium problem is that Arsquorsquo is not an equilibrium At that point the marginal product of labor is higher than the At that point the marginal product of labor is higher than the original real wage so a profit-maximizing firm would want to original real wage so a profit-maximizing firm would want to expand production To do this they must hire more labor than expand production To do this they must hire more labor than L3 and indeed they L3 and indeed they find it find it profitable profitable to hire more labor than to hire more labor than the original the original L1 The only way actually to increase labor L1 The only way actually to increase labor is to is to raise the real-wage raise the real-wage rate above its original level Technological rate above its original level Technological progress therefore favors progress therefore favors workers by increasing employment workers by increasing employment and wagesand wages

bull Early in the 19th century hand-woven cloth was very Early in the 19th century hand-woven cloth was very expensive and a worker was lucky to own the clothes on his expensive and a worker was lucky to own the clothes on his back and a spare set for church on Sunday Textiles were one of back and a spare set for church on Sunday Textiles were one of the first industries to benefit from the Industrial Revolution so the first industries to benefit from the Industrial Revolution so that by the end of the 19th century machine-made fabrics and that by the end of the 19th century machine-made fabrics and mass-production made decent clothing in larger quantities mass-production made decent clothing in larger quantities accessible to most of the population of the more developed accessible to most of the population of the more developed countries Similar progress has been made in most forms of countries Similar progress has been made in most forms of production Agricultural production which at the turn of the production Agricultural production which at the turn of the 20th century absorbed half the labor force now absorbs less 20th century absorbed half the labor force now absorbs less than 3 percent while producing more food more cheaply than than 3 percent while producing more food more cheaply than ever ever

bull We must be careful not to dismiss the Luddites as altogether We must be careful not to dismiss the Luddites as altogether foolish While new technology especially over decades has foolish While new technology especially over decades has proved to be a net gain for workers in general the Luddites proved to be a net gain for workers in general the Luddites were in fact correct that their way of life was threatened were in fact correct that their way of life was threatened Independent weavers became factory hands unskilled Independent weavers became factory hands unskilled workers increasingly women and often children replaced workers increasingly women and often children replaced skilled craftsmen and factory work often involved long hours skilled craftsmen and factory work often involved long hours in brutal conditions The wider society reaps the benefits of in brutal conditions The wider society reaps the benefits of technological change while a narrow group sometimes technological change while a narrow group sometimes disproportionately bears its costs Our analysis also assumes disproportionately bears its costs Our analysis also assumes that markets generally clear The implicit assumption is that that markets generally clear The implicit assumption is that displaced workers move on to new jobs possibly in other forms displaced workers move on to new jobs possibly in other forms of production Markets may have a tendency to clear in the of production Markets may have a tendency to clear in the long run yet workers may find themselves displaced in the long run yet workers may find themselves displaced in the short run say over the course of a business cycleshort run say over the course of a business cycle

Issue 3 Immigration Jobs and Real WagesIssue 3 Immigration Jobs and Real Wages

bull How does an increase in the labor force through immigration or How does an increase in the labor force through immigration or natural population growth affect labor and GDP natural population growth affect labor and GDP

bull One of the emotional issues associated with US immigration One of the emotional issues associated with US immigration policy ndash particularly towards low-wage workers from Mexico ndash policy ndash particularly towards low-wage workers from Mexico ndash is the idea that is the idea that immigrants take jobs away from native immigrants take jobs away from native workers workers We might be tempted to dismiss this fear as another We might be tempted to dismiss this fear as another example of the lump-of-labor fallacy Yet there is a sensible example of the lump-of-labor fallacy Yet there is a sensible intuition behind the argument An increase in the labor force ndash intuition behind the argument An increase in the labor force ndash due either to immigration or to higher population growth rates due either to immigration or to higher population growth rates ndash can be represented as an outward shift of the aggregate labor ndash can be represented as an outward shift of the aggregate labor supply curve as shown in the following Figure Employment supply curve as shown in the following Figure Employment increases but real wages fall It is not then that immigrants increases but real wages fall It is not then that immigrants take jobs away from natives take jobs away from natives Rather they compete for jobsRather they compete for jobs putting downward pressure on real wagesputting downward pressure on real wages

bull Again we must exercise care in interpreting the analysis Again we must exercise care in interpreting the analysis Remember that aggregate labor and average wage rates hide Remember that aggregate labor and average wage rates hide many details of the labor process The incomes of the new many details of the labor process The incomes of the new immigrants immigrants creates demand creates demand for the new production that they for the new production that they make possible Immigrant workers (at least those ndash whether make possible Immigrant workers (at least those ndash whether legal or illegal ndash who have become the focus of the most intense legal or illegal ndash who have become the focus of the most intense political debate) political debate) are likely to possess fewer skills than nativesare likely to possess fewer skills than natives The net effect is that the increased demand for goods and The net effect is that the increased demand for goods and services generated by immigrants is likely to increase the services generated by immigrants is likely to increase the demand for skilled (demand for skilled (and largely nativeand largely native) workers relative to ) workers relative to their supply and so to increase real wages of skilled workers their supply and so to increase real wages of skilled workers Low-skilled immigration may lower the real wage for farm Low-skilled immigration may lower the real wage for farm workers but if anything it would raise the real wage for workers but if anything it would raise the real wage for computer programmerscomputer programmers

Next Task Labor Market in Kuwait

Appendix Is Labor Supply Stable Over Time

bull Statistics on participation rates or average hours for a Statistics on participation rates or average hours for a particular month or year are snapshot of the labor market particular month or year are snapshot of the labor market Can we analyze the effects of that increase on the labor market Can we analyze the effects of that increase on the labor market under the assumption that the labor-supply curves of workers under the assumption that the labor-supply curves of workers remain essentially stableremain essentially stable

bull Data on participation rates in the United States appear to Data on participation rates in the United States appear to support this conjecture (see Figure 811) which shows the support this conjecture (see Figure 811) which shows the overall civilian participation rate trending upward ndash at least overall civilian participation rate trending upward ndash at least from the middle of the 1960sfrom the middle of the 1960s

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

bull The net effect The net effect is measured by the difference between the is measured by the difference between the substitution and income effects shown at point B so that an substitution and income effects shown at point B so that an increase in the wage rate increases the workerrsquos supply of labor increase in the wage rate increases the workerrsquos supply of labor to to l2 to the right of l1 If the substitution effect is always stronger l2 to the right of l1 If the substitution effect is always stronger then the labor supply then the labor supply curve slopes upward curve slopes upward

bull Substitution effects are not necessarily stronger than income Substitution effects are not necessarily stronger than income effectseffects Panel (B) shows the construction of the labor-supply Panel (B) shows the construction of the labor-supply curve starting from point C when income effects are stronger curve starting from point C when income effects are stronger than substitution effects When the real-wage rate increases than substitution effects When the real-wage rate increases from (from (wp)1 to (wp)2 the dominant income effect overwhelms wp)1 to (wp)2 the dominant income effect overwhelms the substitution effect and labor the substitution effect and labor supply (point C) falls from supply (point C) falls from l1 to l1 to l2 If income effects are stronger for all wage rates above l2 If income effects are stronger for all wage rates above ((wp)1 wp)1 then the labor-supply curve will slope downward toward point C then the labor-supply curve will slope downward toward point C higher real wage higher real wage rates lower labor supplyrates lower labor supply

bull Although the labor-supply curve can slope downward towards Although the labor-supply curve can slope downward towards a point like A it is not reasonable to believe that it could slope a point like A it is not reasonable to believe that it could slope downward for every possible wage rate At very low wage rates downward for every possible wage rate At very low wage rates it is more reasonable to suppose that with very low incomes it is more reasonable to suppose that with very low incomes the workerrsquos need for food clothing shelter and other the workerrsquos need for food clothing shelter and other ldquoessentialrdquo goods the income effect is weak and the ldquoessentialrdquo goods the income effect is weak and the substitution effect is strong We should therefore expect the substitution effect is strong We should therefore expect the labor-supply curve to be upward sloping when wage rates are labor-supply curve to be upward sloping when wage rates are low Hence labor supply would be backward bending low Hence labor supply would be backward bending

Backward-bending Labor-supply Curve

Adding Realism TaxesAdding Realism Taxes

bull How does the tax affect the income from a little more or a little How does the tax affect the income from a little more or a little less work To answer this question we must know the less work To answer this question we must know the marginal marginal tax ratetax rate ((the fraction of an additional dollar of income that is the fraction of an additional dollar of income that is paid as taxes) paid as taxes) To keep things simple assume that all income is To keep things simple assume that all income is taxed at the same taxed at the same flatflat rate rate ττ In this case the marginal tax rate In this case the marginal tax rate must also be τ which takes a value between zero and one If a must also be τ which takes a value between zero and one If a worker earns worker earns wpwp for an hour of work the government takes for an hour of work the government takes τ(wp) τ(wp) as taxes and leaves the worker as taxes and leaves the worker (1ndashτ)(wp) (1ndashτ)(wp) as the after-as the after-tax real wagetax real wage

bull Since the worker actually receives the Since the worker actually receives the after-tax real wageafter-tax real wage it is it is the the true opportunity cost of leisure true opportunity cost of leisure Any increase in the Any increase in the marginal tax rate represents a decrease in the opportunity cost marginal tax rate represents a decrease in the opportunity cost of leisure If of leisure If substitution effectssubstitution effects are stronger than income are stronger than income effects then any increase in marginal tax rates effects then any increase in marginal tax rates reducesreduces the the supply of labor supply of labor as shown in the following figureas shown in the following figure

The Effect of a Tax Increase on Labor Supply

bull The labor-supply curve with no taxes is shown on the right of The labor-supply curve with no taxes is shown on the right of the figure At the figure At (wp)1(wp)1 the worker supplies labor the worker supplies labor l1l1 If a tax of If a tax of τ1τ1 is imposed the after-tax real wage is is imposed the after-tax real wage is (1ndashτ1)(wp)1(1ndashτ1)(wp)1 The worker The worker should react exactly as if he paid no taxes but suffered a cut in should react exactly as if he paid no taxes but suffered a cut in his wages This is shown as a movement from point A to point B his wages This is shown as a movement from point A to point B where labor supply has fallen to where labor supply has fallen to l2l2 But of course the wage rate But of course the wage rate did not really falldid not really fall the employer still pays (wp)1 This means the employer still pays (wp)1 This means that (l2 (wp)1) is the labor-supply (point C)that (l2 (wp)1) is the labor-supply (point C)

bull Since this would apply for any real-wage rate every point on Since this would apply for any real-wage rate every point on the original curve shifts to the left Because the the original curve shifts to the left Because the tax rate is tax rate is proportional its absolute effect is greaterproportional its absolute effect is greater as is the shift in the as is the shift in the labor-supply curve at high wage rates resulting in a labor-supply curve at high wage rates resulting in a steepening of the curve Any further increase in the tax rate to steepening of the curve Any further increase in the tax rate to say τ2 would shift the labor-supply curve further to the left say τ2 would shift the labor-supply curve further to the left

bull The length of the line segment BC measures the The length of the line segment BC measures the TAX WEDGETAX WEDGE between the real wage paid by employers and the after-tax real between the real wage paid by employers and the after-tax real wage received by workewage received by workersrs The The largerlarger the tax wedge the the tax wedge the largerlarger the leftward shift of the labor-supply curve and the the leftward shift of the labor-supply curve and the greater the greater the reductionreduction in labor supplied at any real wage in labor supplied at any real wage

bull The idea that tax increases lower labor supply and conversely The idea that tax increases lower labor supply and conversely that tax cuts increase labor supply was a major tenet of the so-that tax cuts increase labor supply was a major tenet of the so-called called supply-side economicssupply-side economics popular in the early 1980s popular in the early 1980s President Ronald Reagan and his advisors used it to argue that President Ronald Reagan and his advisors used it to argue that cuts in marginal tax rates cuts in marginal tax rates would stimulate people would stimulate people to to workwork harder and to harder and to earn larger earn larger incomesincomes

Adding Realism A Standard WorkweekAdding Realism A Standard Workweek

bull Another way in which the simple analysis of labor supply is Another way in which the simple analysis of labor supply is unrealistic is that many unrealistic is that many workers are not given an option about workers are not given an option about the number of hours they workthe number of hours they work Although people work part- Although people work part-time and overtime either may be voluntary or mandatory time and overtime either may be voluntary or mandatory

bull Assuming that workers are Assuming that workers are not permitted to work more than not permitted to work more than 40 hours a week40 hours a week the following figure includes a constraint of the following figure includes a constraint of 40 hours If the worker were permitted to choose freely then 40 hours If the worker were permitted to choose freely then the labor-supply curve would backward bending curve The the labor-supply curve would backward bending curve The overall effect is to of the standard work week is to reshape the overall effect is to of the standard work week is to reshape the labor-supply curve as indicated by the heavy curve with the labor-supply curve as indicated by the heavy curve with the vertical segment that runs through points A F G D and E vertical segment that runs through points A F G D and E Any worker on this vertical segment is constrainedAny worker on this vertical segment is constrained

The Individual Labor-Supply Curve in PracticeThe Individual Labor-Supply Curve in Practice

bull What does the individual labor-supply curve look like in What does the individual labor-supply curve look like in realityreality It is difficult to answer this question because in reality It is difficult to answer this question because in reality we can observe we can observe only one pointonly one point on the labor-supply curve for a on the labor-supply curve for a single worker single worker at a particular timeat a particular time All the other points are All the other points are conjecturesconjectures about what the worker would supply if faced with about what the worker would supply if faced with different wage rates If we imagine that on average workers are different wage rates If we imagine that on average workers are substantially substantially similarsimilar we might nonetheless get some idea of we might nonetheless get some idea of what the individual labor-supply curve might look likewhat the individual labor-supply curve might look like

bull The The National Longitudinal SurveyNational Longitudinal Survey (Youth) has catalogued the (Youth) has catalogued the work histories of a large sample of individuals starting at a work histories of a large sample of individuals starting at a young age The following figure plots the real-wage rates and young age The following figure plots the real-wage rates and average weekly hours of labor for about average weekly hours of labor for about 1000010000 male workers male workers from this survey for a from this survey for a single periodsingle period with the best fitting flexible with the best fitting flexible line through these points serves as our empirical estimate of the line through these points serves as our empirical estimate of the labor-supply curve for these workerslabor-supply curve for these workers

bull The regression line traces out a shape very The regression line traces out a shape very like the backward-like the backward-bendingbending labor-supply curve with a 40-hour constraint What labor-supply curve with a 40-hour constraint What looks like a vertical line above 40 hours is looks like a vertical line above 40 hours is not really a solid line not really a solid line at all but a reflection of the fact that about at all but a reflection of the fact that about 7500 7500 of the 10000 of the 10000 workers in the sample supply 40 hours per week at a variety of workers in the sample supply 40 hours per week at a variety of wage rates The labor-supply curve traces out a segment above wage rates The labor-supply curve traces out a segment above the 40-hour point that corresponds to the constraintthe 40-hour point that corresponds to the constraint

bull There are There are points to the rightpoints to the right of 40 hours This is reasonable of 40 hours This is reasonable since in the real world workers do since in the real world workers do work overtimework overtime ndash either ndash either because they are supervisors or professionals or because because they are supervisors or professionals or because employers offer them the required time-and-half wage rate employers offer them the required time-and-half wage rate The fit of the regression line is far from perfect points lie on The fit of the regression line is far from perfect points lie on both sides of the line We should interpret it as a both sides of the line We should interpret it as a snapshotsnapshot of of the behavior of the typical worker But ofthe behavior of the typical worker But of course the typical course the typical worker is not any actual worker in particularworker is not any actual worker in particular

THE WORKER CHOOSING TO PARTICIPATETHE WORKER CHOOSING TO PARTICIPATE

bull So far we have examined only one aspect of the workerrsquos So far we have examined only one aspect of the workerrsquos labor-supply decision labor-supply decision how many hours to work for given real how many hours to work for given real wagewage We now take up the second aspect We now take up the second aspect participationparticipation ndash that ndash that is is whether or not to work at allwhether or not to work at all A labor-supply curve that starts A labor-supply curve that starts at the origin and slopes upwards for at least a portion of its at the origin and slopes upwards for at least a portion of its length suggests that even length suggests that even if the wage were very lowif the wage were very low ndash say 1cent ndash say 1cent per hour ndash the worker would work a little bit That is clearly per hour ndash the worker would work a little bit That is clearly unrealisticunrealistic no one would work at all for 1cent per hour no one would work at all for 1cent per hour What What factors determine how high the wage factors determine how high the wage must be to induce a person must be to induce a person to participate in the labor marketto participate in the labor market

bull The labor force The labor force participationparticipation decision is a question of decision is a question of opportunity costopportunity cost Idleness has its charms Before anyone enters Idleness has its charms Before anyone enters the labor force the wage rate must be high enough to overcome the labor force the wage rate must be high enough to overcome them them The opportunity cost of participatingThe opportunity cost of participating in the labor force is in the labor force is sum of sum of

1048766 1048766 the implicit valuethe implicit value the worker places on complete idleness the worker places on complete idleness

1048766 1048766 the explicit coststhe explicit costs of working compared to not working such as of working compared to not working such as clothing transport childcare) andclothing transport childcare) and

1048766 1048766 the explicit losses the explicit losses from working (for instance housework not from working (for instance housework not done)done)

bull The opportunity cost is partly psychological and partly material The opportunity cost is partly psychological and partly material If people were completely If people were completely independentindependent of each other the worker of each other the worker might place a lower value on the opportunity cost of might place a lower value on the opportunity cost of participation because then the choice might be literally between participation because then the choice might be literally between work and starvationwork and starvation

bull But most people are not But most people are not completely independentcompletely independent Whether or Whether or not to participate in the labor force could be a not to participate in the labor force could be a genuine choicegenuine choice and would depend on the and would depend on the real wagereal wage

bull The The RESERVATION WAGE RESERVATION WAGE is defined to be is defined to be the opportunity the opportunity cost of working compared to not workingcost of working compared to not working ndash ndash that is the real wage that is the real wage that is high enough to make it just worthwhile for a worker to that is high enough to make it just worthwhile for a worker to participate in the labor forceparticipate in the labor force

bull Taking account of the opportunity costs of participation affects Taking account of the opportunity costs of participation affects the shape of the labor-supply curve As long as the the shape of the labor-supply curve As long as the real wage is real wage is below the reservationbelow the reservation wage ((wp)R) the worker supplies no wage ((wp)R) the worker supplies no labor at all Above the reservation wage there is a normal labor at all Above the reservation wage there is a normal labor-supply curvelabor-supply curve

bull The following captures the two stages of the labor supply The following captures the two stages of the labor supply decision decision FirstFirst at low wages the worker will at low wages the worker will notnot supply any supply any labor at all and small increases in wages have no effect But labor at all and small increases in wages have no effect But secondsecond as soon as the wage rises enough for the worker to bite as soon as the wage rises enough for the worker to bite the bullet and join the labor force the minimum labor supplied the bullet and join the labor force the minimum labor supplied will be well will be well above zeroabove zero and the worker will decide how many and the worker will decide how many hours to supply above this minimum through the usual process hours to supply above this minimum through the usual process of balancing the opportunity cost of leisure against the desire of balancing the opportunity cost of leisure against the desire for consumption goodsfor consumption goods

AGGREGATE LABOR SUPPLY

bull How can we moveHow can we move from the microeconomics of the labor supply from the microeconomics of the labor supply back to an aggregate relationship usable in macroeconomic back to an aggregate relationship usable in macroeconomic analysis analysis If workers were essentially alikeIf workers were essentially alike the problem would the problem would be easy be easy

bull As we have seen labor supply has two dimensions ndash As we have seen labor supply has two dimensions ndash participationparticipation in the labor force and in the labor force and choice of hourschoice of hours of labor of labor Take the participation decision first If all workers were alike Take the participation decision first If all workers were alike except for except for differences in their reservation wagedifferences in their reservation wage then we could then we could rank them from lowest to highest reservation wage The rank them from lowest to highest reservation wage The aggregate labor-supply (participation) curve is strictly aggregate labor-supply (participation) curve is strictly upwardslopingupwardsloping

bull Of course this is too easy Just as we observed in deriving the Of course this is too easy Just as we observed in deriving the aggregate labor demand curve workers are aggregate labor demand curve workers are not all alikenot all alike Once Once again we must interpret the vertical axis as measuring the again we must interpret the vertical axis as measuring the average real wageaverage real wage that at best provides a kind of index for the that at best provides a kind of index for the level of the wage structure level of the wage structure

bull The The problemproblem remains the remains the samesame when we turn to the choice of when we turn to the choice of hourshours Workers are all different and face a structure of wages Workers are all different and face a structure of wages For each worker individually there is a jump from supplying For each worker individually there is a jump from supplying zero to supplying some positive number of hours zero to supplying some positive number of hours when his own when his own wage rate surpasses their wage rate surpasses their reservation wagereservation wage But in aggregate But in aggregate we are we are unlikely to see such a jumpunlikely to see such a jump Not only are there a variety Not only are there a variety of wages offered at any time but reservation wages differof wages offered at any time but reservation wages differ

Derivation of the Aggregate Labor-supply Curve

bull A curve like the one in this figure can be used to display either A curve like the one in this figure can be used to display either the the participation participation decision or decision or the hoursthe hours The horizontal axis can The horizontal axis can either be used for workers either be used for workers or worker-hoursor worker-hours as measures of the as measures of the labor supply The two meanings are not completely labor supply The two meanings are not completely independent by definition independent by definition

bull workers equiv aggregate worker ndash hours average hours per worker workers equiv aggregate worker ndash hours average hours per worker

The Participation Rate and Average Hours

bull Let us look first at the aggregate participation decision The Let us look first at the aggregate participation decision The aggregate number of workers who have decided to participate aggregate number of workers who have decided to participate is known as the is known as the labor forcelabor force the the civilian labor force over 16 civilian labor force over 16 years of ageyears of age This number excludes uniformed members of the This number excludes uniformed members of the armed services and the small number of workers under 16 armed services and the small number of workers under 16 years old The labor force of course has grown right along years old The labor force of course has grown right along with population with population

bull The participation rateThe participation rate (PR) measures (PR) measures the labor force as its ratio the labor force as its ratio to the relevant populationto the relevant population

bull participation rate = labor forcerelevant population participation rate = labor forcerelevant population

bull ldquoldquonon-institutionalrdquo non-institutionalrdquo excludes people in prison or in homes for excludes people in prison or in homes for the aged) the aged)

bull The aggregate number of hours The aggregate number of hours worked is worked is not as easy not as easy as the as the participation rate to relate to the individual workerrsquos choices participation rate to relate to the individual workerrsquos choices If every worker had the same labor-supply curve we would If every worker had the same labor-supply curve we would have to know the wage offered to each one in order to calculate have to know the wage offered to each one in order to calculate the total number of labor hours supplied In reality workers the total number of labor hours supplied In reality workers are not all alike are not all alike Labor-supply curves may vary systematically Labor-supply curves may vary systematically according to the sex age ethnic group education experience according to the sex age ethnic group education experience or other social or economic characteristics of the workersor other social or economic characteristics of the workers And And within any group the labor-supply curves of individuals are within any group the labor-supply curves of individuals are likely to varylikely to vary

bull In principle In principle if we had a good statistical estimate of the typical if we had a good statistical estimate of the typical distribution of the wagesdistribution of the wages we could make a reasonable we could make a reasonable calculation But statisticians at the Bureau of Labor Statistics calculation But statisticians at the Bureau of Labor Statistics (BLS) do not try to calculate the labor supply in this way (BLS) do not try to calculate the labor supply in this way Instead they Instead they count the number of hours that workers actually count the number of hours that workers actually workwork and the average and the average wages and salaries they are paid wages and salaries they are paid

bull In USA the total hours of labor in 1998 was In USA the total hours of labor in 1998 was 236882236882 million million The average hours of work is The average hours of work is 17211721 hours per year = hours per year = 344344 hours hours per week (assuming a 50 week year) This number is 14 percent per week (assuming a 50 week year) This number is 14 percent below the full time 40-hour week which makes sense since it below the full time 40-hour week which makes sense since it averages over full-time part-time and overtime workers averages over full-time part-time and overtime workers

Labor Market EquilibriumLabor Market Equilibrium

bull MARKET CLEARINGMARKET CLEARING

bull When both demand and supply curves are plotted on the same When both demand and supply curves are plotted on the same diagram the crossing point defines the diagram the crossing point defines the equilibrium real-wage equilibrium real-wage rate and the rate and the equilibrium level of labor employedequilibrium level of labor employed

bull The real wage The real wage looks different looks different from the point of view of the firm from the point of view of the firm and the worker For the and the worker For the firmfirm the relevant real wage is the the relevant real wage is the product-real wage product-real wage defined as defined as the number of units of the good the number of units of the good the firm produces that the wage will purchase the firm produces that the wage will purchase ((price of price of productproduct = = w) w) For the For the workerworker the relevant real wage is the the relevant real wage is the consumption-consumption-real real wagewage defined as defined as the number of typical consumption baskets the number of typical consumption baskets that the wage will purchase that the wage will purchase ((price of price of consumption basket consumption basket = = w)w)

bull For aggregate analysis we might use the For aggregate analysis we might use the Producer Price IndexProducer Price Index or the GDP deflator to approximate the or the GDP deflator to approximate the product priceproduct price and the and the CPICPI to approximate the to approximate the consumption price consumption price

bull Suppose that the product-real wage and the consumption-real Suppose that the product-real wage and the consumption-real wage in the following figure start out with the identical value wage in the following figure start out with the identical value ((wp) at the market-clearing point Awp) at the market-clearing point A Now suppose that Now suppose that imported Japanese cars are a large portion of the typical imported Japanese cars are a large portion of the typical workerrsquos consumption basket workerrsquos consumption basket and that and that ceteris paribus ceteris paribus the price the price of Japanese cars rises sharply This means that the of Japanese cars rises sharply This means that the real wage real wage from the point of view of the from the point of view of the consumer falls to (consumer falls to (wpwpCPICPI ) )11 at point at point

B B on the labor-supply curve (LS) so that the worker would on the labor-supply curve (LS) so that the worker would want to supply less labor (want to supply less labor (LL11))

bull The rise in the price of Japanese cars has no effect on the price The rise in the price of Japanese cars has no effect on the price of their products Nevertheless they see a reduction of labor of their products Nevertheless they see a reduction of labor supply at the original market clearing wage It is as if the supply at the original market clearing wage It is as if the labor-supply curve labor-supply curve has shifted to the left to has shifted to the left to LSLSrsquo which passes rsquo which passes through ((through ((wp) L1) at point C wp) L1) at point C At the original wage rate labor At the original wage rate labor demand exceeds labor supply so firms raise wages in an effort demand exceeds labor supply so firms raise wages in an effort to attract workers until they reach the new market-clearing to attract workers until they reach the new market-clearing wage at point D where they pay (wage at point D where they pay (wpwpPPIPPI ) for labor of L ) for labor of L The The

rise in the price of Japanese cars has the effect of raising the rise in the price of Japanese cars has the effect of raising the wages that firms must pay and reducing labor employedwages that firms must pay and reducing labor employed Higher wages partly compensate workers for the higher costs Higher wages partly compensate workers for the higher costs of consumption but firms can afford to pay those higher wages of consumption but firms can afford to pay those higher wages only if marginal products rise as a result of their using less only if marginal products rise as a result of their using less labor labor

bull The rise in wage rates is not enough to compensate workers The rise in wage rates is not enough to compensate workers fully so the consumption-real wage in equilibrium is (wpfully so the consumption-real wage in equilibrium is (wpCPI CPI ) )

atat point E We can think of import prices as a tax levied on point E We can think of import prices as a tax levied on consumers and of an increase in import prices as widening the consumers and of an increase in import prices as widening the tax wedge Unless the issue that we want to analyze depends on tax wedge Unless the issue that we want to analyze depends on the difference between product- and consumption-real wages the difference between product- and consumption-real wages we will treat the real wage as the same for both labor supply we will treat the real wage as the same for both labor supply and labor demandand labor demand

An Increase in the Price of Consumption GoodsAn Increase in the Price of Consumption GoodsRelative to the Price of OutputRelative to the Price of Output

ANALYZING IDEAL LABOR MARKETSANALYZING IDEAL LABOR MARKETS

bull The aggregate labor-supplylabor-demand diagram provides us The aggregate labor-supplylabor-demand diagram provides us with a powerful tool We now analyze three important with a powerful tool We now analyze three important macroeconomic issues macroeconomic issues

(1) the effect of tax cuts on employment (1) the effect of tax cuts on employment

(2) the effect of technological progress on the well-being of (2) the effect of technological progress on the well-being of workers and workers and

(3) the effect of immigration on existing workers (3) the effect of immigration on existing workers

bull Issue 1 Tax Cuts Issue 1 Tax Cuts What are the effects of a cut in marginal What are the effects of a cut in marginal income-tax rates on employment and the level of GDP in the income-tax rates on employment and the level of GDP in the economyeconomy Recall from section that a lower marginal income-Recall from section that a lower marginal income-tax rate increases labor supply at each real wage (a rightward tax rate increases labor supply at each real wage (a rightward shift of the labor-supply) shift of the labor-supply)

bull Labor-market equilibrium moves from point A to point B in Labor-market equilibrium moves from point A to point B in the lower panel of the following Notice that the amount of the lower panel of the following Notice that the amount of labor available to firms increases so that firms move labor available to firms increases so that firms move production from Arsquo to Brsquo on the labor production function in production from Arsquo to Brsquo on the labor production function in the upper panel Also notice that the real wage falls from (the upper panel Also notice that the real wage falls from (wp)1 wp)1 to (wp)2 Since the cut in taxes increases the number of to (wp)2 Since the cut in taxes increases the number of workers workers willing to work at each wage Workers care about their take-willing to work at each wage Workers care about their take-home pay ndash that is about their home pay ndash that is about their after-tax real wage after-tax real wage This is This is perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 can be greater than the old after-tax real wage (1ndashcan be greater than the old after-tax real wage (1ndashτ1τ1)(wp)1 so )(wp)1 so long as the rise in the take-home share (1 ndash τ) is long as the rise in the take-home share (1 ndash τ) is proportionately greater than the fall in the before-tax real proportionately greater than the fall in the before-tax real wage (wp)wage (wp)

bull The analysis depends on substitution effects dominating The analysis depends on substitution effects dominating income effects which they probably do in aggregate if not for income effects which they probably do in aggregate if not for every worker So the supply-siders of the Reagan years are every worker So the supply-siders of the Reagan years are correct in principle How much output will increase depends on correct in principle How much output will increase depends on how large the substitution effect is If most people work a how large the substitution effect is If most people work a standard 40-hour week the effect could be quite small and the standard 40-hour week the effect could be quite small and the increase in output might also be very small in practiceincrease in output might also be very small in practice

Issue 1 The Effect of a Cut in Marginal Tax RatesIssue 1 The Effect of a Cut in Marginal Tax Rates

Issue 2 Technological Progress and Worker WelfareIssue 2 Technological Progress and Worker Welfare

bull Is technological progress and increasing use of machinery and Is technological progress and increasing use of machinery and other capital beneficial for workersother capital beneficial for workers

bull Technological change or capital accumulation have been Technological change or capital accumulation have been known as ldquoLudditesrdquo (known as ldquoLudditesrdquo (it negatively affects the demand for it negatively affects the demand for laborlabor) To see why the Luddites are wrong ndash at least for ) To see why the Luddites are wrong ndash at least for clearing labor markets ndash recall that technological progress or clearing labor markets ndash recall that technological progress or increased capital both increased capital both shift the labor-demand curve upwardshift the labor-demand curve upward The lower panel of the following figure shows that the effect of The lower panel of the following figure shows that the effect of the increased demand for labor is to increase total employment the increased demand for labor is to increase total employment and the real wage Firms and the real wage Firms can pay a higher real wage can pay a higher real wage because because the additional capital or technological progress the additional capital or technological progress increases the increases the marginal product of labormarginal product of labor

bull The The Ludditesrsquo mistake Ludditesrsquo mistake is most easily seen in the upper panel is most easily seen in the upper panel The Luddite argument assumes that fewer workers will The Luddite argument assumes that fewer workers will produce the same total output Production starts at Arsquo using produce the same total output Production starts at Arsquo using L1 L1 workers to produce Y1 After the upward shift in the production workers to produce Y1 After the upward shift in the production function the same output could be produced using less labor function the same output could be produced using less labor ((L3) at point Arsquorsquo The L3) at point Arsquorsquo The problem is that Arsquorsquo is not an equilibrium problem is that Arsquorsquo is not an equilibrium At that point the marginal product of labor is higher than the At that point the marginal product of labor is higher than the original real wage so a profit-maximizing firm would want to original real wage so a profit-maximizing firm would want to expand production To do this they must hire more labor than expand production To do this they must hire more labor than L3 and indeed they L3 and indeed they find it find it profitable profitable to hire more labor than to hire more labor than the original the original L1 The only way actually to increase labor L1 The only way actually to increase labor is to is to raise the real-wage raise the real-wage rate above its original level Technological rate above its original level Technological progress therefore favors progress therefore favors workers by increasing employment workers by increasing employment and wagesand wages

bull Early in the 19th century hand-woven cloth was very Early in the 19th century hand-woven cloth was very expensive and a worker was lucky to own the clothes on his expensive and a worker was lucky to own the clothes on his back and a spare set for church on Sunday Textiles were one of back and a spare set for church on Sunday Textiles were one of the first industries to benefit from the Industrial Revolution so the first industries to benefit from the Industrial Revolution so that by the end of the 19th century machine-made fabrics and that by the end of the 19th century machine-made fabrics and mass-production made decent clothing in larger quantities mass-production made decent clothing in larger quantities accessible to most of the population of the more developed accessible to most of the population of the more developed countries Similar progress has been made in most forms of countries Similar progress has been made in most forms of production Agricultural production which at the turn of the production Agricultural production which at the turn of the 20th century absorbed half the labor force now absorbs less 20th century absorbed half the labor force now absorbs less than 3 percent while producing more food more cheaply than than 3 percent while producing more food more cheaply than ever ever

bull We must be careful not to dismiss the Luddites as altogether We must be careful not to dismiss the Luddites as altogether foolish While new technology especially over decades has foolish While new technology especially over decades has proved to be a net gain for workers in general the Luddites proved to be a net gain for workers in general the Luddites were in fact correct that their way of life was threatened were in fact correct that their way of life was threatened Independent weavers became factory hands unskilled Independent weavers became factory hands unskilled workers increasingly women and often children replaced workers increasingly women and often children replaced skilled craftsmen and factory work often involved long hours skilled craftsmen and factory work often involved long hours in brutal conditions The wider society reaps the benefits of in brutal conditions The wider society reaps the benefits of technological change while a narrow group sometimes technological change while a narrow group sometimes disproportionately bears its costs Our analysis also assumes disproportionately bears its costs Our analysis also assumes that markets generally clear The implicit assumption is that that markets generally clear The implicit assumption is that displaced workers move on to new jobs possibly in other forms displaced workers move on to new jobs possibly in other forms of production Markets may have a tendency to clear in the of production Markets may have a tendency to clear in the long run yet workers may find themselves displaced in the long run yet workers may find themselves displaced in the short run say over the course of a business cycleshort run say over the course of a business cycle

Issue 3 Immigration Jobs and Real WagesIssue 3 Immigration Jobs and Real Wages

bull How does an increase in the labor force through immigration or How does an increase in the labor force through immigration or natural population growth affect labor and GDP natural population growth affect labor and GDP

bull One of the emotional issues associated with US immigration One of the emotional issues associated with US immigration policy ndash particularly towards low-wage workers from Mexico ndash policy ndash particularly towards low-wage workers from Mexico ndash is the idea that is the idea that immigrants take jobs away from native immigrants take jobs away from native workers workers We might be tempted to dismiss this fear as another We might be tempted to dismiss this fear as another example of the lump-of-labor fallacy Yet there is a sensible example of the lump-of-labor fallacy Yet there is a sensible intuition behind the argument An increase in the labor force ndash intuition behind the argument An increase in the labor force ndash due either to immigration or to higher population growth rates due either to immigration or to higher population growth rates ndash can be represented as an outward shift of the aggregate labor ndash can be represented as an outward shift of the aggregate labor supply curve as shown in the following Figure Employment supply curve as shown in the following Figure Employment increases but real wages fall It is not then that immigrants increases but real wages fall It is not then that immigrants take jobs away from natives take jobs away from natives Rather they compete for jobsRather they compete for jobs putting downward pressure on real wagesputting downward pressure on real wages

bull Again we must exercise care in interpreting the analysis Again we must exercise care in interpreting the analysis Remember that aggregate labor and average wage rates hide Remember that aggregate labor and average wage rates hide many details of the labor process The incomes of the new many details of the labor process The incomes of the new immigrants immigrants creates demand creates demand for the new production that they for the new production that they make possible Immigrant workers (at least those ndash whether make possible Immigrant workers (at least those ndash whether legal or illegal ndash who have become the focus of the most intense legal or illegal ndash who have become the focus of the most intense political debate) political debate) are likely to possess fewer skills than nativesare likely to possess fewer skills than natives The net effect is that the increased demand for goods and The net effect is that the increased demand for goods and services generated by immigrants is likely to increase the services generated by immigrants is likely to increase the demand for skilled (demand for skilled (and largely nativeand largely native) workers relative to ) workers relative to their supply and so to increase real wages of skilled workers their supply and so to increase real wages of skilled workers Low-skilled immigration may lower the real wage for farm Low-skilled immigration may lower the real wage for farm workers but if anything it would raise the real wage for workers but if anything it would raise the real wage for computer programmerscomputer programmers

Next Task Labor Market in Kuwait

Appendix Is Labor Supply Stable Over Time

bull Statistics on participation rates or average hours for a Statistics on participation rates or average hours for a particular month or year are snapshot of the labor market particular month or year are snapshot of the labor market Can we analyze the effects of that increase on the labor market Can we analyze the effects of that increase on the labor market under the assumption that the labor-supply curves of workers under the assumption that the labor-supply curves of workers remain essentially stableremain essentially stable

bull Data on participation rates in the United States appear to Data on participation rates in the United States appear to support this conjecture (see Figure 811) which shows the support this conjecture (see Figure 811) which shows the overall civilian participation rate trending upward ndash at least overall civilian participation rate trending upward ndash at least from the middle of the 1960sfrom the middle of the 1960s

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

bull Although the labor-supply curve can slope downward towards Although the labor-supply curve can slope downward towards a point like A it is not reasonable to believe that it could slope a point like A it is not reasonable to believe that it could slope downward for every possible wage rate At very low wage rates downward for every possible wage rate At very low wage rates it is more reasonable to suppose that with very low incomes it is more reasonable to suppose that with very low incomes the workerrsquos need for food clothing shelter and other the workerrsquos need for food clothing shelter and other ldquoessentialrdquo goods the income effect is weak and the ldquoessentialrdquo goods the income effect is weak and the substitution effect is strong We should therefore expect the substitution effect is strong We should therefore expect the labor-supply curve to be upward sloping when wage rates are labor-supply curve to be upward sloping when wage rates are low Hence labor supply would be backward bending low Hence labor supply would be backward bending

Backward-bending Labor-supply Curve

Adding Realism TaxesAdding Realism Taxes

bull How does the tax affect the income from a little more or a little How does the tax affect the income from a little more or a little less work To answer this question we must know the less work To answer this question we must know the marginal marginal tax ratetax rate ((the fraction of an additional dollar of income that is the fraction of an additional dollar of income that is paid as taxes) paid as taxes) To keep things simple assume that all income is To keep things simple assume that all income is taxed at the same taxed at the same flatflat rate rate ττ In this case the marginal tax rate In this case the marginal tax rate must also be τ which takes a value between zero and one If a must also be τ which takes a value between zero and one If a worker earns worker earns wpwp for an hour of work the government takes for an hour of work the government takes τ(wp) τ(wp) as taxes and leaves the worker as taxes and leaves the worker (1ndashτ)(wp) (1ndashτ)(wp) as the after-as the after-tax real wagetax real wage

bull Since the worker actually receives the Since the worker actually receives the after-tax real wageafter-tax real wage it is it is the the true opportunity cost of leisure true opportunity cost of leisure Any increase in the Any increase in the marginal tax rate represents a decrease in the opportunity cost marginal tax rate represents a decrease in the opportunity cost of leisure If of leisure If substitution effectssubstitution effects are stronger than income are stronger than income effects then any increase in marginal tax rates effects then any increase in marginal tax rates reducesreduces the the supply of labor supply of labor as shown in the following figureas shown in the following figure

The Effect of a Tax Increase on Labor Supply

bull The labor-supply curve with no taxes is shown on the right of The labor-supply curve with no taxes is shown on the right of the figure At the figure At (wp)1(wp)1 the worker supplies labor the worker supplies labor l1l1 If a tax of If a tax of τ1τ1 is imposed the after-tax real wage is is imposed the after-tax real wage is (1ndashτ1)(wp)1(1ndashτ1)(wp)1 The worker The worker should react exactly as if he paid no taxes but suffered a cut in should react exactly as if he paid no taxes but suffered a cut in his wages This is shown as a movement from point A to point B his wages This is shown as a movement from point A to point B where labor supply has fallen to where labor supply has fallen to l2l2 But of course the wage rate But of course the wage rate did not really falldid not really fall the employer still pays (wp)1 This means the employer still pays (wp)1 This means that (l2 (wp)1) is the labor-supply (point C)that (l2 (wp)1) is the labor-supply (point C)

bull Since this would apply for any real-wage rate every point on Since this would apply for any real-wage rate every point on the original curve shifts to the left Because the the original curve shifts to the left Because the tax rate is tax rate is proportional its absolute effect is greaterproportional its absolute effect is greater as is the shift in the as is the shift in the labor-supply curve at high wage rates resulting in a labor-supply curve at high wage rates resulting in a steepening of the curve Any further increase in the tax rate to steepening of the curve Any further increase in the tax rate to say τ2 would shift the labor-supply curve further to the left say τ2 would shift the labor-supply curve further to the left

bull The length of the line segment BC measures the The length of the line segment BC measures the TAX WEDGETAX WEDGE between the real wage paid by employers and the after-tax real between the real wage paid by employers and the after-tax real wage received by workewage received by workersrs The The largerlarger the tax wedge the the tax wedge the largerlarger the leftward shift of the labor-supply curve and the the leftward shift of the labor-supply curve and the greater the greater the reductionreduction in labor supplied at any real wage in labor supplied at any real wage

bull The idea that tax increases lower labor supply and conversely The idea that tax increases lower labor supply and conversely that tax cuts increase labor supply was a major tenet of the so-that tax cuts increase labor supply was a major tenet of the so-called called supply-side economicssupply-side economics popular in the early 1980s popular in the early 1980s President Ronald Reagan and his advisors used it to argue that President Ronald Reagan and his advisors used it to argue that cuts in marginal tax rates cuts in marginal tax rates would stimulate people would stimulate people to to workwork harder and to harder and to earn larger earn larger incomesincomes

Adding Realism A Standard WorkweekAdding Realism A Standard Workweek

bull Another way in which the simple analysis of labor supply is Another way in which the simple analysis of labor supply is unrealistic is that many unrealistic is that many workers are not given an option about workers are not given an option about the number of hours they workthe number of hours they work Although people work part- Although people work part-time and overtime either may be voluntary or mandatory time and overtime either may be voluntary or mandatory

bull Assuming that workers are Assuming that workers are not permitted to work more than not permitted to work more than 40 hours a week40 hours a week the following figure includes a constraint of the following figure includes a constraint of 40 hours If the worker were permitted to choose freely then 40 hours If the worker were permitted to choose freely then the labor-supply curve would backward bending curve The the labor-supply curve would backward bending curve The overall effect is to of the standard work week is to reshape the overall effect is to of the standard work week is to reshape the labor-supply curve as indicated by the heavy curve with the labor-supply curve as indicated by the heavy curve with the vertical segment that runs through points A F G D and E vertical segment that runs through points A F G D and E Any worker on this vertical segment is constrainedAny worker on this vertical segment is constrained

The Individual Labor-Supply Curve in PracticeThe Individual Labor-Supply Curve in Practice

bull What does the individual labor-supply curve look like in What does the individual labor-supply curve look like in realityreality It is difficult to answer this question because in reality It is difficult to answer this question because in reality we can observe we can observe only one pointonly one point on the labor-supply curve for a on the labor-supply curve for a single worker single worker at a particular timeat a particular time All the other points are All the other points are conjecturesconjectures about what the worker would supply if faced with about what the worker would supply if faced with different wage rates If we imagine that on average workers are different wage rates If we imagine that on average workers are substantially substantially similarsimilar we might nonetheless get some idea of we might nonetheless get some idea of what the individual labor-supply curve might look likewhat the individual labor-supply curve might look like

bull The The National Longitudinal SurveyNational Longitudinal Survey (Youth) has catalogued the (Youth) has catalogued the work histories of a large sample of individuals starting at a work histories of a large sample of individuals starting at a young age The following figure plots the real-wage rates and young age The following figure plots the real-wage rates and average weekly hours of labor for about average weekly hours of labor for about 1000010000 male workers male workers from this survey for a from this survey for a single periodsingle period with the best fitting flexible with the best fitting flexible line through these points serves as our empirical estimate of the line through these points serves as our empirical estimate of the labor-supply curve for these workerslabor-supply curve for these workers

bull The regression line traces out a shape very The regression line traces out a shape very like the backward-like the backward-bendingbending labor-supply curve with a 40-hour constraint What labor-supply curve with a 40-hour constraint What looks like a vertical line above 40 hours is looks like a vertical line above 40 hours is not really a solid line not really a solid line at all but a reflection of the fact that about at all but a reflection of the fact that about 7500 7500 of the 10000 of the 10000 workers in the sample supply 40 hours per week at a variety of workers in the sample supply 40 hours per week at a variety of wage rates The labor-supply curve traces out a segment above wage rates The labor-supply curve traces out a segment above the 40-hour point that corresponds to the constraintthe 40-hour point that corresponds to the constraint

bull There are There are points to the rightpoints to the right of 40 hours This is reasonable of 40 hours This is reasonable since in the real world workers do since in the real world workers do work overtimework overtime ndash either ndash either because they are supervisors or professionals or because because they are supervisors or professionals or because employers offer them the required time-and-half wage rate employers offer them the required time-and-half wage rate The fit of the regression line is far from perfect points lie on The fit of the regression line is far from perfect points lie on both sides of the line We should interpret it as a both sides of the line We should interpret it as a snapshotsnapshot of of the behavior of the typical worker But ofthe behavior of the typical worker But of course the typical course the typical worker is not any actual worker in particularworker is not any actual worker in particular

THE WORKER CHOOSING TO PARTICIPATETHE WORKER CHOOSING TO PARTICIPATE

bull So far we have examined only one aspect of the workerrsquos So far we have examined only one aspect of the workerrsquos labor-supply decision labor-supply decision how many hours to work for given real how many hours to work for given real wagewage We now take up the second aspect We now take up the second aspect participationparticipation ndash that ndash that is is whether or not to work at allwhether or not to work at all A labor-supply curve that starts A labor-supply curve that starts at the origin and slopes upwards for at least a portion of its at the origin and slopes upwards for at least a portion of its length suggests that even length suggests that even if the wage were very lowif the wage were very low ndash say 1cent ndash say 1cent per hour ndash the worker would work a little bit That is clearly per hour ndash the worker would work a little bit That is clearly unrealisticunrealistic no one would work at all for 1cent per hour no one would work at all for 1cent per hour What What factors determine how high the wage factors determine how high the wage must be to induce a person must be to induce a person to participate in the labor marketto participate in the labor market

bull The labor force The labor force participationparticipation decision is a question of decision is a question of opportunity costopportunity cost Idleness has its charms Before anyone enters Idleness has its charms Before anyone enters the labor force the wage rate must be high enough to overcome the labor force the wage rate must be high enough to overcome them them The opportunity cost of participatingThe opportunity cost of participating in the labor force is in the labor force is sum of sum of

1048766 1048766 the implicit valuethe implicit value the worker places on complete idleness the worker places on complete idleness

1048766 1048766 the explicit coststhe explicit costs of working compared to not working such as of working compared to not working such as clothing transport childcare) andclothing transport childcare) and

1048766 1048766 the explicit losses the explicit losses from working (for instance housework not from working (for instance housework not done)done)

bull The opportunity cost is partly psychological and partly material The opportunity cost is partly psychological and partly material If people were completely If people were completely independentindependent of each other the worker of each other the worker might place a lower value on the opportunity cost of might place a lower value on the opportunity cost of participation because then the choice might be literally between participation because then the choice might be literally between work and starvationwork and starvation

bull But most people are not But most people are not completely independentcompletely independent Whether or Whether or not to participate in the labor force could be a not to participate in the labor force could be a genuine choicegenuine choice and would depend on the and would depend on the real wagereal wage

bull The The RESERVATION WAGE RESERVATION WAGE is defined to be is defined to be the opportunity the opportunity cost of working compared to not workingcost of working compared to not working ndash ndash that is the real wage that is the real wage that is high enough to make it just worthwhile for a worker to that is high enough to make it just worthwhile for a worker to participate in the labor forceparticipate in the labor force

bull Taking account of the opportunity costs of participation affects Taking account of the opportunity costs of participation affects the shape of the labor-supply curve As long as the the shape of the labor-supply curve As long as the real wage is real wage is below the reservationbelow the reservation wage ((wp)R) the worker supplies no wage ((wp)R) the worker supplies no labor at all Above the reservation wage there is a normal labor at all Above the reservation wage there is a normal labor-supply curvelabor-supply curve

bull The following captures the two stages of the labor supply The following captures the two stages of the labor supply decision decision FirstFirst at low wages the worker will at low wages the worker will notnot supply any supply any labor at all and small increases in wages have no effect But labor at all and small increases in wages have no effect But secondsecond as soon as the wage rises enough for the worker to bite as soon as the wage rises enough for the worker to bite the bullet and join the labor force the minimum labor supplied the bullet and join the labor force the minimum labor supplied will be well will be well above zeroabove zero and the worker will decide how many and the worker will decide how many hours to supply above this minimum through the usual process hours to supply above this minimum through the usual process of balancing the opportunity cost of leisure against the desire of balancing the opportunity cost of leisure against the desire for consumption goodsfor consumption goods

AGGREGATE LABOR SUPPLY

bull How can we moveHow can we move from the microeconomics of the labor supply from the microeconomics of the labor supply back to an aggregate relationship usable in macroeconomic back to an aggregate relationship usable in macroeconomic analysis analysis If workers were essentially alikeIf workers were essentially alike the problem would the problem would be easy be easy

bull As we have seen labor supply has two dimensions ndash As we have seen labor supply has two dimensions ndash participationparticipation in the labor force and in the labor force and choice of hourschoice of hours of labor of labor Take the participation decision first If all workers were alike Take the participation decision first If all workers were alike except for except for differences in their reservation wagedifferences in their reservation wage then we could then we could rank them from lowest to highest reservation wage The rank them from lowest to highest reservation wage The aggregate labor-supply (participation) curve is strictly aggregate labor-supply (participation) curve is strictly upwardslopingupwardsloping

bull Of course this is too easy Just as we observed in deriving the Of course this is too easy Just as we observed in deriving the aggregate labor demand curve workers are aggregate labor demand curve workers are not all alikenot all alike Once Once again we must interpret the vertical axis as measuring the again we must interpret the vertical axis as measuring the average real wageaverage real wage that at best provides a kind of index for the that at best provides a kind of index for the level of the wage structure level of the wage structure

bull The The problemproblem remains the remains the samesame when we turn to the choice of when we turn to the choice of hourshours Workers are all different and face a structure of wages Workers are all different and face a structure of wages For each worker individually there is a jump from supplying For each worker individually there is a jump from supplying zero to supplying some positive number of hours zero to supplying some positive number of hours when his own when his own wage rate surpasses their wage rate surpasses their reservation wagereservation wage But in aggregate But in aggregate we are we are unlikely to see such a jumpunlikely to see such a jump Not only are there a variety Not only are there a variety of wages offered at any time but reservation wages differof wages offered at any time but reservation wages differ

Derivation of the Aggregate Labor-supply Curve

bull A curve like the one in this figure can be used to display either A curve like the one in this figure can be used to display either the the participation participation decision or decision or the hoursthe hours The horizontal axis can The horizontal axis can either be used for workers either be used for workers or worker-hoursor worker-hours as measures of the as measures of the labor supply The two meanings are not completely labor supply The two meanings are not completely independent by definition independent by definition

bull workers equiv aggregate worker ndash hours average hours per worker workers equiv aggregate worker ndash hours average hours per worker

The Participation Rate and Average Hours

bull Let us look first at the aggregate participation decision The Let us look first at the aggregate participation decision The aggregate number of workers who have decided to participate aggregate number of workers who have decided to participate is known as the is known as the labor forcelabor force the the civilian labor force over 16 civilian labor force over 16 years of ageyears of age This number excludes uniformed members of the This number excludes uniformed members of the armed services and the small number of workers under 16 armed services and the small number of workers under 16 years old The labor force of course has grown right along years old The labor force of course has grown right along with population with population

bull The participation rateThe participation rate (PR) measures (PR) measures the labor force as its ratio the labor force as its ratio to the relevant populationto the relevant population

bull participation rate = labor forcerelevant population participation rate = labor forcerelevant population

bull ldquoldquonon-institutionalrdquo non-institutionalrdquo excludes people in prison or in homes for excludes people in prison or in homes for the aged) the aged)

bull The aggregate number of hours The aggregate number of hours worked is worked is not as easy not as easy as the as the participation rate to relate to the individual workerrsquos choices participation rate to relate to the individual workerrsquos choices If every worker had the same labor-supply curve we would If every worker had the same labor-supply curve we would have to know the wage offered to each one in order to calculate have to know the wage offered to each one in order to calculate the total number of labor hours supplied In reality workers the total number of labor hours supplied In reality workers are not all alike are not all alike Labor-supply curves may vary systematically Labor-supply curves may vary systematically according to the sex age ethnic group education experience according to the sex age ethnic group education experience or other social or economic characteristics of the workersor other social or economic characteristics of the workers And And within any group the labor-supply curves of individuals are within any group the labor-supply curves of individuals are likely to varylikely to vary

bull In principle In principle if we had a good statistical estimate of the typical if we had a good statistical estimate of the typical distribution of the wagesdistribution of the wages we could make a reasonable we could make a reasonable calculation But statisticians at the Bureau of Labor Statistics calculation But statisticians at the Bureau of Labor Statistics (BLS) do not try to calculate the labor supply in this way (BLS) do not try to calculate the labor supply in this way Instead they Instead they count the number of hours that workers actually count the number of hours that workers actually workwork and the average and the average wages and salaries they are paid wages and salaries they are paid

bull In USA the total hours of labor in 1998 was In USA the total hours of labor in 1998 was 236882236882 million million The average hours of work is The average hours of work is 17211721 hours per year = hours per year = 344344 hours hours per week (assuming a 50 week year) This number is 14 percent per week (assuming a 50 week year) This number is 14 percent below the full time 40-hour week which makes sense since it below the full time 40-hour week which makes sense since it averages over full-time part-time and overtime workers averages over full-time part-time and overtime workers

Labor Market EquilibriumLabor Market Equilibrium

bull MARKET CLEARINGMARKET CLEARING

bull When both demand and supply curves are plotted on the same When both demand and supply curves are plotted on the same diagram the crossing point defines the diagram the crossing point defines the equilibrium real-wage equilibrium real-wage rate and the rate and the equilibrium level of labor employedequilibrium level of labor employed

bull The real wage The real wage looks different looks different from the point of view of the firm from the point of view of the firm and the worker For the and the worker For the firmfirm the relevant real wage is the the relevant real wage is the product-real wage product-real wage defined as defined as the number of units of the good the number of units of the good the firm produces that the wage will purchase the firm produces that the wage will purchase ((price of price of productproduct = = w) w) For the For the workerworker the relevant real wage is the the relevant real wage is the consumption-consumption-real real wagewage defined as defined as the number of typical consumption baskets the number of typical consumption baskets that the wage will purchase that the wage will purchase ((price of price of consumption basket consumption basket = = w)w)

bull For aggregate analysis we might use the For aggregate analysis we might use the Producer Price IndexProducer Price Index or the GDP deflator to approximate the or the GDP deflator to approximate the product priceproduct price and the and the CPICPI to approximate the to approximate the consumption price consumption price

bull Suppose that the product-real wage and the consumption-real Suppose that the product-real wage and the consumption-real wage in the following figure start out with the identical value wage in the following figure start out with the identical value ((wp) at the market-clearing point Awp) at the market-clearing point A Now suppose that Now suppose that imported Japanese cars are a large portion of the typical imported Japanese cars are a large portion of the typical workerrsquos consumption basket workerrsquos consumption basket and that and that ceteris paribus ceteris paribus the price the price of Japanese cars rises sharply This means that the of Japanese cars rises sharply This means that the real wage real wage from the point of view of the from the point of view of the consumer falls to (consumer falls to (wpwpCPICPI ) )11 at point at point

B B on the labor-supply curve (LS) so that the worker would on the labor-supply curve (LS) so that the worker would want to supply less labor (want to supply less labor (LL11))

bull The rise in the price of Japanese cars has no effect on the price The rise in the price of Japanese cars has no effect on the price of their products Nevertheless they see a reduction of labor of their products Nevertheless they see a reduction of labor supply at the original market clearing wage It is as if the supply at the original market clearing wage It is as if the labor-supply curve labor-supply curve has shifted to the left to has shifted to the left to LSLSrsquo which passes rsquo which passes through ((through ((wp) L1) at point C wp) L1) at point C At the original wage rate labor At the original wage rate labor demand exceeds labor supply so firms raise wages in an effort demand exceeds labor supply so firms raise wages in an effort to attract workers until they reach the new market-clearing to attract workers until they reach the new market-clearing wage at point D where they pay (wage at point D where they pay (wpwpPPIPPI ) for labor of L ) for labor of L The The

rise in the price of Japanese cars has the effect of raising the rise in the price of Japanese cars has the effect of raising the wages that firms must pay and reducing labor employedwages that firms must pay and reducing labor employed Higher wages partly compensate workers for the higher costs Higher wages partly compensate workers for the higher costs of consumption but firms can afford to pay those higher wages of consumption but firms can afford to pay those higher wages only if marginal products rise as a result of their using less only if marginal products rise as a result of their using less labor labor

bull The rise in wage rates is not enough to compensate workers The rise in wage rates is not enough to compensate workers fully so the consumption-real wage in equilibrium is (wpfully so the consumption-real wage in equilibrium is (wpCPI CPI ) )

atat point E We can think of import prices as a tax levied on point E We can think of import prices as a tax levied on consumers and of an increase in import prices as widening the consumers and of an increase in import prices as widening the tax wedge Unless the issue that we want to analyze depends on tax wedge Unless the issue that we want to analyze depends on the difference between product- and consumption-real wages the difference between product- and consumption-real wages we will treat the real wage as the same for both labor supply we will treat the real wage as the same for both labor supply and labor demandand labor demand

An Increase in the Price of Consumption GoodsAn Increase in the Price of Consumption GoodsRelative to the Price of OutputRelative to the Price of Output

ANALYZING IDEAL LABOR MARKETSANALYZING IDEAL LABOR MARKETS

bull The aggregate labor-supplylabor-demand diagram provides us The aggregate labor-supplylabor-demand diagram provides us with a powerful tool We now analyze three important with a powerful tool We now analyze three important macroeconomic issues macroeconomic issues

(1) the effect of tax cuts on employment (1) the effect of tax cuts on employment

(2) the effect of technological progress on the well-being of (2) the effect of technological progress on the well-being of workers and workers and

(3) the effect of immigration on existing workers (3) the effect of immigration on existing workers

bull Issue 1 Tax Cuts Issue 1 Tax Cuts What are the effects of a cut in marginal What are the effects of a cut in marginal income-tax rates on employment and the level of GDP in the income-tax rates on employment and the level of GDP in the economyeconomy Recall from section that a lower marginal income-Recall from section that a lower marginal income-tax rate increases labor supply at each real wage (a rightward tax rate increases labor supply at each real wage (a rightward shift of the labor-supply) shift of the labor-supply)

bull Labor-market equilibrium moves from point A to point B in Labor-market equilibrium moves from point A to point B in the lower panel of the following Notice that the amount of the lower panel of the following Notice that the amount of labor available to firms increases so that firms move labor available to firms increases so that firms move production from Arsquo to Brsquo on the labor production function in production from Arsquo to Brsquo on the labor production function in the upper panel Also notice that the real wage falls from (the upper panel Also notice that the real wage falls from (wp)1 wp)1 to (wp)2 Since the cut in taxes increases the number of to (wp)2 Since the cut in taxes increases the number of workers workers willing to work at each wage Workers care about their take-willing to work at each wage Workers care about their take-home pay ndash that is about their home pay ndash that is about their after-tax real wage after-tax real wage This is This is perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 can be greater than the old after-tax real wage (1ndashcan be greater than the old after-tax real wage (1ndashτ1τ1)(wp)1 so )(wp)1 so long as the rise in the take-home share (1 ndash τ) is long as the rise in the take-home share (1 ndash τ) is proportionately greater than the fall in the before-tax real proportionately greater than the fall in the before-tax real wage (wp)wage (wp)

bull The analysis depends on substitution effects dominating The analysis depends on substitution effects dominating income effects which they probably do in aggregate if not for income effects which they probably do in aggregate if not for every worker So the supply-siders of the Reagan years are every worker So the supply-siders of the Reagan years are correct in principle How much output will increase depends on correct in principle How much output will increase depends on how large the substitution effect is If most people work a how large the substitution effect is If most people work a standard 40-hour week the effect could be quite small and the standard 40-hour week the effect could be quite small and the increase in output might also be very small in practiceincrease in output might also be very small in practice

Issue 1 The Effect of a Cut in Marginal Tax RatesIssue 1 The Effect of a Cut in Marginal Tax Rates

Issue 2 Technological Progress and Worker WelfareIssue 2 Technological Progress and Worker Welfare

bull Is technological progress and increasing use of machinery and Is technological progress and increasing use of machinery and other capital beneficial for workersother capital beneficial for workers

bull Technological change or capital accumulation have been Technological change or capital accumulation have been known as ldquoLudditesrdquo (known as ldquoLudditesrdquo (it negatively affects the demand for it negatively affects the demand for laborlabor) To see why the Luddites are wrong ndash at least for ) To see why the Luddites are wrong ndash at least for clearing labor markets ndash recall that technological progress or clearing labor markets ndash recall that technological progress or increased capital both increased capital both shift the labor-demand curve upwardshift the labor-demand curve upward The lower panel of the following figure shows that the effect of The lower panel of the following figure shows that the effect of the increased demand for labor is to increase total employment the increased demand for labor is to increase total employment and the real wage Firms and the real wage Firms can pay a higher real wage can pay a higher real wage because because the additional capital or technological progress the additional capital or technological progress increases the increases the marginal product of labormarginal product of labor

bull The The Ludditesrsquo mistake Ludditesrsquo mistake is most easily seen in the upper panel is most easily seen in the upper panel The Luddite argument assumes that fewer workers will The Luddite argument assumes that fewer workers will produce the same total output Production starts at Arsquo using produce the same total output Production starts at Arsquo using L1 L1 workers to produce Y1 After the upward shift in the production workers to produce Y1 After the upward shift in the production function the same output could be produced using less labor function the same output could be produced using less labor ((L3) at point Arsquorsquo The L3) at point Arsquorsquo The problem is that Arsquorsquo is not an equilibrium problem is that Arsquorsquo is not an equilibrium At that point the marginal product of labor is higher than the At that point the marginal product of labor is higher than the original real wage so a profit-maximizing firm would want to original real wage so a profit-maximizing firm would want to expand production To do this they must hire more labor than expand production To do this they must hire more labor than L3 and indeed they L3 and indeed they find it find it profitable profitable to hire more labor than to hire more labor than the original the original L1 The only way actually to increase labor L1 The only way actually to increase labor is to is to raise the real-wage raise the real-wage rate above its original level Technological rate above its original level Technological progress therefore favors progress therefore favors workers by increasing employment workers by increasing employment and wagesand wages

bull Early in the 19th century hand-woven cloth was very Early in the 19th century hand-woven cloth was very expensive and a worker was lucky to own the clothes on his expensive and a worker was lucky to own the clothes on his back and a spare set for church on Sunday Textiles were one of back and a spare set for church on Sunday Textiles were one of the first industries to benefit from the Industrial Revolution so the first industries to benefit from the Industrial Revolution so that by the end of the 19th century machine-made fabrics and that by the end of the 19th century machine-made fabrics and mass-production made decent clothing in larger quantities mass-production made decent clothing in larger quantities accessible to most of the population of the more developed accessible to most of the population of the more developed countries Similar progress has been made in most forms of countries Similar progress has been made in most forms of production Agricultural production which at the turn of the production Agricultural production which at the turn of the 20th century absorbed half the labor force now absorbs less 20th century absorbed half the labor force now absorbs less than 3 percent while producing more food more cheaply than than 3 percent while producing more food more cheaply than ever ever

bull We must be careful not to dismiss the Luddites as altogether We must be careful not to dismiss the Luddites as altogether foolish While new technology especially over decades has foolish While new technology especially over decades has proved to be a net gain for workers in general the Luddites proved to be a net gain for workers in general the Luddites were in fact correct that their way of life was threatened were in fact correct that their way of life was threatened Independent weavers became factory hands unskilled Independent weavers became factory hands unskilled workers increasingly women and often children replaced workers increasingly women and often children replaced skilled craftsmen and factory work often involved long hours skilled craftsmen and factory work often involved long hours in brutal conditions The wider society reaps the benefits of in brutal conditions The wider society reaps the benefits of technological change while a narrow group sometimes technological change while a narrow group sometimes disproportionately bears its costs Our analysis also assumes disproportionately bears its costs Our analysis also assumes that markets generally clear The implicit assumption is that that markets generally clear The implicit assumption is that displaced workers move on to new jobs possibly in other forms displaced workers move on to new jobs possibly in other forms of production Markets may have a tendency to clear in the of production Markets may have a tendency to clear in the long run yet workers may find themselves displaced in the long run yet workers may find themselves displaced in the short run say over the course of a business cycleshort run say over the course of a business cycle

Issue 3 Immigration Jobs and Real WagesIssue 3 Immigration Jobs and Real Wages

bull How does an increase in the labor force through immigration or How does an increase in the labor force through immigration or natural population growth affect labor and GDP natural population growth affect labor and GDP

bull One of the emotional issues associated with US immigration One of the emotional issues associated with US immigration policy ndash particularly towards low-wage workers from Mexico ndash policy ndash particularly towards low-wage workers from Mexico ndash is the idea that is the idea that immigrants take jobs away from native immigrants take jobs away from native workers workers We might be tempted to dismiss this fear as another We might be tempted to dismiss this fear as another example of the lump-of-labor fallacy Yet there is a sensible example of the lump-of-labor fallacy Yet there is a sensible intuition behind the argument An increase in the labor force ndash intuition behind the argument An increase in the labor force ndash due either to immigration or to higher population growth rates due either to immigration or to higher population growth rates ndash can be represented as an outward shift of the aggregate labor ndash can be represented as an outward shift of the aggregate labor supply curve as shown in the following Figure Employment supply curve as shown in the following Figure Employment increases but real wages fall It is not then that immigrants increases but real wages fall It is not then that immigrants take jobs away from natives take jobs away from natives Rather they compete for jobsRather they compete for jobs putting downward pressure on real wagesputting downward pressure on real wages

bull Again we must exercise care in interpreting the analysis Again we must exercise care in interpreting the analysis Remember that aggregate labor and average wage rates hide Remember that aggregate labor and average wage rates hide many details of the labor process The incomes of the new many details of the labor process The incomes of the new immigrants immigrants creates demand creates demand for the new production that they for the new production that they make possible Immigrant workers (at least those ndash whether make possible Immigrant workers (at least those ndash whether legal or illegal ndash who have become the focus of the most intense legal or illegal ndash who have become the focus of the most intense political debate) political debate) are likely to possess fewer skills than nativesare likely to possess fewer skills than natives The net effect is that the increased demand for goods and The net effect is that the increased demand for goods and services generated by immigrants is likely to increase the services generated by immigrants is likely to increase the demand for skilled (demand for skilled (and largely nativeand largely native) workers relative to ) workers relative to their supply and so to increase real wages of skilled workers their supply and so to increase real wages of skilled workers Low-skilled immigration may lower the real wage for farm Low-skilled immigration may lower the real wage for farm workers but if anything it would raise the real wage for workers but if anything it would raise the real wage for computer programmerscomputer programmers

Next Task Labor Market in Kuwait

Appendix Is Labor Supply Stable Over Time

bull Statistics on participation rates or average hours for a Statistics on participation rates or average hours for a particular month or year are snapshot of the labor market particular month or year are snapshot of the labor market Can we analyze the effects of that increase on the labor market Can we analyze the effects of that increase on the labor market under the assumption that the labor-supply curves of workers under the assumption that the labor-supply curves of workers remain essentially stableremain essentially stable

bull Data on participation rates in the United States appear to Data on participation rates in the United States appear to support this conjecture (see Figure 811) which shows the support this conjecture (see Figure 811) which shows the overall civilian participation rate trending upward ndash at least overall civilian participation rate trending upward ndash at least from the middle of the 1960sfrom the middle of the 1960s

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

Backward-bending Labor-supply Curve

Adding Realism TaxesAdding Realism Taxes

bull How does the tax affect the income from a little more or a little How does the tax affect the income from a little more or a little less work To answer this question we must know the less work To answer this question we must know the marginal marginal tax ratetax rate ((the fraction of an additional dollar of income that is the fraction of an additional dollar of income that is paid as taxes) paid as taxes) To keep things simple assume that all income is To keep things simple assume that all income is taxed at the same taxed at the same flatflat rate rate ττ In this case the marginal tax rate In this case the marginal tax rate must also be τ which takes a value between zero and one If a must also be τ which takes a value between zero and one If a worker earns worker earns wpwp for an hour of work the government takes for an hour of work the government takes τ(wp) τ(wp) as taxes and leaves the worker as taxes and leaves the worker (1ndashτ)(wp) (1ndashτ)(wp) as the after-as the after-tax real wagetax real wage

bull Since the worker actually receives the Since the worker actually receives the after-tax real wageafter-tax real wage it is it is the the true opportunity cost of leisure true opportunity cost of leisure Any increase in the Any increase in the marginal tax rate represents a decrease in the opportunity cost marginal tax rate represents a decrease in the opportunity cost of leisure If of leisure If substitution effectssubstitution effects are stronger than income are stronger than income effects then any increase in marginal tax rates effects then any increase in marginal tax rates reducesreduces the the supply of labor supply of labor as shown in the following figureas shown in the following figure

The Effect of a Tax Increase on Labor Supply

bull The labor-supply curve with no taxes is shown on the right of The labor-supply curve with no taxes is shown on the right of the figure At the figure At (wp)1(wp)1 the worker supplies labor the worker supplies labor l1l1 If a tax of If a tax of τ1τ1 is imposed the after-tax real wage is is imposed the after-tax real wage is (1ndashτ1)(wp)1(1ndashτ1)(wp)1 The worker The worker should react exactly as if he paid no taxes but suffered a cut in should react exactly as if he paid no taxes but suffered a cut in his wages This is shown as a movement from point A to point B his wages This is shown as a movement from point A to point B where labor supply has fallen to where labor supply has fallen to l2l2 But of course the wage rate But of course the wage rate did not really falldid not really fall the employer still pays (wp)1 This means the employer still pays (wp)1 This means that (l2 (wp)1) is the labor-supply (point C)that (l2 (wp)1) is the labor-supply (point C)

bull Since this would apply for any real-wage rate every point on Since this would apply for any real-wage rate every point on the original curve shifts to the left Because the the original curve shifts to the left Because the tax rate is tax rate is proportional its absolute effect is greaterproportional its absolute effect is greater as is the shift in the as is the shift in the labor-supply curve at high wage rates resulting in a labor-supply curve at high wage rates resulting in a steepening of the curve Any further increase in the tax rate to steepening of the curve Any further increase in the tax rate to say τ2 would shift the labor-supply curve further to the left say τ2 would shift the labor-supply curve further to the left

bull The length of the line segment BC measures the The length of the line segment BC measures the TAX WEDGETAX WEDGE between the real wage paid by employers and the after-tax real between the real wage paid by employers and the after-tax real wage received by workewage received by workersrs The The largerlarger the tax wedge the the tax wedge the largerlarger the leftward shift of the labor-supply curve and the the leftward shift of the labor-supply curve and the greater the greater the reductionreduction in labor supplied at any real wage in labor supplied at any real wage

bull The idea that tax increases lower labor supply and conversely The idea that tax increases lower labor supply and conversely that tax cuts increase labor supply was a major tenet of the so-that tax cuts increase labor supply was a major tenet of the so-called called supply-side economicssupply-side economics popular in the early 1980s popular in the early 1980s President Ronald Reagan and his advisors used it to argue that President Ronald Reagan and his advisors used it to argue that cuts in marginal tax rates cuts in marginal tax rates would stimulate people would stimulate people to to workwork harder and to harder and to earn larger earn larger incomesincomes

Adding Realism A Standard WorkweekAdding Realism A Standard Workweek

bull Another way in which the simple analysis of labor supply is Another way in which the simple analysis of labor supply is unrealistic is that many unrealistic is that many workers are not given an option about workers are not given an option about the number of hours they workthe number of hours they work Although people work part- Although people work part-time and overtime either may be voluntary or mandatory time and overtime either may be voluntary or mandatory

bull Assuming that workers are Assuming that workers are not permitted to work more than not permitted to work more than 40 hours a week40 hours a week the following figure includes a constraint of the following figure includes a constraint of 40 hours If the worker were permitted to choose freely then 40 hours If the worker were permitted to choose freely then the labor-supply curve would backward bending curve The the labor-supply curve would backward bending curve The overall effect is to of the standard work week is to reshape the overall effect is to of the standard work week is to reshape the labor-supply curve as indicated by the heavy curve with the labor-supply curve as indicated by the heavy curve with the vertical segment that runs through points A F G D and E vertical segment that runs through points A F G D and E Any worker on this vertical segment is constrainedAny worker on this vertical segment is constrained

The Individual Labor-Supply Curve in PracticeThe Individual Labor-Supply Curve in Practice

bull What does the individual labor-supply curve look like in What does the individual labor-supply curve look like in realityreality It is difficult to answer this question because in reality It is difficult to answer this question because in reality we can observe we can observe only one pointonly one point on the labor-supply curve for a on the labor-supply curve for a single worker single worker at a particular timeat a particular time All the other points are All the other points are conjecturesconjectures about what the worker would supply if faced with about what the worker would supply if faced with different wage rates If we imagine that on average workers are different wage rates If we imagine that on average workers are substantially substantially similarsimilar we might nonetheless get some idea of we might nonetheless get some idea of what the individual labor-supply curve might look likewhat the individual labor-supply curve might look like

bull The The National Longitudinal SurveyNational Longitudinal Survey (Youth) has catalogued the (Youth) has catalogued the work histories of a large sample of individuals starting at a work histories of a large sample of individuals starting at a young age The following figure plots the real-wage rates and young age The following figure plots the real-wage rates and average weekly hours of labor for about average weekly hours of labor for about 1000010000 male workers male workers from this survey for a from this survey for a single periodsingle period with the best fitting flexible with the best fitting flexible line through these points serves as our empirical estimate of the line through these points serves as our empirical estimate of the labor-supply curve for these workerslabor-supply curve for these workers

bull The regression line traces out a shape very The regression line traces out a shape very like the backward-like the backward-bendingbending labor-supply curve with a 40-hour constraint What labor-supply curve with a 40-hour constraint What looks like a vertical line above 40 hours is looks like a vertical line above 40 hours is not really a solid line not really a solid line at all but a reflection of the fact that about at all but a reflection of the fact that about 7500 7500 of the 10000 of the 10000 workers in the sample supply 40 hours per week at a variety of workers in the sample supply 40 hours per week at a variety of wage rates The labor-supply curve traces out a segment above wage rates The labor-supply curve traces out a segment above the 40-hour point that corresponds to the constraintthe 40-hour point that corresponds to the constraint

bull There are There are points to the rightpoints to the right of 40 hours This is reasonable of 40 hours This is reasonable since in the real world workers do since in the real world workers do work overtimework overtime ndash either ndash either because they are supervisors or professionals or because because they are supervisors or professionals or because employers offer them the required time-and-half wage rate employers offer them the required time-and-half wage rate The fit of the regression line is far from perfect points lie on The fit of the regression line is far from perfect points lie on both sides of the line We should interpret it as a both sides of the line We should interpret it as a snapshotsnapshot of of the behavior of the typical worker But ofthe behavior of the typical worker But of course the typical course the typical worker is not any actual worker in particularworker is not any actual worker in particular

THE WORKER CHOOSING TO PARTICIPATETHE WORKER CHOOSING TO PARTICIPATE

bull So far we have examined only one aspect of the workerrsquos So far we have examined only one aspect of the workerrsquos labor-supply decision labor-supply decision how many hours to work for given real how many hours to work for given real wagewage We now take up the second aspect We now take up the second aspect participationparticipation ndash that ndash that is is whether or not to work at allwhether or not to work at all A labor-supply curve that starts A labor-supply curve that starts at the origin and slopes upwards for at least a portion of its at the origin and slopes upwards for at least a portion of its length suggests that even length suggests that even if the wage were very lowif the wage were very low ndash say 1cent ndash say 1cent per hour ndash the worker would work a little bit That is clearly per hour ndash the worker would work a little bit That is clearly unrealisticunrealistic no one would work at all for 1cent per hour no one would work at all for 1cent per hour What What factors determine how high the wage factors determine how high the wage must be to induce a person must be to induce a person to participate in the labor marketto participate in the labor market

bull The labor force The labor force participationparticipation decision is a question of decision is a question of opportunity costopportunity cost Idleness has its charms Before anyone enters Idleness has its charms Before anyone enters the labor force the wage rate must be high enough to overcome the labor force the wage rate must be high enough to overcome them them The opportunity cost of participatingThe opportunity cost of participating in the labor force is in the labor force is sum of sum of

1048766 1048766 the implicit valuethe implicit value the worker places on complete idleness the worker places on complete idleness

1048766 1048766 the explicit coststhe explicit costs of working compared to not working such as of working compared to not working such as clothing transport childcare) andclothing transport childcare) and

1048766 1048766 the explicit losses the explicit losses from working (for instance housework not from working (for instance housework not done)done)

bull The opportunity cost is partly psychological and partly material The opportunity cost is partly psychological and partly material If people were completely If people were completely independentindependent of each other the worker of each other the worker might place a lower value on the opportunity cost of might place a lower value on the opportunity cost of participation because then the choice might be literally between participation because then the choice might be literally between work and starvationwork and starvation

bull But most people are not But most people are not completely independentcompletely independent Whether or Whether or not to participate in the labor force could be a not to participate in the labor force could be a genuine choicegenuine choice and would depend on the and would depend on the real wagereal wage

bull The The RESERVATION WAGE RESERVATION WAGE is defined to be is defined to be the opportunity the opportunity cost of working compared to not workingcost of working compared to not working ndash ndash that is the real wage that is the real wage that is high enough to make it just worthwhile for a worker to that is high enough to make it just worthwhile for a worker to participate in the labor forceparticipate in the labor force

bull Taking account of the opportunity costs of participation affects Taking account of the opportunity costs of participation affects the shape of the labor-supply curve As long as the the shape of the labor-supply curve As long as the real wage is real wage is below the reservationbelow the reservation wage ((wp)R) the worker supplies no wage ((wp)R) the worker supplies no labor at all Above the reservation wage there is a normal labor at all Above the reservation wage there is a normal labor-supply curvelabor-supply curve

bull The following captures the two stages of the labor supply The following captures the two stages of the labor supply decision decision FirstFirst at low wages the worker will at low wages the worker will notnot supply any supply any labor at all and small increases in wages have no effect But labor at all and small increases in wages have no effect But secondsecond as soon as the wage rises enough for the worker to bite as soon as the wage rises enough for the worker to bite the bullet and join the labor force the minimum labor supplied the bullet and join the labor force the minimum labor supplied will be well will be well above zeroabove zero and the worker will decide how many and the worker will decide how many hours to supply above this minimum through the usual process hours to supply above this minimum through the usual process of balancing the opportunity cost of leisure against the desire of balancing the opportunity cost of leisure against the desire for consumption goodsfor consumption goods

AGGREGATE LABOR SUPPLY

bull How can we moveHow can we move from the microeconomics of the labor supply from the microeconomics of the labor supply back to an aggregate relationship usable in macroeconomic back to an aggregate relationship usable in macroeconomic analysis analysis If workers were essentially alikeIf workers were essentially alike the problem would the problem would be easy be easy

bull As we have seen labor supply has two dimensions ndash As we have seen labor supply has two dimensions ndash participationparticipation in the labor force and in the labor force and choice of hourschoice of hours of labor of labor Take the participation decision first If all workers were alike Take the participation decision first If all workers were alike except for except for differences in their reservation wagedifferences in their reservation wage then we could then we could rank them from lowest to highest reservation wage The rank them from lowest to highest reservation wage The aggregate labor-supply (participation) curve is strictly aggregate labor-supply (participation) curve is strictly upwardslopingupwardsloping

bull Of course this is too easy Just as we observed in deriving the Of course this is too easy Just as we observed in deriving the aggregate labor demand curve workers are aggregate labor demand curve workers are not all alikenot all alike Once Once again we must interpret the vertical axis as measuring the again we must interpret the vertical axis as measuring the average real wageaverage real wage that at best provides a kind of index for the that at best provides a kind of index for the level of the wage structure level of the wage structure

bull The The problemproblem remains the remains the samesame when we turn to the choice of when we turn to the choice of hourshours Workers are all different and face a structure of wages Workers are all different and face a structure of wages For each worker individually there is a jump from supplying For each worker individually there is a jump from supplying zero to supplying some positive number of hours zero to supplying some positive number of hours when his own when his own wage rate surpasses their wage rate surpasses their reservation wagereservation wage But in aggregate But in aggregate we are we are unlikely to see such a jumpunlikely to see such a jump Not only are there a variety Not only are there a variety of wages offered at any time but reservation wages differof wages offered at any time but reservation wages differ

Derivation of the Aggregate Labor-supply Curve

bull A curve like the one in this figure can be used to display either A curve like the one in this figure can be used to display either the the participation participation decision or decision or the hoursthe hours The horizontal axis can The horizontal axis can either be used for workers either be used for workers or worker-hoursor worker-hours as measures of the as measures of the labor supply The two meanings are not completely labor supply The two meanings are not completely independent by definition independent by definition

bull workers equiv aggregate worker ndash hours average hours per worker workers equiv aggregate worker ndash hours average hours per worker

The Participation Rate and Average Hours

bull Let us look first at the aggregate participation decision The Let us look first at the aggregate participation decision The aggregate number of workers who have decided to participate aggregate number of workers who have decided to participate is known as the is known as the labor forcelabor force the the civilian labor force over 16 civilian labor force over 16 years of ageyears of age This number excludes uniformed members of the This number excludes uniformed members of the armed services and the small number of workers under 16 armed services and the small number of workers under 16 years old The labor force of course has grown right along years old The labor force of course has grown right along with population with population

bull The participation rateThe participation rate (PR) measures (PR) measures the labor force as its ratio the labor force as its ratio to the relevant populationto the relevant population

bull participation rate = labor forcerelevant population participation rate = labor forcerelevant population

bull ldquoldquonon-institutionalrdquo non-institutionalrdquo excludes people in prison or in homes for excludes people in prison or in homes for the aged) the aged)

bull The aggregate number of hours The aggregate number of hours worked is worked is not as easy not as easy as the as the participation rate to relate to the individual workerrsquos choices participation rate to relate to the individual workerrsquos choices If every worker had the same labor-supply curve we would If every worker had the same labor-supply curve we would have to know the wage offered to each one in order to calculate have to know the wage offered to each one in order to calculate the total number of labor hours supplied In reality workers the total number of labor hours supplied In reality workers are not all alike are not all alike Labor-supply curves may vary systematically Labor-supply curves may vary systematically according to the sex age ethnic group education experience according to the sex age ethnic group education experience or other social or economic characteristics of the workersor other social or economic characteristics of the workers And And within any group the labor-supply curves of individuals are within any group the labor-supply curves of individuals are likely to varylikely to vary

bull In principle In principle if we had a good statistical estimate of the typical if we had a good statistical estimate of the typical distribution of the wagesdistribution of the wages we could make a reasonable we could make a reasonable calculation But statisticians at the Bureau of Labor Statistics calculation But statisticians at the Bureau of Labor Statistics (BLS) do not try to calculate the labor supply in this way (BLS) do not try to calculate the labor supply in this way Instead they Instead they count the number of hours that workers actually count the number of hours that workers actually workwork and the average and the average wages and salaries they are paid wages and salaries they are paid

bull In USA the total hours of labor in 1998 was In USA the total hours of labor in 1998 was 236882236882 million million The average hours of work is The average hours of work is 17211721 hours per year = hours per year = 344344 hours hours per week (assuming a 50 week year) This number is 14 percent per week (assuming a 50 week year) This number is 14 percent below the full time 40-hour week which makes sense since it below the full time 40-hour week which makes sense since it averages over full-time part-time and overtime workers averages over full-time part-time and overtime workers

Labor Market EquilibriumLabor Market Equilibrium

bull MARKET CLEARINGMARKET CLEARING

bull When both demand and supply curves are plotted on the same When both demand and supply curves are plotted on the same diagram the crossing point defines the diagram the crossing point defines the equilibrium real-wage equilibrium real-wage rate and the rate and the equilibrium level of labor employedequilibrium level of labor employed

bull The real wage The real wage looks different looks different from the point of view of the firm from the point of view of the firm and the worker For the and the worker For the firmfirm the relevant real wage is the the relevant real wage is the product-real wage product-real wage defined as defined as the number of units of the good the number of units of the good the firm produces that the wage will purchase the firm produces that the wage will purchase ((price of price of productproduct = = w) w) For the For the workerworker the relevant real wage is the the relevant real wage is the consumption-consumption-real real wagewage defined as defined as the number of typical consumption baskets the number of typical consumption baskets that the wage will purchase that the wage will purchase ((price of price of consumption basket consumption basket = = w)w)

bull For aggregate analysis we might use the For aggregate analysis we might use the Producer Price IndexProducer Price Index or the GDP deflator to approximate the or the GDP deflator to approximate the product priceproduct price and the and the CPICPI to approximate the to approximate the consumption price consumption price

bull Suppose that the product-real wage and the consumption-real Suppose that the product-real wage and the consumption-real wage in the following figure start out with the identical value wage in the following figure start out with the identical value ((wp) at the market-clearing point Awp) at the market-clearing point A Now suppose that Now suppose that imported Japanese cars are a large portion of the typical imported Japanese cars are a large portion of the typical workerrsquos consumption basket workerrsquos consumption basket and that and that ceteris paribus ceteris paribus the price the price of Japanese cars rises sharply This means that the of Japanese cars rises sharply This means that the real wage real wage from the point of view of the from the point of view of the consumer falls to (consumer falls to (wpwpCPICPI ) )11 at point at point

B B on the labor-supply curve (LS) so that the worker would on the labor-supply curve (LS) so that the worker would want to supply less labor (want to supply less labor (LL11))

bull The rise in the price of Japanese cars has no effect on the price The rise in the price of Japanese cars has no effect on the price of their products Nevertheless they see a reduction of labor of their products Nevertheless they see a reduction of labor supply at the original market clearing wage It is as if the supply at the original market clearing wage It is as if the labor-supply curve labor-supply curve has shifted to the left to has shifted to the left to LSLSrsquo which passes rsquo which passes through ((through ((wp) L1) at point C wp) L1) at point C At the original wage rate labor At the original wage rate labor demand exceeds labor supply so firms raise wages in an effort demand exceeds labor supply so firms raise wages in an effort to attract workers until they reach the new market-clearing to attract workers until they reach the new market-clearing wage at point D where they pay (wage at point D where they pay (wpwpPPIPPI ) for labor of L ) for labor of L The The

rise in the price of Japanese cars has the effect of raising the rise in the price of Japanese cars has the effect of raising the wages that firms must pay and reducing labor employedwages that firms must pay and reducing labor employed Higher wages partly compensate workers for the higher costs Higher wages partly compensate workers for the higher costs of consumption but firms can afford to pay those higher wages of consumption but firms can afford to pay those higher wages only if marginal products rise as a result of their using less only if marginal products rise as a result of their using less labor labor

bull The rise in wage rates is not enough to compensate workers The rise in wage rates is not enough to compensate workers fully so the consumption-real wage in equilibrium is (wpfully so the consumption-real wage in equilibrium is (wpCPI CPI ) )

atat point E We can think of import prices as a tax levied on point E We can think of import prices as a tax levied on consumers and of an increase in import prices as widening the consumers and of an increase in import prices as widening the tax wedge Unless the issue that we want to analyze depends on tax wedge Unless the issue that we want to analyze depends on the difference between product- and consumption-real wages the difference between product- and consumption-real wages we will treat the real wage as the same for both labor supply we will treat the real wage as the same for both labor supply and labor demandand labor demand

An Increase in the Price of Consumption GoodsAn Increase in the Price of Consumption GoodsRelative to the Price of OutputRelative to the Price of Output

ANALYZING IDEAL LABOR MARKETSANALYZING IDEAL LABOR MARKETS

bull The aggregate labor-supplylabor-demand diagram provides us The aggregate labor-supplylabor-demand diagram provides us with a powerful tool We now analyze three important with a powerful tool We now analyze three important macroeconomic issues macroeconomic issues

(1) the effect of tax cuts on employment (1) the effect of tax cuts on employment

(2) the effect of technological progress on the well-being of (2) the effect of technological progress on the well-being of workers and workers and

(3) the effect of immigration on existing workers (3) the effect of immigration on existing workers

bull Issue 1 Tax Cuts Issue 1 Tax Cuts What are the effects of a cut in marginal What are the effects of a cut in marginal income-tax rates on employment and the level of GDP in the income-tax rates on employment and the level of GDP in the economyeconomy Recall from section that a lower marginal income-Recall from section that a lower marginal income-tax rate increases labor supply at each real wage (a rightward tax rate increases labor supply at each real wage (a rightward shift of the labor-supply) shift of the labor-supply)

bull Labor-market equilibrium moves from point A to point B in Labor-market equilibrium moves from point A to point B in the lower panel of the following Notice that the amount of the lower panel of the following Notice that the amount of labor available to firms increases so that firms move labor available to firms increases so that firms move production from Arsquo to Brsquo on the labor production function in production from Arsquo to Brsquo on the labor production function in the upper panel Also notice that the real wage falls from (the upper panel Also notice that the real wage falls from (wp)1 wp)1 to (wp)2 Since the cut in taxes increases the number of to (wp)2 Since the cut in taxes increases the number of workers workers willing to work at each wage Workers care about their take-willing to work at each wage Workers care about their take-home pay ndash that is about their home pay ndash that is about their after-tax real wage after-tax real wage This is This is perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 can be greater than the old after-tax real wage (1ndashcan be greater than the old after-tax real wage (1ndashτ1τ1)(wp)1 so )(wp)1 so long as the rise in the take-home share (1 ndash τ) is long as the rise in the take-home share (1 ndash τ) is proportionately greater than the fall in the before-tax real proportionately greater than the fall in the before-tax real wage (wp)wage (wp)

bull The analysis depends on substitution effects dominating The analysis depends on substitution effects dominating income effects which they probably do in aggregate if not for income effects which they probably do in aggregate if not for every worker So the supply-siders of the Reagan years are every worker So the supply-siders of the Reagan years are correct in principle How much output will increase depends on correct in principle How much output will increase depends on how large the substitution effect is If most people work a how large the substitution effect is If most people work a standard 40-hour week the effect could be quite small and the standard 40-hour week the effect could be quite small and the increase in output might also be very small in practiceincrease in output might also be very small in practice

Issue 1 The Effect of a Cut in Marginal Tax RatesIssue 1 The Effect of a Cut in Marginal Tax Rates

Issue 2 Technological Progress and Worker WelfareIssue 2 Technological Progress and Worker Welfare

bull Is technological progress and increasing use of machinery and Is technological progress and increasing use of machinery and other capital beneficial for workersother capital beneficial for workers

bull Technological change or capital accumulation have been Technological change or capital accumulation have been known as ldquoLudditesrdquo (known as ldquoLudditesrdquo (it negatively affects the demand for it negatively affects the demand for laborlabor) To see why the Luddites are wrong ndash at least for ) To see why the Luddites are wrong ndash at least for clearing labor markets ndash recall that technological progress or clearing labor markets ndash recall that technological progress or increased capital both increased capital both shift the labor-demand curve upwardshift the labor-demand curve upward The lower panel of the following figure shows that the effect of The lower panel of the following figure shows that the effect of the increased demand for labor is to increase total employment the increased demand for labor is to increase total employment and the real wage Firms and the real wage Firms can pay a higher real wage can pay a higher real wage because because the additional capital or technological progress the additional capital or technological progress increases the increases the marginal product of labormarginal product of labor

bull The The Ludditesrsquo mistake Ludditesrsquo mistake is most easily seen in the upper panel is most easily seen in the upper panel The Luddite argument assumes that fewer workers will The Luddite argument assumes that fewer workers will produce the same total output Production starts at Arsquo using produce the same total output Production starts at Arsquo using L1 L1 workers to produce Y1 After the upward shift in the production workers to produce Y1 After the upward shift in the production function the same output could be produced using less labor function the same output could be produced using less labor ((L3) at point Arsquorsquo The L3) at point Arsquorsquo The problem is that Arsquorsquo is not an equilibrium problem is that Arsquorsquo is not an equilibrium At that point the marginal product of labor is higher than the At that point the marginal product of labor is higher than the original real wage so a profit-maximizing firm would want to original real wage so a profit-maximizing firm would want to expand production To do this they must hire more labor than expand production To do this they must hire more labor than L3 and indeed they L3 and indeed they find it find it profitable profitable to hire more labor than to hire more labor than the original the original L1 The only way actually to increase labor L1 The only way actually to increase labor is to is to raise the real-wage raise the real-wage rate above its original level Technological rate above its original level Technological progress therefore favors progress therefore favors workers by increasing employment workers by increasing employment and wagesand wages

bull Early in the 19th century hand-woven cloth was very Early in the 19th century hand-woven cloth was very expensive and a worker was lucky to own the clothes on his expensive and a worker was lucky to own the clothes on his back and a spare set for church on Sunday Textiles were one of back and a spare set for church on Sunday Textiles were one of the first industries to benefit from the Industrial Revolution so the first industries to benefit from the Industrial Revolution so that by the end of the 19th century machine-made fabrics and that by the end of the 19th century machine-made fabrics and mass-production made decent clothing in larger quantities mass-production made decent clothing in larger quantities accessible to most of the population of the more developed accessible to most of the population of the more developed countries Similar progress has been made in most forms of countries Similar progress has been made in most forms of production Agricultural production which at the turn of the production Agricultural production which at the turn of the 20th century absorbed half the labor force now absorbs less 20th century absorbed half the labor force now absorbs less than 3 percent while producing more food more cheaply than than 3 percent while producing more food more cheaply than ever ever

bull We must be careful not to dismiss the Luddites as altogether We must be careful not to dismiss the Luddites as altogether foolish While new technology especially over decades has foolish While new technology especially over decades has proved to be a net gain for workers in general the Luddites proved to be a net gain for workers in general the Luddites were in fact correct that their way of life was threatened were in fact correct that their way of life was threatened Independent weavers became factory hands unskilled Independent weavers became factory hands unskilled workers increasingly women and often children replaced workers increasingly women and often children replaced skilled craftsmen and factory work often involved long hours skilled craftsmen and factory work often involved long hours in brutal conditions The wider society reaps the benefits of in brutal conditions The wider society reaps the benefits of technological change while a narrow group sometimes technological change while a narrow group sometimes disproportionately bears its costs Our analysis also assumes disproportionately bears its costs Our analysis also assumes that markets generally clear The implicit assumption is that that markets generally clear The implicit assumption is that displaced workers move on to new jobs possibly in other forms displaced workers move on to new jobs possibly in other forms of production Markets may have a tendency to clear in the of production Markets may have a tendency to clear in the long run yet workers may find themselves displaced in the long run yet workers may find themselves displaced in the short run say over the course of a business cycleshort run say over the course of a business cycle

Issue 3 Immigration Jobs and Real WagesIssue 3 Immigration Jobs and Real Wages

bull How does an increase in the labor force through immigration or How does an increase in the labor force through immigration or natural population growth affect labor and GDP natural population growth affect labor and GDP

bull One of the emotional issues associated with US immigration One of the emotional issues associated with US immigration policy ndash particularly towards low-wage workers from Mexico ndash policy ndash particularly towards low-wage workers from Mexico ndash is the idea that is the idea that immigrants take jobs away from native immigrants take jobs away from native workers workers We might be tempted to dismiss this fear as another We might be tempted to dismiss this fear as another example of the lump-of-labor fallacy Yet there is a sensible example of the lump-of-labor fallacy Yet there is a sensible intuition behind the argument An increase in the labor force ndash intuition behind the argument An increase in the labor force ndash due either to immigration or to higher population growth rates due either to immigration or to higher population growth rates ndash can be represented as an outward shift of the aggregate labor ndash can be represented as an outward shift of the aggregate labor supply curve as shown in the following Figure Employment supply curve as shown in the following Figure Employment increases but real wages fall It is not then that immigrants increases but real wages fall It is not then that immigrants take jobs away from natives take jobs away from natives Rather they compete for jobsRather they compete for jobs putting downward pressure on real wagesputting downward pressure on real wages

bull Again we must exercise care in interpreting the analysis Again we must exercise care in interpreting the analysis Remember that aggregate labor and average wage rates hide Remember that aggregate labor and average wage rates hide many details of the labor process The incomes of the new many details of the labor process The incomes of the new immigrants immigrants creates demand creates demand for the new production that they for the new production that they make possible Immigrant workers (at least those ndash whether make possible Immigrant workers (at least those ndash whether legal or illegal ndash who have become the focus of the most intense legal or illegal ndash who have become the focus of the most intense political debate) political debate) are likely to possess fewer skills than nativesare likely to possess fewer skills than natives The net effect is that the increased demand for goods and The net effect is that the increased demand for goods and services generated by immigrants is likely to increase the services generated by immigrants is likely to increase the demand for skilled (demand for skilled (and largely nativeand largely native) workers relative to ) workers relative to their supply and so to increase real wages of skilled workers their supply and so to increase real wages of skilled workers Low-skilled immigration may lower the real wage for farm Low-skilled immigration may lower the real wage for farm workers but if anything it would raise the real wage for workers but if anything it would raise the real wage for computer programmerscomputer programmers

Next Task Labor Market in Kuwait

Appendix Is Labor Supply Stable Over Time

bull Statistics on participation rates or average hours for a Statistics on participation rates or average hours for a particular month or year are snapshot of the labor market particular month or year are snapshot of the labor market Can we analyze the effects of that increase on the labor market Can we analyze the effects of that increase on the labor market under the assumption that the labor-supply curves of workers under the assumption that the labor-supply curves of workers remain essentially stableremain essentially stable

bull Data on participation rates in the United States appear to Data on participation rates in the United States appear to support this conjecture (see Figure 811) which shows the support this conjecture (see Figure 811) which shows the overall civilian participation rate trending upward ndash at least overall civilian participation rate trending upward ndash at least from the middle of the 1960sfrom the middle of the 1960s

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

Adding Realism TaxesAdding Realism Taxes

bull How does the tax affect the income from a little more or a little How does the tax affect the income from a little more or a little less work To answer this question we must know the less work To answer this question we must know the marginal marginal tax ratetax rate ((the fraction of an additional dollar of income that is the fraction of an additional dollar of income that is paid as taxes) paid as taxes) To keep things simple assume that all income is To keep things simple assume that all income is taxed at the same taxed at the same flatflat rate rate ττ In this case the marginal tax rate In this case the marginal tax rate must also be τ which takes a value between zero and one If a must also be τ which takes a value between zero and one If a worker earns worker earns wpwp for an hour of work the government takes for an hour of work the government takes τ(wp) τ(wp) as taxes and leaves the worker as taxes and leaves the worker (1ndashτ)(wp) (1ndashτ)(wp) as the after-as the after-tax real wagetax real wage

bull Since the worker actually receives the Since the worker actually receives the after-tax real wageafter-tax real wage it is it is the the true opportunity cost of leisure true opportunity cost of leisure Any increase in the Any increase in the marginal tax rate represents a decrease in the opportunity cost marginal tax rate represents a decrease in the opportunity cost of leisure If of leisure If substitution effectssubstitution effects are stronger than income are stronger than income effects then any increase in marginal tax rates effects then any increase in marginal tax rates reducesreduces the the supply of labor supply of labor as shown in the following figureas shown in the following figure

The Effect of a Tax Increase on Labor Supply

bull The labor-supply curve with no taxes is shown on the right of The labor-supply curve with no taxes is shown on the right of the figure At the figure At (wp)1(wp)1 the worker supplies labor the worker supplies labor l1l1 If a tax of If a tax of τ1τ1 is imposed the after-tax real wage is is imposed the after-tax real wage is (1ndashτ1)(wp)1(1ndashτ1)(wp)1 The worker The worker should react exactly as if he paid no taxes but suffered a cut in should react exactly as if he paid no taxes but suffered a cut in his wages This is shown as a movement from point A to point B his wages This is shown as a movement from point A to point B where labor supply has fallen to where labor supply has fallen to l2l2 But of course the wage rate But of course the wage rate did not really falldid not really fall the employer still pays (wp)1 This means the employer still pays (wp)1 This means that (l2 (wp)1) is the labor-supply (point C)that (l2 (wp)1) is the labor-supply (point C)

bull Since this would apply for any real-wage rate every point on Since this would apply for any real-wage rate every point on the original curve shifts to the left Because the the original curve shifts to the left Because the tax rate is tax rate is proportional its absolute effect is greaterproportional its absolute effect is greater as is the shift in the as is the shift in the labor-supply curve at high wage rates resulting in a labor-supply curve at high wage rates resulting in a steepening of the curve Any further increase in the tax rate to steepening of the curve Any further increase in the tax rate to say τ2 would shift the labor-supply curve further to the left say τ2 would shift the labor-supply curve further to the left

bull The length of the line segment BC measures the The length of the line segment BC measures the TAX WEDGETAX WEDGE between the real wage paid by employers and the after-tax real between the real wage paid by employers and the after-tax real wage received by workewage received by workersrs The The largerlarger the tax wedge the the tax wedge the largerlarger the leftward shift of the labor-supply curve and the the leftward shift of the labor-supply curve and the greater the greater the reductionreduction in labor supplied at any real wage in labor supplied at any real wage

bull The idea that tax increases lower labor supply and conversely The idea that tax increases lower labor supply and conversely that tax cuts increase labor supply was a major tenet of the so-that tax cuts increase labor supply was a major tenet of the so-called called supply-side economicssupply-side economics popular in the early 1980s popular in the early 1980s President Ronald Reagan and his advisors used it to argue that President Ronald Reagan and his advisors used it to argue that cuts in marginal tax rates cuts in marginal tax rates would stimulate people would stimulate people to to workwork harder and to harder and to earn larger earn larger incomesincomes

Adding Realism A Standard WorkweekAdding Realism A Standard Workweek

bull Another way in which the simple analysis of labor supply is Another way in which the simple analysis of labor supply is unrealistic is that many unrealistic is that many workers are not given an option about workers are not given an option about the number of hours they workthe number of hours they work Although people work part- Although people work part-time and overtime either may be voluntary or mandatory time and overtime either may be voluntary or mandatory

bull Assuming that workers are Assuming that workers are not permitted to work more than not permitted to work more than 40 hours a week40 hours a week the following figure includes a constraint of the following figure includes a constraint of 40 hours If the worker were permitted to choose freely then 40 hours If the worker were permitted to choose freely then the labor-supply curve would backward bending curve The the labor-supply curve would backward bending curve The overall effect is to of the standard work week is to reshape the overall effect is to of the standard work week is to reshape the labor-supply curve as indicated by the heavy curve with the labor-supply curve as indicated by the heavy curve with the vertical segment that runs through points A F G D and E vertical segment that runs through points A F G D and E Any worker on this vertical segment is constrainedAny worker on this vertical segment is constrained

The Individual Labor-Supply Curve in PracticeThe Individual Labor-Supply Curve in Practice

bull What does the individual labor-supply curve look like in What does the individual labor-supply curve look like in realityreality It is difficult to answer this question because in reality It is difficult to answer this question because in reality we can observe we can observe only one pointonly one point on the labor-supply curve for a on the labor-supply curve for a single worker single worker at a particular timeat a particular time All the other points are All the other points are conjecturesconjectures about what the worker would supply if faced with about what the worker would supply if faced with different wage rates If we imagine that on average workers are different wage rates If we imagine that on average workers are substantially substantially similarsimilar we might nonetheless get some idea of we might nonetheless get some idea of what the individual labor-supply curve might look likewhat the individual labor-supply curve might look like

bull The The National Longitudinal SurveyNational Longitudinal Survey (Youth) has catalogued the (Youth) has catalogued the work histories of a large sample of individuals starting at a work histories of a large sample of individuals starting at a young age The following figure plots the real-wage rates and young age The following figure plots the real-wage rates and average weekly hours of labor for about average weekly hours of labor for about 1000010000 male workers male workers from this survey for a from this survey for a single periodsingle period with the best fitting flexible with the best fitting flexible line through these points serves as our empirical estimate of the line through these points serves as our empirical estimate of the labor-supply curve for these workerslabor-supply curve for these workers

bull The regression line traces out a shape very The regression line traces out a shape very like the backward-like the backward-bendingbending labor-supply curve with a 40-hour constraint What labor-supply curve with a 40-hour constraint What looks like a vertical line above 40 hours is looks like a vertical line above 40 hours is not really a solid line not really a solid line at all but a reflection of the fact that about at all but a reflection of the fact that about 7500 7500 of the 10000 of the 10000 workers in the sample supply 40 hours per week at a variety of workers in the sample supply 40 hours per week at a variety of wage rates The labor-supply curve traces out a segment above wage rates The labor-supply curve traces out a segment above the 40-hour point that corresponds to the constraintthe 40-hour point that corresponds to the constraint

bull There are There are points to the rightpoints to the right of 40 hours This is reasonable of 40 hours This is reasonable since in the real world workers do since in the real world workers do work overtimework overtime ndash either ndash either because they are supervisors or professionals or because because they are supervisors or professionals or because employers offer them the required time-and-half wage rate employers offer them the required time-and-half wage rate The fit of the regression line is far from perfect points lie on The fit of the regression line is far from perfect points lie on both sides of the line We should interpret it as a both sides of the line We should interpret it as a snapshotsnapshot of of the behavior of the typical worker But ofthe behavior of the typical worker But of course the typical course the typical worker is not any actual worker in particularworker is not any actual worker in particular

THE WORKER CHOOSING TO PARTICIPATETHE WORKER CHOOSING TO PARTICIPATE

bull So far we have examined only one aspect of the workerrsquos So far we have examined only one aspect of the workerrsquos labor-supply decision labor-supply decision how many hours to work for given real how many hours to work for given real wagewage We now take up the second aspect We now take up the second aspect participationparticipation ndash that ndash that is is whether or not to work at allwhether or not to work at all A labor-supply curve that starts A labor-supply curve that starts at the origin and slopes upwards for at least a portion of its at the origin and slopes upwards for at least a portion of its length suggests that even length suggests that even if the wage were very lowif the wage were very low ndash say 1cent ndash say 1cent per hour ndash the worker would work a little bit That is clearly per hour ndash the worker would work a little bit That is clearly unrealisticunrealistic no one would work at all for 1cent per hour no one would work at all for 1cent per hour What What factors determine how high the wage factors determine how high the wage must be to induce a person must be to induce a person to participate in the labor marketto participate in the labor market

bull The labor force The labor force participationparticipation decision is a question of decision is a question of opportunity costopportunity cost Idleness has its charms Before anyone enters Idleness has its charms Before anyone enters the labor force the wage rate must be high enough to overcome the labor force the wage rate must be high enough to overcome them them The opportunity cost of participatingThe opportunity cost of participating in the labor force is in the labor force is sum of sum of

1048766 1048766 the implicit valuethe implicit value the worker places on complete idleness the worker places on complete idleness

1048766 1048766 the explicit coststhe explicit costs of working compared to not working such as of working compared to not working such as clothing transport childcare) andclothing transport childcare) and

1048766 1048766 the explicit losses the explicit losses from working (for instance housework not from working (for instance housework not done)done)

bull The opportunity cost is partly psychological and partly material The opportunity cost is partly psychological and partly material If people were completely If people were completely independentindependent of each other the worker of each other the worker might place a lower value on the opportunity cost of might place a lower value on the opportunity cost of participation because then the choice might be literally between participation because then the choice might be literally between work and starvationwork and starvation

bull But most people are not But most people are not completely independentcompletely independent Whether or Whether or not to participate in the labor force could be a not to participate in the labor force could be a genuine choicegenuine choice and would depend on the and would depend on the real wagereal wage

bull The The RESERVATION WAGE RESERVATION WAGE is defined to be is defined to be the opportunity the opportunity cost of working compared to not workingcost of working compared to not working ndash ndash that is the real wage that is the real wage that is high enough to make it just worthwhile for a worker to that is high enough to make it just worthwhile for a worker to participate in the labor forceparticipate in the labor force

bull Taking account of the opportunity costs of participation affects Taking account of the opportunity costs of participation affects the shape of the labor-supply curve As long as the the shape of the labor-supply curve As long as the real wage is real wage is below the reservationbelow the reservation wage ((wp)R) the worker supplies no wage ((wp)R) the worker supplies no labor at all Above the reservation wage there is a normal labor at all Above the reservation wage there is a normal labor-supply curvelabor-supply curve

bull The following captures the two stages of the labor supply The following captures the two stages of the labor supply decision decision FirstFirst at low wages the worker will at low wages the worker will notnot supply any supply any labor at all and small increases in wages have no effect But labor at all and small increases in wages have no effect But secondsecond as soon as the wage rises enough for the worker to bite as soon as the wage rises enough for the worker to bite the bullet and join the labor force the minimum labor supplied the bullet and join the labor force the minimum labor supplied will be well will be well above zeroabove zero and the worker will decide how many and the worker will decide how many hours to supply above this minimum through the usual process hours to supply above this minimum through the usual process of balancing the opportunity cost of leisure against the desire of balancing the opportunity cost of leisure against the desire for consumption goodsfor consumption goods

AGGREGATE LABOR SUPPLY

bull How can we moveHow can we move from the microeconomics of the labor supply from the microeconomics of the labor supply back to an aggregate relationship usable in macroeconomic back to an aggregate relationship usable in macroeconomic analysis analysis If workers were essentially alikeIf workers were essentially alike the problem would the problem would be easy be easy

bull As we have seen labor supply has two dimensions ndash As we have seen labor supply has two dimensions ndash participationparticipation in the labor force and in the labor force and choice of hourschoice of hours of labor of labor Take the participation decision first If all workers were alike Take the participation decision first If all workers were alike except for except for differences in their reservation wagedifferences in their reservation wage then we could then we could rank them from lowest to highest reservation wage The rank them from lowest to highest reservation wage The aggregate labor-supply (participation) curve is strictly aggregate labor-supply (participation) curve is strictly upwardslopingupwardsloping

bull Of course this is too easy Just as we observed in deriving the Of course this is too easy Just as we observed in deriving the aggregate labor demand curve workers are aggregate labor demand curve workers are not all alikenot all alike Once Once again we must interpret the vertical axis as measuring the again we must interpret the vertical axis as measuring the average real wageaverage real wage that at best provides a kind of index for the that at best provides a kind of index for the level of the wage structure level of the wage structure

bull The The problemproblem remains the remains the samesame when we turn to the choice of when we turn to the choice of hourshours Workers are all different and face a structure of wages Workers are all different and face a structure of wages For each worker individually there is a jump from supplying For each worker individually there is a jump from supplying zero to supplying some positive number of hours zero to supplying some positive number of hours when his own when his own wage rate surpasses their wage rate surpasses their reservation wagereservation wage But in aggregate But in aggregate we are we are unlikely to see such a jumpunlikely to see such a jump Not only are there a variety Not only are there a variety of wages offered at any time but reservation wages differof wages offered at any time but reservation wages differ

Derivation of the Aggregate Labor-supply Curve

bull A curve like the one in this figure can be used to display either A curve like the one in this figure can be used to display either the the participation participation decision or decision or the hoursthe hours The horizontal axis can The horizontal axis can either be used for workers either be used for workers or worker-hoursor worker-hours as measures of the as measures of the labor supply The two meanings are not completely labor supply The two meanings are not completely independent by definition independent by definition

bull workers equiv aggregate worker ndash hours average hours per worker workers equiv aggregate worker ndash hours average hours per worker

The Participation Rate and Average Hours

bull Let us look first at the aggregate participation decision The Let us look first at the aggregate participation decision The aggregate number of workers who have decided to participate aggregate number of workers who have decided to participate is known as the is known as the labor forcelabor force the the civilian labor force over 16 civilian labor force over 16 years of ageyears of age This number excludes uniformed members of the This number excludes uniformed members of the armed services and the small number of workers under 16 armed services and the small number of workers under 16 years old The labor force of course has grown right along years old The labor force of course has grown right along with population with population

bull The participation rateThe participation rate (PR) measures (PR) measures the labor force as its ratio the labor force as its ratio to the relevant populationto the relevant population

bull participation rate = labor forcerelevant population participation rate = labor forcerelevant population

bull ldquoldquonon-institutionalrdquo non-institutionalrdquo excludes people in prison or in homes for excludes people in prison or in homes for the aged) the aged)

bull The aggregate number of hours The aggregate number of hours worked is worked is not as easy not as easy as the as the participation rate to relate to the individual workerrsquos choices participation rate to relate to the individual workerrsquos choices If every worker had the same labor-supply curve we would If every worker had the same labor-supply curve we would have to know the wage offered to each one in order to calculate have to know the wage offered to each one in order to calculate the total number of labor hours supplied In reality workers the total number of labor hours supplied In reality workers are not all alike are not all alike Labor-supply curves may vary systematically Labor-supply curves may vary systematically according to the sex age ethnic group education experience according to the sex age ethnic group education experience or other social or economic characteristics of the workersor other social or economic characteristics of the workers And And within any group the labor-supply curves of individuals are within any group the labor-supply curves of individuals are likely to varylikely to vary

bull In principle In principle if we had a good statistical estimate of the typical if we had a good statistical estimate of the typical distribution of the wagesdistribution of the wages we could make a reasonable we could make a reasonable calculation But statisticians at the Bureau of Labor Statistics calculation But statisticians at the Bureau of Labor Statistics (BLS) do not try to calculate the labor supply in this way (BLS) do not try to calculate the labor supply in this way Instead they Instead they count the number of hours that workers actually count the number of hours that workers actually workwork and the average and the average wages and salaries they are paid wages and salaries they are paid

bull In USA the total hours of labor in 1998 was In USA the total hours of labor in 1998 was 236882236882 million million The average hours of work is The average hours of work is 17211721 hours per year = hours per year = 344344 hours hours per week (assuming a 50 week year) This number is 14 percent per week (assuming a 50 week year) This number is 14 percent below the full time 40-hour week which makes sense since it below the full time 40-hour week which makes sense since it averages over full-time part-time and overtime workers averages over full-time part-time and overtime workers

Labor Market EquilibriumLabor Market Equilibrium

bull MARKET CLEARINGMARKET CLEARING

bull When both demand and supply curves are plotted on the same When both demand and supply curves are plotted on the same diagram the crossing point defines the diagram the crossing point defines the equilibrium real-wage equilibrium real-wage rate and the rate and the equilibrium level of labor employedequilibrium level of labor employed

bull The real wage The real wage looks different looks different from the point of view of the firm from the point of view of the firm and the worker For the and the worker For the firmfirm the relevant real wage is the the relevant real wage is the product-real wage product-real wage defined as defined as the number of units of the good the number of units of the good the firm produces that the wage will purchase the firm produces that the wage will purchase ((price of price of productproduct = = w) w) For the For the workerworker the relevant real wage is the the relevant real wage is the consumption-consumption-real real wagewage defined as defined as the number of typical consumption baskets the number of typical consumption baskets that the wage will purchase that the wage will purchase ((price of price of consumption basket consumption basket = = w)w)

bull For aggregate analysis we might use the For aggregate analysis we might use the Producer Price IndexProducer Price Index or the GDP deflator to approximate the or the GDP deflator to approximate the product priceproduct price and the and the CPICPI to approximate the to approximate the consumption price consumption price

bull Suppose that the product-real wage and the consumption-real Suppose that the product-real wage and the consumption-real wage in the following figure start out with the identical value wage in the following figure start out with the identical value ((wp) at the market-clearing point Awp) at the market-clearing point A Now suppose that Now suppose that imported Japanese cars are a large portion of the typical imported Japanese cars are a large portion of the typical workerrsquos consumption basket workerrsquos consumption basket and that and that ceteris paribus ceteris paribus the price the price of Japanese cars rises sharply This means that the of Japanese cars rises sharply This means that the real wage real wage from the point of view of the from the point of view of the consumer falls to (consumer falls to (wpwpCPICPI ) )11 at point at point

B B on the labor-supply curve (LS) so that the worker would on the labor-supply curve (LS) so that the worker would want to supply less labor (want to supply less labor (LL11))

bull The rise in the price of Japanese cars has no effect on the price The rise in the price of Japanese cars has no effect on the price of their products Nevertheless they see a reduction of labor of their products Nevertheless they see a reduction of labor supply at the original market clearing wage It is as if the supply at the original market clearing wage It is as if the labor-supply curve labor-supply curve has shifted to the left to has shifted to the left to LSLSrsquo which passes rsquo which passes through ((through ((wp) L1) at point C wp) L1) at point C At the original wage rate labor At the original wage rate labor demand exceeds labor supply so firms raise wages in an effort demand exceeds labor supply so firms raise wages in an effort to attract workers until they reach the new market-clearing to attract workers until they reach the new market-clearing wage at point D where they pay (wage at point D where they pay (wpwpPPIPPI ) for labor of L ) for labor of L The The

rise in the price of Japanese cars has the effect of raising the rise in the price of Japanese cars has the effect of raising the wages that firms must pay and reducing labor employedwages that firms must pay and reducing labor employed Higher wages partly compensate workers for the higher costs Higher wages partly compensate workers for the higher costs of consumption but firms can afford to pay those higher wages of consumption but firms can afford to pay those higher wages only if marginal products rise as a result of their using less only if marginal products rise as a result of their using less labor labor

bull The rise in wage rates is not enough to compensate workers The rise in wage rates is not enough to compensate workers fully so the consumption-real wage in equilibrium is (wpfully so the consumption-real wage in equilibrium is (wpCPI CPI ) )

atat point E We can think of import prices as a tax levied on point E We can think of import prices as a tax levied on consumers and of an increase in import prices as widening the consumers and of an increase in import prices as widening the tax wedge Unless the issue that we want to analyze depends on tax wedge Unless the issue that we want to analyze depends on the difference between product- and consumption-real wages the difference between product- and consumption-real wages we will treat the real wage as the same for both labor supply we will treat the real wage as the same for both labor supply and labor demandand labor demand

An Increase in the Price of Consumption GoodsAn Increase in the Price of Consumption GoodsRelative to the Price of OutputRelative to the Price of Output

ANALYZING IDEAL LABOR MARKETSANALYZING IDEAL LABOR MARKETS

bull The aggregate labor-supplylabor-demand diagram provides us The aggregate labor-supplylabor-demand diagram provides us with a powerful tool We now analyze three important with a powerful tool We now analyze three important macroeconomic issues macroeconomic issues

(1) the effect of tax cuts on employment (1) the effect of tax cuts on employment

(2) the effect of technological progress on the well-being of (2) the effect of technological progress on the well-being of workers and workers and

(3) the effect of immigration on existing workers (3) the effect of immigration on existing workers

bull Issue 1 Tax Cuts Issue 1 Tax Cuts What are the effects of a cut in marginal What are the effects of a cut in marginal income-tax rates on employment and the level of GDP in the income-tax rates on employment and the level of GDP in the economyeconomy Recall from section that a lower marginal income-Recall from section that a lower marginal income-tax rate increases labor supply at each real wage (a rightward tax rate increases labor supply at each real wage (a rightward shift of the labor-supply) shift of the labor-supply)

bull Labor-market equilibrium moves from point A to point B in Labor-market equilibrium moves from point A to point B in the lower panel of the following Notice that the amount of the lower panel of the following Notice that the amount of labor available to firms increases so that firms move labor available to firms increases so that firms move production from Arsquo to Brsquo on the labor production function in production from Arsquo to Brsquo on the labor production function in the upper panel Also notice that the real wage falls from (the upper panel Also notice that the real wage falls from (wp)1 wp)1 to (wp)2 Since the cut in taxes increases the number of to (wp)2 Since the cut in taxes increases the number of workers workers willing to work at each wage Workers care about their take-willing to work at each wage Workers care about their take-home pay ndash that is about their home pay ndash that is about their after-tax real wage after-tax real wage This is This is perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 can be greater than the old after-tax real wage (1ndashcan be greater than the old after-tax real wage (1ndashτ1τ1)(wp)1 so )(wp)1 so long as the rise in the take-home share (1 ndash τ) is long as the rise in the take-home share (1 ndash τ) is proportionately greater than the fall in the before-tax real proportionately greater than the fall in the before-tax real wage (wp)wage (wp)

bull The analysis depends on substitution effects dominating The analysis depends on substitution effects dominating income effects which they probably do in aggregate if not for income effects which they probably do in aggregate if not for every worker So the supply-siders of the Reagan years are every worker So the supply-siders of the Reagan years are correct in principle How much output will increase depends on correct in principle How much output will increase depends on how large the substitution effect is If most people work a how large the substitution effect is If most people work a standard 40-hour week the effect could be quite small and the standard 40-hour week the effect could be quite small and the increase in output might also be very small in practiceincrease in output might also be very small in practice

Issue 1 The Effect of a Cut in Marginal Tax RatesIssue 1 The Effect of a Cut in Marginal Tax Rates

Issue 2 Technological Progress and Worker WelfareIssue 2 Technological Progress and Worker Welfare

bull Is technological progress and increasing use of machinery and Is technological progress and increasing use of machinery and other capital beneficial for workersother capital beneficial for workers

bull Technological change or capital accumulation have been Technological change or capital accumulation have been known as ldquoLudditesrdquo (known as ldquoLudditesrdquo (it negatively affects the demand for it negatively affects the demand for laborlabor) To see why the Luddites are wrong ndash at least for ) To see why the Luddites are wrong ndash at least for clearing labor markets ndash recall that technological progress or clearing labor markets ndash recall that technological progress or increased capital both increased capital both shift the labor-demand curve upwardshift the labor-demand curve upward The lower panel of the following figure shows that the effect of The lower panel of the following figure shows that the effect of the increased demand for labor is to increase total employment the increased demand for labor is to increase total employment and the real wage Firms and the real wage Firms can pay a higher real wage can pay a higher real wage because because the additional capital or technological progress the additional capital or technological progress increases the increases the marginal product of labormarginal product of labor

bull The The Ludditesrsquo mistake Ludditesrsquo mistake is most easily seen in the upper panel is most easily seen in the upper panel The Luddite argument assumes that fewer workers will The Luddite argument assumes that fewer workers will produce the same total output Production starts at Arsquo using produce the same total output Production starts at Arsquo using L1 L1 workers to produce Y1 After the upward shift in the production workers to produce Y1 After the upward shift in the production function the same output could be produced using less labor function the same output could be produced using less labor ((L3) at point Arsquorsquo The L3) at point Arsquorsquo The problem is that Arsquorsquo is not an equilibrium problem is that Arsquorsquo is not an equilibrium At that point the marginal product of labor is higher than the At that point the marginal product of labor is higher than the original real wage so a profit-maximizing firm would want to original real wage so a profit-maximizing firm would want to expand production To do this they must hire more labor than expand production To do this they must hire more labor than L3 and indeed they L3 and indeed they find it find it profitable profitable to hire more labor than to hire more labor than the original the original L1 The only way actually to increase labor L1 The only way actually to increase labor is to is to raise the real-wage raise the real-wage rate above its original level Technological rate above its original level Technological progress therefore favors progress therefore favors workers by increasing employment workers by increasing employment and wagesand wages

bull Early in the 19th century hand-woven cloth was very Early in the 19th century hand-woven cloth was very expensive and a worker was lucky to own the clothes on his expensive and a worker was lucky to own the clothes on his back and a spare set for church on Sunday Textiles were one of back and a spare set for church on Sunday Textiles were one of the first industries to benefit from the Industrial Revolution so the first industries to benefit from the Industrial Revolution so that by the end of the 19th century machine-made fabrics and that by the end of the 19th century machine-made fabrics and mass-production made decent clothing in larger quantities mass-production made decent clothing in larger quantities accessible to most of the population of the more developed accessible to most of the population of the more developed countries Similar progress has been made in most forms of countries Similar progress has been made in most forms of production Agricultural production which at the turn of the production Agricultural production which at the turn of the 20th century absorbed half the labor force now absorbs less 20th century absorbed half the labor force now absorbs less than 3 percent while producing more food more cheaply than than 3 percent while producing more food more cheaply than ever ever

bull We must be careful not to dismiss the Luddites as altogether We must be careful not to dismiss the Luddites as altogether foolish While new technology especially over decades has foolish While new technology especially over decades has proved to be a net gain for workers in general the Luddites proved to be a net gain for workers in general the Luddites were in fact correct that their way of life was threatened were in fact correct that their way of life was threatened Independent weavers became factory hands unskilled Independent weavers became factory hands unskilled workers increasingly women and often children replaced workers increasingly women and often children replaced skilled craftsmen and factory work often involved long hours skilled craftsmen and factory work often involved long hours in brutal conditions The wider society reaps the benefits of in brutal conditions The wider society reaps the benefits of technological change while a narrow group sometimes technological change while a narrow group sometimes disproportionately bears its costs Our analysis also assumes disproportionately bears its costs Our analysis also assumes that markets generally clear The implicit assumption is that that markets generally clear The implicit assumption is that displaced workers move on to new jobs possibly in other forms displaced workers move on to new jobs possibly in other forms of production Markets may have a tendency to clear in the of production Markets may have a tendency to clear in the long run yet workers may find themselves displaced in the long run yet workers may find themselves displaced in the short run say over the course of a business cycleshort run say over the course of a business cycle

Issue 3 Immigration Jobs and Real WagesIssue 3 Immigration Jobs and Real Wages

bull How does an increase in the labor force through immigration or How does an increase in the labor force through immigration or natural population growth affect labor and GDP natural population growth affect labor and GDP

bull One of the emotional issues associated with US immigration One of the emotional issues associated with US immigration policy ndash particularly towards low-wage workers from Mexico ndash policy ndash particularly towards low-wage workers from Mexico ndash is the idea that is the idea that immigrants take jobs away from native immigrants take jobs away from native workers workers We might be tempted to dismiss this fear as another We might be tempted to dismiss this fear as another example of the lump-of-labor fallacy Yet there is a sensible example of the lump-of-labor fallacy Yet there is a sensible intuition behind the argument An increase in the labor force ndash intuition behind the argument An increase in the labor force ndash due either to immigration or to higher population growth rates due either to immigration or to higher population growth rates ndash can be represented as an outward shift of the aggregate labor ndash can be represented as an outward shift of the aggregate labor supply curve as shown in the following Figure Employment supply curve as shown in the following Figure Employment increases but real wages fall It is not then that immigrants increases but real wages fall It is not then that immigrants take jobs away from natives take jobs away from natives Rather they compete for jobsRather they compete for jobs putting downward pressure on real wagesputting downward pressure on real wages

bull Again we must exercise care in interpreting the analysis Again we must exercise care in interpreting the analysis Remember that aggregate labor and average wage rates hide Remember that aggregate labor and average wage rates hide many details of the labor process The incomes of the new many details of the labor process The incomes of the new immigrants immigrants creates demand creates demand for the new production that they for the new production that they make possible Immigrant workers (at least those ndash whether make possible Immigrant workers (at least those ndash whether legal or illegal ndash who have become the focus of the most intense legal or illegal ndash who have become the focus of the most intense political debate) political debate) are likely to possess fewer skills than nativesare likely to possess fewer skills than natives The net effect is that the increased demand for goods and The net effect is that the increased demand for goods and services generated by immigrants is likely to increase the services generated by immigrants is likely to increase the demand for skilled (demand for skilled (and largely nativeand largely native) workers relative to ) workers relative to their supply and so to increase real wages of skilled workers their supply and so to increase real wages of skilled workers Low-skilled immigration may lower the real wage for farm Low-skilled immigration may lower the real wage for farm workers but if anything it would raise the real wage for workers but if anything it would raise the real wage for computer programmerscomputer programmers

Next Task Labor Market in Kuwait

Appendix Is Labor Supply Stable Over Time

bull Statistics on participation rates or average hours for a Statistics on participation rates or average hours for a particular month or year are snapshot of the labor market particular month or year are snapshot of the labor market Can we analyze the effects of that increase on the labor market Can we analyze the effects of that increase on the labor market under the assumption that the labor-supply curves of workers under the assumption that the labor-supply curves of workers remain essentially stableremain essentially stable

bull Data on participation rates in the United States appear to Data on participation rates in the United States appear to support this conjecture (see Figure 811) which shows the support this conjecture (see Figure 811) which shows the overall civilian participation rate trending upward ndash at least overall civilian participation rate trending upward ndash at least from the middle of the 1960sfrom the middle of the 1960s

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

The Effect of a Tax Increase on Labor Supply

bull The labor-supply curve with no taxes is shown on the right of The labor-supply curve with no taxes is shown on the right of the figure At the figure At (wp)1(wp)1 the worker supplies labor the worker supplies labor l1l1 If a tax of If a tax of τ1τ1 is imposed the after-tax real wage is is imposed the after-tax real wage is (1ndashτ1)(wp)1(1ndashτ1)(wp)1 The worker The worker should react exactly as if he paid no taxes but suffered a cut in should react exactly as if he paid no taxes but suffered a cut in his wages This is shown as a movement from point A to point B his wages This is shown as a movement from point A to point B where labor supply has fallen to where labor supply has fallen to l2l2 But of course the wage rate But of course the wage rate did not really falldid not really fall the employer still pays (wp)1 This means the employer still pays (wp)1 This means that (l2 (wp)1) is the labor-supply (point C)that (l2 (wp)1) is the labor-supply (point C)

bull Since this would apply for any real-wage rate every point on Since this would apply for any real-wage rate every point on the original curve shifts to the left Because the the original curve shifts to the left Because the tax rate is tax rate is proportional its absolute effect is greaterproportional its absolute effect is greater as is the shift in the as is the shift in the labor-supply curve at high wage rates resulting in a labor-supply curve at high wage rates resulting in a steepening of the curve Any further increase in the tax rate to steepening of the curve Any further increase in the tax rate to say τ2 would shift the labor-supply curve further to the left say τ2 would shift the labor-supply curve further to the left

bull The length of the line segment BC measures the The length of the line segment BC measures the TAX WEDGETAX WEDGE between the real wage paid by employers and the after-tax real between the real wage paid by employers and the after-tax real wage received by workewage received by workersrs The The largerlarger the tax wedge the the tax wedge the largerlarger the leftward shift of the labor-supply curve and the the leftward shift of the labor-supply curve and the greater the greater the reductionreduction in labor supplied at any real wage in labor supplied at any real wage

bull The idea that tax increases lower labor supply and conversely The idea that tax increases lower labor supply and conversely that tax cuts increase labor supply was a major tenet of the so-that tax cuts increase labor supply was a major tenet of the so-called called supply-side economicssupply-side economics popular in the early 1980s popular in the early 1980s President Ronald Reagan and his advisors used it to argue that President Ronald Reagan and his advisors used it to argue that cuts in marginal tax rates cuts in marginal tax rates would stimulate people would stimulate people to to workwork harder and to harder and to earn larger earn larger incomesincomes

Adding Realism A Standard WorkweekAdding Realism A Standard Workweek

bull Another way in which the simple analysis of labor supply is Another way in which the simple analysis of labor supply is unrealistic is that many unrealistic is that many workers are not given an option about workers are not given an option about the number of hours they workthe number of hours they work Although people work part- Although people work part-time and overtime either may be voluntary or mandatory time and overtime either may be voluntary or mandatory

bull Assuming that workers are Assuming that workers are not permitted to work more than not permitted to work more than 40 hours a week40 hours a week the following figure includes a constraint of the following figure includes a constraint of 40 hours If the worker were permitted to choose freely then 40 hours If the worker were permitted to choose freely then the labor-supply curve would backward bending curve The the labor-supply curve would backward bending curve The overall effect is to of the standard work week is to reshape the overall effect is to of the standard work week is to reshape the labor-supply curve as indicated by the heavy curve with the labor-supply curve as indicated by the heavy curve with the vertical segment that runs through points A F G D and E vertical segment that runs through points A F G D and E Any worker on this vertical segment is constrainedAny worker on this vertical segment is constrained

The Individual Labor-Supply Curve in PracticeThe Individual Labor-Supply Curve in Practice

bull What does the individual labor-supply curve look like in What does the individual labor-supply curve look like in realityreality It is difficult to answer this question because in reality It is difficult to answer this question because in reality we can observe we can observe only one pointonly one point on the labor-supply curve for a on the labor-supply curve for a single worker single worker at a particular timeat a particular time All the other points are All the other points are conjecturesconjectures about what the worker would supply if faced with about what the worker would supply if faced with different wage rates If we imagine that on average workers are different wage rates If we imagine that on average workers are substantially substantially similarsimilar we might nonetheless get some idea of we might nonetheless get some idea of what the individual labor-supply curve might look likewhat the individual labor-supply curve might look like

bull The The National Longitudinal SurveyNational Longitudinal Survey (Youth) has catalogued the (Youth) has catalogued the work histories of a large sample of individuals starting at a work histories of a large sample of individuals starting at a young age The following figure plots the real-wage rates and young age The following figure plots the real-wage rates and average weekly hours of labor for about average weekly hours of labor for about 1000010000 male workers male workers from this survey for a from this survey for a single periodsingle period with the best fitting flexible with the best fitting flexible line through these points serves as our empirical estimate of the line through these points serves as our empirical estimate of the labor-supply curve for these workerslabor-supply curve for these workers

bull The regression line traces out a shape very The regression line traces out a shape very like the backward-like the backward-bendingbending labor-supply curve with a 40-hour constraint What labor-supply curve with a 40-hour constraint What looks like a vertical line above 40 hours is looks like a vertical line above 40 hours is not really a solid line not really a solid line at all but a reflection of the fact that about at all but a reflection of the fact that about 7500 7500 of the 10000 of the 10000 workers in the sample supply 40 hours per week at a variety of workers in the sample supply 40 hours per week at a variety of wage rates The labor-supply curve traces out a segment above wage rates The labor-supply curve traces out a segment above the 40-hour point that corresponds to the constraintthe 40-hour point that corresponds to the constraint

bull There are There are points to the rightpoints to the right of 40 hours This is reasonable of 40 hours This is reasonable since in the real world workers do since in the real world workers do work overtimework overtime ndash either ndash either because they are supervisors or professionals or because because they are supervisors or professionals or because employers offer them the required time-and-half wage rate employers offer them the required time-and-half wage rate The fit of the regression line is far from perfect points lie on The fit of the regression line is far from perfect points lie on both sides of the line We should interpret it as a both sides of the line We should interpret it as a snapshotsnapshot of of the behavior of the typical worker But ofthe behavior of the typical worker But of course the typical course the typical worker is not any actual worker in particularworker is not any actual worker in particular

THE WORKER CHOOSING TO PARTICIPATETHE WORKER CHOOSING TO PARTICIPATE

bull So far we have examined only one aspect of the workerrsquos So far we have examined only one aspect of the workerrsquos labor-supply decision labor-supply decision how many hours to work for given real how many hours to work for given real wagewage We now take up the second aspect We now take up the second aspect participationparticipation ndash that ndash that is is whether or not to work at allwhether or not to work at all A labor-supply curve that starts A labor-supply curve that starts at the origin and slopes upwards for at least a portion of its at the origin and slopes upwards for at least a portion of its length suggests that even length suggests that even if the wage were very lowif the wage were very low ndash say 1cent ndash say 1cent per hour ndash the worker would work a little bit That is clearly per hour ndash the worker would work a little bit That is clearly unrealisticunrealistic no one would work at all for 1cent per hour no one would work at all for 1cent per hour What What factors determine how high the wage factors determine how high the wage must be to induce a person must be to induce a person to participate in the labor marketto participate in the labor market

bull The labor force The labor force participationparticipation decision is a question of decision is a question of opportunity costopportunity cost Idleness has its charms Before anyone enters Idleness has its charms Before anyone enters the labor force the wage rate must be high enough to overcome the labor force the wage rate must be high enough to overcome them them The opportunity cost of participatingThe opportunity cost of participating in the labor force is in the labor force is sum of sum of

1048766 1048766 the implicit valuethe implicit value the worker places on complete idleness the worker places on complete idleness

1048766 1048766 the explicit coststhe explicit costs of working compared to not working such as of working compared to not working such as clothing transport childcare) andclothing transport childcare) and

1048766 1048766 the explicit losses the explicit losses from working (for instance housework not from working (for instance housework not done)done)

bull The opportunity cost is partly psychological and partly material The opportunity cost is partly psychological and partly material If people were completely If people were completely independentindependent of each other the worker of each other the worker might place a lower value on the opportunity cost of might place a lower value on the opportunity cost of participation because then the choice might be literally between participation because then the choice might be literally between work and starvationwork and starvation

bull But most people are not But most people are not completely independentcompletely independent Whether or Whether or not to participate in the labor force could be a not to participate in the labor force could be a genuine choicegenuine choice and would depend on the and would depend on the real wagereal wage

bull The The RESERVATION WAGE RESERVATION WAGE is defined to be is defined to be the opportunity the opportunity cost of working compared to not workingcost of working compared to not working ndash ndash that is the real wage that is the real wage that is high enough to make it just worthwhile for a worker to that is high enough to make it just worthwhile for a worker to participate in the labor forceparticipate in the labor force

bull Taking account of the opportunity costs of participation affects Taking account of the opportunity costs of participation affects the shape of the labor-supply curve As long as the the shape of the labor-supply curve As long as the real wage is real wage is below the reservationbelow the reservation wage ((wp)R) the worker supplies no wage ((wp)R) the worker supplies no labor at all Above the reservation wage there is a normal labor at all Above the reservation wage there is a normal labor-supply curvelabor-supply curve

bull The following captures the two stages of the labor supply The following captures the two stages of the labor supply decision decision FirstFirst at low wages the worker will at low wages the worker will notnot supply any supply any labor at all and small increases in wages have no effect But labor at all and small increases in wages have no effect But secondsecond as soon as the wage rises enough for the worker to bite as soon as the wage rises enough for the worker to bite the bullet and join the labor force the minimum labor supplied the bullet and join the labor force the minimum labor supplied will be well will be well above zeroabove zero and the worker will decide how many and the worker will decide how many hours to supply above this minimum through the usual process hours to supply above this minimum through the usual process of balancing the opportunity cost of leisure against the desire of balancing the opportunity cost of leisure against the desire for consumption goodsfor consumption goods

AGGREGATE LABOR SUPPLY

bull How can we moveHow can we move from the microeconomics of the labor supply from the microeconomics of the labor supply back to an aggregate relationship usable in macroeconomic back to an aggregate relationship usable in macroeconomic analysis analysis If workers were essentially alikeIf workers were essentially alike the problem would the problem would be easy be easy

bull As we have seen labor supply has two dimensions ndash As we have seen labor supply has two dimensions ndash participationparticipation in the labor force and in the labor force and choice of hourschoice of hours of labor of labor Take the participation decision first If all workers were alike Take the participation decision first If all workers were alike except for except for differences in their reservation wagedifferences in their reservation wage then we could then we could rank them from lowest to highest reservation wage The rank them from lowest to highest reservation wage The aggregate labor-supply (participation) curve is strictly aggregate labor-supply (participation) curve is strictly upwardslopingupwardsloping

bull Of course this is too easy Just as we observed in deriving the Of course this is too easy Just as we observed in deriving the aggregate labor demand curve workers are aggregate labor demand curve workers are not all alikenot all alike Once Once again we must interpret the vertical axis as measuring the again we must interpret the vertical axis as measuring the average real wageaverage real wage that at best provides a kind of index for the that at best provides a kind of index for the level of the wage structure level of the wage structure

bull The The problemproblem remains the remains the samesame when we turn to the choice of when we turn to the choice of hourshours Workers are all different and face a structure of wages Workers are all different and face a structure of wages For each worker individually there is a jump from supplying For each worker individually there is a jump from supplying zero to supplying some positive number of hours zero to supplying some positive number of hours when his own when his own wage rate surpasses their wage rate surpasses their reservation wagereservation wage But in aggregate But in aggregate we are we are unlikely to see such a jumpunlikely to see such a jump Not only are there a variety Not only are there a variety of wages offered at any time but reservation wages differof wages offered at any time but reservation wages differ

Derivation of the Aggregate Labor-supply Curve

bull A curve like the one in this figure can be used to display either A curve like the one in this figure can be used to display either the the participation participation decision or decision or the hoursthe hours The horizontal axis can The horizontal axis can either be used for workers either be used for workers or worker-hoursor worker-hours as measures of the as measures of the labor supply The two meanings are not completely labor supply The two meanings are not completely independent by definition independent by definition

bull workers equiv aggregate worker ndash hours average hours per worker workers equiv aggregate worker ndash hours average hours per worker

The Participation Rate and Average Hours

bull Let us look first at the aggregate participation decision The Let us look first at the aggregate participation decision The aggregate number of workers who have decided to participate aggregate number of workers who have decided to participate is known as the is known as the labor forcelabor force the the civilian labor force over 16 civilian labor force over 16 years of ageyears of age This number excludes uniformed members of the This number excludes uniformed members of the armed services and the small number of workers under 16 armed services and the small number of workers under 16 years old The labor force of course has grown right along years old The labor force of course has grown right along with population with population

bull The participation rateThe participation rate (PR) measures (PR) measures the labor force as its ratio the labor force as its ratio to the relevant populationto the relevant population

bull participation rate = labor forcerelevant population participation rate = labor forcerelevant population

bull ldquoldquonon-institutionalrdquo non-institutionalrdquo excludes people in prison or in homes for excludes people in prison or in homes for the aged) the aged)

bull The aggregate number of hours The aggregate number of hours worked is worked is not as easy not as easy as the as the participation rate to relate to the individual workerrsquos choices participation rate to relate to the individual workerrsquos choices If every worker had the same labor-supply curve we would If every worker had the same labor-supply curve we would have to know the wage offered to each one in order to calculate have to know the wage offered to each one in order to calculate the total number of labor hours supplied In reality workers the total number of labor hours supplied In reality workers are not all alike are not all alike Labor-supply curves may vary systematically Labor-supply curves may vary systematically according to the sex age ethnic group education experience according to the sex age ethnic group education experience or other social or economic characteristics of the workersor other social or economic characteristics of the workers And And within any group the labor-supply curves of individuals are within any group the labor-supply curves of individuals are likely to varylikely to vary

bull In principle In principle if we had a good statistical estimate of the typical if we had a good statistical estimate of the typical distribution of the wagesdistribution of the wages we could make a reasonable we could make a reasonable calculation But statisticians at the Bureau of Labor Statistics calculation But statisticians at the Bureau of Labor Statistics (BLS) do not try to calculate the labor supply in this way (BLS) do not try to calculate the labor supply in this way Instead they Instead they count the number of hours that workers actually count the number of hours that workers actually workwork and the average and the average wages and salaries they are paid wages and salaries they are paid

bull In USA the total hours of labor in 1998 was In USA the total hours of labor in 1998 was 236882236882 million million The average hours of work is The average hours of work is 17211721 hours per year = hours per year = 344344 hours hours per week (assuming a 50 week year) This number is 14 percent per week (assuming a 50 week year) This number is 14 percent below the full time 40-hour week which makes sense since it below the full time 40-hour week which makes sense since it averages over full-time part-time and overtime workers averages over full-time part-time and overtime workers

Labor Market EquilibriumLabor Market Equilibrium

bull MARKET CLEARINGMARKET CLEARING

bull When both demand and supply curves are plotted on the same When both demand and supply curves are plotted on the same diagram the crossing point defines the diagram the crossing point defines the equilibrium real-wage equilibrium real-wage rate and the rate and the equilibrium level of labor employedequilibrium level of labor employed

bull The real wage The real wage looks different looks different from the point of view of the firm from the point of view of the firm and the worker For the and the worker For the firmfirm the relevant real wage is the the relevant real wage is the product-real wage product-real wage defined as defined as the number of units of the good the number of units of the good the firm produces that the wage will purchase the firm produces that the wage will purchase ((price of price of productproduct = = w) w) For the For the workerworker the relevant real wage is the the relevant real wage is the consumption-consumption-real real wagewage defined as defined as the number of typical consumption baskets the number of typical consumption baskets that the wage will purchase that the wage will purchase ((price of price of consumption basket consumption basket = = w)w)

bull For aggregate analysis we might use the For aggregate analysis we might use the Producer Price IndexProducer Price Index or the GDP deflator to approximate the or the GDP deflator to approximate the product priceproduct price and the and the CPICPI to approximate the to approximate the consumption price consumption price

bull Suppose that the product-real wage and the consumption-real Suppose that the product-real wage and the consumption-real wage in the following figure start out with the identical value wage in the following figure start out with the identical value ((wp) at the market-clearing point Awp) at the market-clearing point A Now suppose that Now suppose that imported Japanese cars are a large portion of the typical imported Japanese cars are a large portion of the typical workerrsquos consumption basket workerrsquos consumption basket and that and that ceteris paribus ceteris paribus the price the price of Japanese cars rises sharply This means that the of Japanese cars rises sharply This means that the real wage real wage from the point of view of the from the point of view of the consumer falls to (consumer falls to (wpwpCPICPI ) )11 at point at point

B B on the labor-supply curve (LS) so that the worker would on the labor-supply curve (LS) so that the worker would want to supply less labor (want to supply less labor (LL11))

bull The rise in the price of Japanese cars has no effect on the price The rise in the price of Japanese cars has no effect on the price of their products Nevertheless they see a reduction of labor of their products Nevertheless they see a reduction of labor supply at the original market clearing wage It is as if the supply at the original market clearing wage It is as if the labor-supply curve labor-supply curve has shifted to the left to has shifted to the left to LSLSrsquo which passes rsquo which passes through ((through ((wp) L1) at point C wp) L1) at point C At the original wage rate labor At the original wage rate labor demand exceeds labor supply so firms raise wages in an effort demand exceeds labor supply so firms raise wages in an effort to attract workers until they reach the new market-clearing to attract workers until they reach the new market-clearing wage at point D where they pay (wage at point D where they pay (wpwpPPIPPI ) for labor of L ) for labor of L The The

rise in the price of Japanese cars has the effect of raising the rise in the price of Japanese cars has the effect of raising the wages that firms must pay and reducing labor employedwages that firms must pay and reducing labor employed Higher wages partly compensate workers for the higher costs Higher wages partly compensate workers for the higher costs of consumption but firms can afford to pay those higher wages of consumption but firms can afford to pay those higher wages only if marginal products rise as a result of their using less only if marginal products rise as a result of their using less labor labor

bull The rise in wage rates is not enough to compensate workers The rise in wage rates is not enough to compensate workers fully so the consumption-real wage in equilibrium is (wpfully so the consumption-real wage in equilibrium is (wpCPI CPI ) )

atat point E We can think of import prices as a tax levied on point E We can think of import prices as a tax levied on consumers and of an increase in import prices as widening the consumers and of an increase in import prices as widening the tax wedge Unless the issue that we want to analyze depends on tax wedge Unless the issue that we want to analyze depends on the difference between product- and consumption-real wages the difference between product- and consumption-real wages we will treat the real wage as the same for both labor supply we will treat the real wage as the same for both labor supply and labor demandand labor demand

An Increase in the Price of Consumption GoodsAn Increase in the Price of Consumption GoodsRelative to the Price of OutputRelative to the Price of Output

ANALYZING IDEAL LABOR MARKETSANALYZING IDEAL LABOR MARKETS

bull The aggregate labor-supplylabor-demand diagram provides us The aggregate labor-supplylabor-demand diagram provides us with a powerful tool We now analyze three important with a powerful tool We now analyze three important macroeconomic issues macroeconomic issues

(1) the effect of tax cuts on employment (1) the effect of tax cuts on employment

(2) the effect of technological progress on the well-being of (2) the effect of technological progress on the well-being of workers and workers and

(3) the effect of immigration on existing workers (3) the effect of immigration on existing workers

bull Issue 1 Tax Cuts Issue 1 Tax Cuts What are the effects of a cut in marginal What are the effects of a cut in marginal income-tax rates on employment and the level of GDP in the income-tax rates on employment and the level of GDP in the economyeconomy Recall from section that a lower marginal income-Recall from section that a lower marginal income-tax rate increases labor supply at each real wage (a rightward tax rate increases labor supply at each real wage (a rightward shift of the labor-supply) shift of the labor-supply)

bull Labor-market equilibrium moves from point A to point B in Labor-market equilibrium moves from point A to point B in the lower panel of the following Notice that the amount of the lower panel of the following Notice that the amount of labor available to firms increases so that firms move labor available to firms increases so that firms move production from Arsquo to Brsquo on the labor production function in production from Arsquo to Brsquo on the labor production function in the upper panel Also notice that the real wage falls from (the upper panel Also notice that the real wage falls from (wp)1 wp)1 to (wp)2 Since the cut in taxes increases the number of to (wp)2 Since the cut in taxes increases the number of workers workers willing to work at each wage Workers care about their take-willing to work at each wage Workers care about their take-home pay ndash that is about their home pay ndash that is about their after-tax real wage after-tax real wage This is This is perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 can be greater than the old after-tax real wage (1ndashcan be greater than the old after-tax real wage (1ndashτ1τ1)(wp)1 so )(wp)1 so long as the rise in the take-home share (1 ndash τ) is long as the rise in the take-home share (1 ndash τ) is proportionately greater than the fall in the before-tax real proportionately greater than the fall in the before-tax real wage (wp)wage (wp)

bull The analysis depends on substitution effects dominating The analysis depends on substitution effects dominating income effects which they probably do in aggregate if not for income effects which they probably do in aggregate if not for every worker So the supply-siders of the Reagan years are every worker So the supply-siders of the Reagan years are correct in principle How much output will increase depends on correct in principle How much output will increase depends on how large the substitution effect is If most people work a how large the substitution effect is If most people work a standard 40-hour week the effect could be quite small and the standard 40-hour week the effect could be quite small and the increase in output might also be very small in practiceincrease in output might also be very small in practice

Issue 1 The Effect of a Cut in Marginal Tax RatesIssue 1 The Effect of a Cut in Marginal Tax Rates

Issue 2 Technological Progress and Worker WelfareIssue 2 Technological Progress and Worker Welfare

bull Is technological progress and increasing use of machinery and Is technological progress and increasing use of machinery and other capital beneficial for workersother capital beneficial for workers

bull Technological change or capital accumulation have been Technological change or capital accumulation have been known as ldquoLudditesrdquo (known as ldquoLudditesrdquo (it negatively affects the demand for it negatively affects the demand for laborlabor) To see why the Luddites are wrong ndash at least for ) To see why the Luddites are wrong ndash at least for clearing labor markets ndash recall that technological progress or clearing labor markets ndash recall that technological progress or increased capital both increased capital both shift the labor-demand curve upwardshift the labor-demand curve upward The lower panel of the following figure shows that the effect of The lower panel of the following figure shows that the effect of the increased demand for labor is to increase total employment the increased demand for labor is to increase total employment and the real wage Firms and the real wage Firms can pay a higher real wage can pay a higher real wage because because the additional capital or technological progress the additional capital or technological progress increases the increases the marginal product of labormarginal product of labor

bull The The Ludditesrsquo mistake Ludditesrsquo mistake is most easily seen in the upper panel is most easily seen in the upper panel The Luddite argument assumes that fewer workers will The Luddite argument assumes that fewer workers will produce the same total output Production starts at Arsquo using produce the same total output Production starts at Arsquo using L1 L1 workers to produce Y1 After the upward shift in the production workers to produce Y1 After the upward shift in the production function the same output could be produced using less labor function the same output could be produced using less labor ((L3) at point Arsquorsquo The L3) at point Arsquorsquo The problem is that Arsquorsquo is not an equilibrium problem is that Arsquorsquo is not an equilibrium At that point the marginal product of labor is higher than the At that point the marginal product of labor is higher than the original real wage so a profit-maximizing firm would want to original real wage so a profit-maximizing firm would want to expand production To do this they must hire more labor than expand production To do this they must hire more labor than L3 and indeed they L3 and indeed they find it find it profitable profitable to hire more labor than to hire more labor than the original the original L1 The only way actually to increase labor L1 The only way actually to increase labor is to is to raise the real-wage raise the real-wage rate above its original level Technological rate above its original level Technological progress therefore favors progress therefore favors workers by increasing employment workers by increasing employment and wagesand wages

bull Early in the 19th century hand-woven cloth was very Early in the 19th century hand-woven cloth was very expensive and a worker was lucky to own the clothes on his expensive and a worker was lucky to own the clothes on his back and a spare set for church on Sunday Textiles were one of back and a spare set for church on Sunday Textiles were one of the first industries to benefit from the Industrial Revolution so the first industries to benefit from the Industrial Revolution so that by the end of the 19th century machine-made fabrics and that by the end of the 19th century machine-made fabrics and mass-production made decent clothing in larger quantities mass-production made decent clothing in larger quantities accessible to most of the population of the more developed accessible to most of the population of the more developed countries Similar progress has been made in most forms of countries Similar progress has been made in most forms of production Agricultural production which at the turn of the production Agricultural production which at the turn of the 20th century absorbed half the labor force now absorbs less 20th century absorbed half the labor force now absorbs less than 3 percent while producing more food more cheaply than than 3 percent while producing more food more cheaply than ever ever

bull We must be careful not to dismiss the Luddites as altogether We must be careful not to dismiss the Luddites as altogether foolish While new technology especially over decades has foolish While new technology especially over decades has proved to be a net gain for workers in general the Luddites proved to be a net gain for workers in general the Luddites were in fact correct that their way of life was threatened were in fact correct that their way of life was threatened Independent weavers became factory hands unskilled Independent weavers became factory hands unskilled workers increasingly women and often children replaced workers increasingly women and often children replaced skilled craftsmen and factory work often involved long hours skilled craftsmen and factory work often involved long hours in brutal conditions The wider society reaps the benefits of in brutal conditions The wider society reaps the benefits of technological change while a narrow group sometimes technological change while a narrow group sometimes disproportionately bears its costs Our analysis also assumes disproportionately bears its costs Our analysis also assumes that markets generally clear The implicit assumption is that that markets generally clear The implicit assumption is that displaced workers move on to new jobs possibly in other forms displaced workers move on to new jobs possibly in other forms of production Markets may have a tendency to clear in the of production Markets may have a tendency to clear in the long run yet workers may find themselves displaced in the long run yet workers may find themselves displaced in the short run say over the course of a business cycleshort run say over the course of a business cycle

Issue 3 Immigration Jobs and Real WagesIssue 3 Immigration Jobs and Real Wages

bull How does an increase in the labor force through immigration or How does an increase in the labor force through immigration or natural population growth affect labor and GDP natural population growth affect labor and GDP

bull One of the emotional issues associated with US immigration One of the emotional issues associated with US immigration policy ndash particularly towards low-wage workers from Mexico ndash policy ndash particularly towards low-wage workers from Mexico ndash is the idea that is the idea that immigrants take jobs away from native immigrants take jobs away from native workers workers We might be tempted to dismiss this fear as another We might be tempted to dismiss this fear as another example of the lump-of-labor fallacy Yet there is a sensible example of the lump-of-labor fallacy Yet there is a sensible intuition behind the argument An increase in the labor force ndash intuition behind the argument An increase in the labor force ndash due either to immigration or to higher population growth rates due either to immigration or to higher population growth rates ndash can be represented as an outward shift of the aggregate labor ndash can be represented as an outward shift of the aggregate labor supply curve as shown in the following Figure Employment supply curve as shown in the following Figure Employment increases but real wages fall It is not then that immigrants increases but real wages fall It is not then that immigrants take jobs away from natives take jobs away from natives Rather they compete for jobsRather they compete for jobs putting downward pressure on real wagesputting downward pressure on real wages

bull Again we must exercise care in interpreting the analysis Again we must exercise care in interpreting the analysis Remember that aggregate labor and average wage rates hide Remember that aggregate labor and average wage rates hide many details of the labor process The incomes of the new many details of the labor process The incomes of the new immigrants immigrants creates demand creates demand for the new production that they for the new production that they make possible Immigrant workers (at least those ndash whether make possible Immigrant workers (at least those ndash whether legal or illegal ndash who have become the focus of the most intense legal or illegal ndash who have become the focus of the most intense political debate) political debate) are likely to possess fewer skills than nativesare likely to possess fewer skills than natives The net effect is that the increased demand for goods and The net effect is that the increased demand for goods and services generated by immigrants is likely to increase the services generated by immigrants is likely to increase the demand for skilled (demand for skilled (and largely nativeand largely native) workers relative to ) workers relative to their supply and so to increase real wages of skilled workers their supply and so to increase real wages of skilled workers Low-skilled immigration may lower the real wage for farm Low-skilled immigration may lower the real wage for farm workers but if anything it would raise the real wage for workers but if anything it would raise the real wage for computer programmerscomputer programmers

Next Task Labor Market in Kuwait

Appendix Is Labor Supply Stable Over Time

bull Statistics on participation rates or average hours for a Statistics on participation rates or average hours for a particular month or year are snapshot of the labor market particular month or year are snapshot of the labor market Can we analyze the effects of that increase on the labor market Can we analyze the effects of that increase on the labor market under the assumption that the labor-supply curves of workers under the assumption that the labor-supply curves of workers remain essentially stableremain essentially stable

bull Data on participation rates in the United States appear to Data on participation rates in the United States appear to support this conjecture (see Figure 811) which shows the support this conjecture (see Figure 811) which shows the overall civilian participation rate trending upward ndash at least overall civilian participation rate trending upward ndash at least from the middle of the 1960sfrom the middle of the 1960s

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

bull The labor-supply curve with no taxes is shown on the right of The labor-supply curve with no taxes is shown on the right of the figure At the figure At (wp)1(wp)1 the worker supplies labor the worker supplies labor l1l1 If a tax of If a tax of τ1τ1 is imposed the after-tax real wage is is imposed the after-tax real wage is (1ndashτ1)(wp)1(1ndashτ1)(wp)1 The worker The worker should react exactly as if he paid no taxes but suffered a cut in should react exactly as if he paid no taxes but suffered a cut in his wages This is shown as a movement from point A to point B his wages This is shown as a movement from point A to point B where labor supply has fallen to where labor supply has fallen to l2l2 But of course the wage rate But of course the wage rate did not really falldid not really fall the employer still pays (wp)1 This means the employer still pays (wp)1 This means that (l2 (wp)1) is the labor-supply (point C)that (l2 (wp)1) is the labor-supply (point C)

bull Since this would apply for any real-wage rate every point on Since this would apply for any real-wage rate every point on the original curve shifts to the left Because the the original curve shifts to the left Because the tax rate is tax rate is proportional its absolute effect is greaterproportional its absolute effect is greater as is the shift in the as is the shift in the labor-supply curve at high wage rates resulting in a labor-supply curve at high wage rates resulting in a steepening of the curve Any further increase in the tax rate to steepening of the curve Any further increase in the tax rate to say τ2 would shift the labor-supply curve further to the left say τ2 would shift the labor-supply curve further to the left

bull The length of the line segment BC measures the The length of the line segment BC measures the TAX WEDGETAX WEDGE between the real wage paid by employers and the after-tax real between the real wage paid by employers and the after-tax real wage received by workewage received by workersrs The The largerlarger the tax wedge the the tax wedge the largerlarger the leftward shift of the labor-supply curve and the the leftward shift of the labor-supply curve and the greater the greater the reductionreduction in labor supplied at any real wage in labor supplied at any real wage

bull The idea that tax increases lower labor supply and conversely The idea that tax increases lower labor supply and conversely that tax cuts increase labor supply was a major tenet of the so-that tax cuts increase labor supply was a major tenet of the so-called called supply-side economicssupply-side economics popular in the early 1980s popular in the early 1980s President Ronald Reagan and his advisors used it to argue that President Ronald Reagan and his advisors used it to argue that cuts in marginal tax rates cuts in marginal tax rates would stimulate people would stimulate people to to workwork harder and to harder and to earn larger earn larger incomesincomes

Adding Realism A Standard WorkweekAdding Realism A Standard Workweek

bull Another way in which the simple analysis of labor supply is Another way in which the simple analysis of labor supply is unrealistic is that many unrealistic is that many workers are not given an option about workers are not given an option about the number of hours they workthe number of hours they work Although people work part- Although people work part-time and overtime either may be voluntary or mandatory time and overtime either may be voluntary or mandatory

bull Assuming that workers are Assuming that workers are not permitted to work more than not permitted to work more than 40 hours a week40 hours a week the following figure includes a constraint of the following figure includes a constraint of 40 hours If the worker were permitted to choose freely then 40 hours If the worker were permitted to choose freely then the labor-supply curve would backward bending curve The the labor-supply curve would backward bending curve The overall effect is to of the standard work week is to reshape the overall effect is to of the standard work week is to reshape the labor-supply curve as indicated by the heavy curve with the labor-supply curve as indicated by the heavy curve with the vertical segment that runs through points A F G D and E vertical segment that runs through points A F G D and E Any worker on this vertical segment is constrainedAny worker on this vertical segment is constrained

The Individual Labor-Supply Curve in PracticeThe Individual Labor-Supply Curve in Practice

bull What does the individual labor-supply curve look like in What does the individual labor-supply curve look like in realityreality It is difficult to answer this question because in reality It is difficult to answer this question because in reality we can observe we can observe only one pointonly one point on the labor-supply curve for a on the labor-supply curve for a single worker single worker at a particular timeat a particular time All the other points are All the other points are conjecturesconjectures about what the worker would supply if faced with about what the worker would supply if faced with different wage rates If we imagine that on average workers are different wage rates If we imagine that on average workers are substantially substantially similarsimilar we might nonetheless get some idea of we might nonetheless get some idea of what the individual labor-supply curve might look likewhat the individual labor-supply curve might look like

bull The The National Longitudinal SurveyNational Longitudinal Survey (Youth) has catalogued the (Youth) has catalogued the work histories of a large sample of individuals starting at a work histories of a large sample of individuals starting at a young age The following figure plots the real-wage rates and young age The following figure plots the real-wage rates and average weekly hours of labor for about average weekly hours of labor for about 1000010000 male workers male workers from this survey for a from this survey for a single periodsingle period with the best fitting flexible with the best fitting flexible line through these points serves as our empirical estimate of the line through these points serves as our empirical estimate of the labor-supply curve for these workerslabor-supply curve for these workers

bull The regression line traces out a shape very The regression line traces out a shape very like the backward-like the backward-bendingbending labor-supply curve with a 40-hour constraint What labor-supply curve with a 40-hour constraint What looks like a vertical line above 40 hours is looks like a vertical line above 40 hours is not really a solid line not really a solid line at all but a reflection of the fact that about at all but a reflection of the fact that about 7500 7500 of the 10000 of the 10000 workers in the sample supply 40 hours per week at a variety of workers in the sample supply 40 hours per week at a variety of wage rates The labor-supply curve traces out a segment above wage rates The labor-supply curve traces out a segment above the 40-hour point that corresponds to the constraintthe 40-hour point that corresponds to the constraint

bull There are There are points to the rightpoints to the right of 40 hours This is reasonable of 40 hours This is reasonable since in the real world workers do since in the real world workers do work overtimework overtime ndash either ndash either because they are supervisors or professionals or because because they are supervisors or professionals or because employers offer them the required time-and-half wage rate employers offer them the required time-and-half wage rate The fit of the regression line is far from perfect points lie on The fit of the regression line is far from perfect points lie on both sides of the line We should interpret it as a both sides of the line We should interpret it as a snapshotsnapshot of of the behavior of the typical worker But ofthe behavior of the typical worker But of course the typical course the typical worker is not any actual worker in particularworker is not any actual worker in particular

THE WORKER CHOOSING TO PARTICIPATETHE WORKER CHOOSING TO PARTICIPATE

bull So far we have examined only one aspect of the workerrsquos So far we have examined only one aspect of the workerrsquos labor-supply decision labor-supply decision how many hours to work for given real how many hours to work for given real wagewage We now take up the second aspect We now take up the second aspect participationparticipation ndash that ndash that is is whether or not to work at allwhether or not to work at all A labor-supply curve that starts A labor-supply curve that starts at the origin and slopes upwards for at least a portion of its at the origin and slopes upwards for at least a portion of its length suggests that even length suggests that even if the wage were very lowif the wage were very low ndash say 1cent ndash say 1cent per hour ndash the worker would work a little bit That is clearly per hour ndash the worker would work a little bit That is clearly unrealisticunrealistic no one would work at all for 1cent per hour no one would work at all for 1cent per hour What What factors determine how high the wage factors determine how high the wage must be to induce a person must be to induce a person to participate in the labor marketto participate in the labor market

bull The labor force The labor force participationparticipation decision is a question of decision is a question of opportunity costopportunity cost Idleness has its charms Before anyone enters Idleness has its charms Before anyone enters the labor force the wage rate must be high enough to overcome the labor force the wage rate must be high enough to overcome them them The opportunity cost of participatingThe opportunity cost of participating in the labor force is in the labor force is sum of sum of

1048766 1048766 the implicit valuethe implicit value the worker places on complete idleness the worker places on complete idleness

1048766 1048766 the explicit coststhe explicit costs of working compared to not working such as of working compared to not working such as clothing transport childcare) andclothing transport childcare) and

1048766 1048766 the explicit losses the explicit losses from working (for instance housework not from working (for instance housework not done)done)

bull The opportunity cost is partly psychological and partly material The opportunity cost is partly psychological and partly material If people were completely If people were completely independentindependent of each other the worker of each other the worker might place a lower value on the opportunity cost of might place a lower value on the opportunity cost of participation because then the choice might be literally between participation because then the choice might be literally between work and starvationwork and starvation

bull But most people are not But most people are not completely independentcompletely independent Whether or Whether or not to participate in the labor force could be a not to participate in the labor force could be a genuine choicegenuine choice and would depend on the and would depend on the real wagereal wage

bull The The RESERVATION WAGE RESERVATION WAGE is defined to be is defined to be the opportunity the opportunity cost of working compared to not workingcost of working compared to not working ndash ndash that is the real wage that is the real wage that is high enough to make it just worthwhile for a worker to that is high enough to make it just worthwhile for a worker to participate in the labor forceparticipate in the labor force

bull Taking account of the opportunity costs of participation affects Taking account of the opportunity costs of participation affects the shape of the labor-supply curve As long as the the shape of the labor-supply curve As long as the real wage is real wage is below the reservationbelow the reservation wage ((wp)R) the worker supplies no wage ((wp)R) the worker supplies no labor at all Above the reservation wage there is a normal labor at all Above the reservation wage there is a normal labor-supply curvelabor-supply curve

bull The following captures the two stages of the labor supply The following captures the two stages of the labor supply decision decision FirstFirst at low wages the worker will at low wages the worker will notnot supply any supply any labor at all and small increases in wages have no effect But labor at all and small increases in wages have no effect But secondsecond as soon as the wage rises enough for the worker to bite as soon as the wage rises enough for the worker to bite the bullet and join the labor force the minimum labor supplied the bullet and join the labor force the minimum labor supplied will be well will be well above zeroabove zero and the worker will decide how many and the worker will decide how many hours to supply above this minimum through the usual process hours to supply above this minimum through the usual process of balancing the opportunity cost of leisure against the desire of balancing the opportunity cost of leisure against the desire for consumption goodsfor consumption goods

AGGREGATE LABOR SUPPLY

bull How can we moveHow can we move from the microeconomics of the labor supply from the microeconomics of the labor supply back to an aggregate relationship usable in macroeconomic back to an aggregate relationship usable in macroeconomic analysis analysis If workers were essentially alikeIf workers were essentially alike the problem would the problem would be easy be easy

bull As we have seen labor supply has two dimensions ndash As we have seen labor supply has two dimensions ndash participationparticipation in the labor force and in the labor force and choice of hourschoice of hours of labor of labor Take the participation decision first If all workers were alike Take the participation decision first If all workers were alike except for except for differences in their reservation wagedifferences in their reservation wage then we could then we could rank them from lowest to highest reservation wage The rank them from lowest to highest reservation wage The aggregate labor-supply (participation) curve is strictly aggregate labor-supply (participation) curve is strictly upwardslopingupwardsloping

bull Of course this is too easy Just as we observed in deriving the Of course this is too easy Just as we observed in deriving the aggregate labor demand curve workers are aggregate labor demand curve workers are not all alikenot all alike Once Once again we must interpret the vertical axis as measuring the again we must interpret the vertical axis as measuring the average real wageaverage real wage that at best provides a kind of index for the that at best provides a kind of index for the level of the wage structure level of the wage structure

bull The The problemproblem remains the remains the samesame when we turn to the choice of when we turn to the choice of hourshours Workers are all different and face a structure of wages Workers are all different and face a structure of wages For each worker individually there is a jump from supplying For each worker individually there is a jump from supplying zero to supplying some positive number of hours zero to supplying some positive number of hours when his own when his own wage rate surpasses their wage rate surpasses their reservation wagereservation wage But in aggregate But in aggregate we are we are unlikely to see such a jumpunlikely to see such a jump Not only are there a variety Not only are there a variety of wages offered at any time but reservation wages differof wages offered at any time but reservation wages differ

Derivation of the Aggregate Labor-supply Curve

bull A curve like the one in this figure can be used to display either A curve like the one in this figure can be used to display either the the participation participation decision or decision or the hoursthe hours The horizontal axis can The horizontal axis can either be used for workers either be used for workers or worker-hoursor worker-hours as measures of the as measures of the labor supply The two meanings are not completely labor supply The two meanings are not completely independent by definition independent by definition

bull workers equiv aggregate worker ndash hours average hours per worker workers equiv aggregate worker ndash hours average hours per worker

The Participation Rate and Average Hours

bull Let us look first at the aggregate participation decision The Let us look first at the aggregate participation decision The aggregate number of workers who have decided to participate aggregate number of workers who have decided to participate is known as the is known as the labor forcelabor force the the civilian labor force over 16 civilian labor force over 16 years of ageyears of age This number excludes uniformed members of the This number excludes uniformed members of the armed services and the small number of workers under 16 armed services and the small number of workers under 16 years old The labor force of course has grown right along years old The labor force of course has grown right along with population with population

bull The participation rateThe participation rate (PR) measures (PR) measures the labor force as its ratio the labor force as its ratio to the relevant populationto the relevant population

bull participation rate = labor forcerelevant population participation rate = labor forcerelevant population

bull ldquoldquonon-institutionalrdquo non-institutionalrdquo excludes people in prison or in homes for excludes people in prison or in homes for the aged) the aged)

bull The aggregate number of hours The aggregate number of hours worked is worked is not as easy not as easy as the as the participation rate to relate to the individual workerrsquos choices participation rate to relate to the individual workerrsquos choices If every worker had the same labor-supply curve we would If every worker had the same labor-supply curve we would have to know the wage offered to each one in order to calculate have to know the wage offered to each one in order to calculate the total number of labor hours supplied In reality workers the total number of labor hours supplied In reality workers are not all alike are not all alike Labor-supply curves may vary systematically Labor-supply curves may vary systematically according to the sex age ethnic group education experience according to the sex age ethnic group education experience or other social or economic characteristics of the workersor other social or economic characteristics of the workers And And within any group the labor-supply curves of individuals are within any group the labor-supply curves of individuals are likely to varylikely to vary

bull In principle In principle if we had a good statistical estimate of the typical if we had a good statistical estimate of the typical distribution of the wagesdistribution of the wages we could make a reasonable we could make a reasonable calculation But statisticians at the Bureau of Labor Statistics calculation But statisticians at the Bureau of Labor Statistics (BLS) do not try to calculate the labor supply in this way (BLS) do not try to calculate the labor supply in this way Instead they Instead they count the number of hours that workers actually count the number of hours that workers actually workwork and the average and the average wages and salaries they are paid wages and salaries they are paid

bull In USA the total hours of labor in 1998 was In USA the total hours of labor in 1998 was 236882236882 million million The average hours of work is The average hours of work is 17211721 hours per year = hours per year = 344344 hours hours per week (assuming a 50 week year) This number is 14 percent per week (assuming a 50 week year) This number is 14 percent below the full time 40-hour week which makes sense since it below the full time 40-hour week which makes sense since it averages over full-time part-time and overtime workers averages over full-time part-time and overtime workers

Labor Market EquilibriumLabor Market Equilibrium

bull MARKET CLEARINGMARKET CLEARING

bull When both demand and supply curves are plotted on the same When both demand and supply curves are plotted on the same diagram the crossing point defines the diagram the crossing point defines the equilibrium real-wage equilibrium real-wage rate and the rate and the equilibrium level of labor employedequilibrium level of labor employed

bull The real wage The real wage looks different looks different from the point of view of the firm from the point of view of the firm and the worker For the and the worker For the firmfirm the relevant real wage is the the relevant real wage is the product-real wage product-real wage defined as defined as the number of units of the good the number of units of the good the firm produces that the wage will purchase the firm produces that the wage will purchase ((price of price of productproduct = = w) w) For the For the workerworker the relevant real wage is the the relevant real wage is the consumption-consumption-real real wagewage defined as defined as the number of typical consumption baskets the number of typical consumption baskets that the wage will purchase that the wage will purchase ((price of price of consumption basket consumption basket = = w)w)

bull For aggregate analysis we might use the For aggregate analysis we might use the Producer Price IndexProducer Price Index or the GDP deflator to approximate the or the GDP deflator to approximate the product priceproduct price and the and the CPICPI to approximate the to approximate the consumption price consumption price

bull Suppose that the product-real wage and the consumption-real Suppose that the product-real wage and the consumption-real wage in the following figure start out with the identical value wage in the following figure start out with the identical value ((wp) at the market-clearing point Awp) at the market-clearing point A Now suppose that Now suppose that imported Japanese cars are a large portion of the typical imported Japanese cars are a large portion of the typical workerrsquos consumption basket workerrsquos consumption basket and that and that ceteris paribus ceteris paribus the price the price of Japanese cars rises sharply This means that the of Japanese cars rises sharply This means that the real wage real wage from the point of view of the from the point of view of the consumer falls to (consumer falls to (wpwpCPICPI ) )11 at point at point

B B on the labor-supply curve (LS) so that the worker would on the labor-supply curve (LS) so that the worker would want to supply less labor (want to supply less labor (LL11))

bull The rise in the price of Japanese cars has no effect on the price The rise in the price of Japanese cars has no effect on the price of their products Nevertheless they see a reduction of labor of their products Nevertheless they see a reduction of labor supply at the original market clearing wage It is as if the supply at the original market clearing wage It is as if the labor-supply curve labor-supply curve has shifted to the left to has shifted to the left to LSLSrsquo which passes rsquo which passes through ((through ((wp) L1) at point C wp) L1) at point C At the original wage rate labor At the original wage rate labor demand exceeds labor supply so firms raise wages in an effort demand exceeds labor supply so firms raise wages in an effort to attract workers until they reach the new market-clearing to attract workers until they reach the new market-clearing wage at point D where they pay (wage at point D where they pay (wpwpPPIPPI ) for labor of L ) for labor of L The The

rise in the price of Japanese cars has the effect of raising the rise in the price of Japanese cars has the effect of raising the wages that firms must pay and reducing labor employedwages that firms must pay and reducing labor employed Higher wages partly compensate workers for the higher costs Higher wages partly compensate workers for the higher costs of consumption but firms can afford to pay those higher wages of consumption but firms can afford to pay those higher wages only if marginal products rise as a result of their using less only if marginal products rise as a result of their using less labor labor

bull The rise in wage rates is not enough to compensate workers The rise in wage rates is not enough to compensate workers fully so the consumption-real wage in equilibrium is (wpfully so the consumption-real wage in equilibrium is (wpCPI CPI ) )

atat point E We can think of import prices as a tax levied on point E We can think of import prices as a tax levied on consumers and of an increase in import prices as widening the consumers and of an increase in import prices as widening the tax wedge Unless the issue that we want to analyze depends on tax wedge Unless the issue that we want to analyze depends on the difference between product- and consumption-real wages the difference between product- and consumption-real wages we will treat the real wage as the same for both labor supply we will treat the real wage as the same for both labor supply and labor demandand labor demand

An Increase in the Price of Consumption GoodsAn Increase in the Price of Consumption GoodsRelative to the Price of OutputRelative to the Price of Output

ANALYZING IDEAL LABOR MARKETSANALYZING IDEAL LABOR MARKETS

bull The aggregate labor-supplylabor-demand diagram provides us The aggregate labor-supplylabor-demand diagram provides us with a powerful tool We now analyze three important with a powerful tool We now analyze three important macroeconomic issues macroeconomic issues

(1) the effect of tax cuts on employment (1) the effect of tax cuts on employment

(2) the effect of technological progress on the well-being of (2) the effect of technological progress on the well-being of workers and workers and

(3) the effect of immigration on existing workers (3) the effect of immigration on existing workers

bull Issue 1 Tax Cuts Issue 1 Tax Cuts What are the effects of a cut in marginal What are the effects of a cut in marginal income-tax rates on employment and the level of GDP in the income-tax rates on employment and the level of GDP in the economyeconomy Recall from section that a lower marginal income-Recall from section that a lower marginal income-tax rate increases labor supply at each real wage (a rightward tax rate increases labor supply at each real wage (a rightward shift of the labor-supply) shift of the labor-supply)

bull Labor-market equilibrium moves from point A to point B in Labor-market equilibrium moves from point A to point B in the lower panel of the following Notice that the amount of the lower panel of the following Notice that the amount of labor available to firms increases so that firms move labor available to firms increases so that firms move production from Arsquo to Brsquo on the labor production function in production from Arsquo to Brsquo on the labor production function in the upper panel Also notice that the real wage falls from (the upper panel Also notice that the real wage falls from (wp)1 wp)1 to (wp)2 Since the cut in taxes increases the number of to (wp)2 Since the cut in taxes increases the number of workers workers willing to work at each wage Workers care about their take-willing to work at each wage Workers care about their take-home pay ndash that is about their home pay ndash that is about their after-tax real wage after-tax real wage This is This is perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 can be greater than the old after-tax real wage (1ndashcan be greater than the old after-tax real wage (1ndashτ1τ1)(wp)1 so )(wp)1 so long as the rise in the take-home share (1 ndash τ) is long as the rise in the take-home share (1 ndash τ) is proportionately greater than the fall in the before-tax real proportionately greater than the fall in the before-tax real wage (wp)wage (wp)

bull The analysis depends on substitution effects dominating The analysis depends on substitution effects dominating income effects which they probably do in aggregate if not for income effects which they probably do in aggregate if not for every worker So the supply-siders of the Reagan years are every worker So the supply-siders of the Reagan years are correct in principle How much output will increase depends on correct in principle How much output will increase depends on how large the substitution effect is If most people work a how large the substitution effect is If most people work a standard 40-hour week the effect could be quite small and the standard 40-hour week the effect could be quite small and the increase in output might also be very small in practiceincrease in output might also be very small in practice

Issue 1 The Effect of a Cut in Marginal Tax RatesIssue 1 The Effect of a Cut in Marginal Tax Rates

Issue 2 Technological Progress and Worker WelfareIssue 2 Technological Progress and Worker Welfare

bull Is technological progress and increasing use of machinery and Is technological progress and increasing use of machinery and other capital beneficial for workersother capital beneficial for workers

bull Technological change or capital accumulation have been Technological change or capital accumulation have been known as ldquoLudditesrdquo (known as ldquoLudditesrdquo (it negatively affects the demand for it negatively affects the demand for laborlabor) To see why the Luddites are wrong ndash at least for ) To see why the Luddites are wrong ndash at least for clearing labor markets ndash recall that technological progress or clearing labor markets ndash recall that technological progress or increased capital both increased capital both shift the labor-demand curve upwardshift the labor-demand curve upward The lower panel of the following figure shows that the effect of The lower panel of the following figure shows that the effect of the increased demand for labor is to increase total employment the increased demand for labor is to increase total employment and the real wage Firms and the real wage Firms can pay a higher real wage can pay a higher real wage because because the additional capital or technological progress the additional capital or technological progress increases the increases the marginal product of labormarginal product of labor

bull The The Ludditesrsquo mistake Ludditesrsquo mistake is most easily seen in the upper panel is most easily seen in the upper panel The Luddite argument assumes that fewer workers will The Luddite argument assumes that fewer workers will produce the same total output Production starts at Arsquo using produce the same total output Production starts at Arsquo using L1 L1 workers to produce Y1 After the upward shift in the production workers to produce Y1 After the upward shift in the production function the same output could be produced using less labor function the same output could be produced using less labor ((L3) at point Arsquorsquo The L3) at point Arsquorsquo The problem is that Arsquorsquo is not an equilibrium problem is that Arsquorsquo is not an equilibrium At that point the marginal product of labor is higher than the At that point the marginal product of labor is higher than the original real wage so a profit-maximizing firm would want to original real wage so a profit-maximizing firm would want to expand production To do this they must hire more labor than expand production To do this they must hire more labor than L3 and indeed they L3 and indeed they find it find it profitable profitable to hire more labor than to hire more labor than the original the original L1 The only way actually to increase labor L1 The only way actually to increase labor is to is to raise the real-wage raise the real-wage rate above its original level Technological rate above its original level Technological progress therefore favors progress therefore favors workers by increasing employment workers by increasing employment and wagesand wages

bull Early in the 19th century hand-woven cloth was very Early in the 19th century hand-woven cloth was very expensive and a worker was lucky to own the clothes on his expensive and a worker was lucky to own the clothes on his back and a spare set for church on Sunday Textiles were one of back and a spare set for church on Sunday Textiles were one of the first industries to benefit from the Industrial Revolution so the first industries to benefit from the Industrial Revolution so that by the end of the 19th century machine-made fabrics and that by the end of the 19th century machine-made fabrics and mass-production made decent clothing in larger quantities mass-production made decent clothing in larger quantities accessible to most of the population of the more developed accessible to most of the population of the more developed countries Similar progress has been made in most forms of countries Similar progress has been made in most forms of production Agricultural production which at the turn of the production Agricultural production which at the turn of the 20th century absorbed half the labor force now absorbs less 20th century absorbed half the labor force now absorbs less than 3 percent while producing more food more cheaply than than 3 percent while producing more food more cheaply than ever ever

bull We must be careful not to dismiss the Luddites as altogether We must be careful not to dismiss the Luddites as altogether foolish While new technology especially over decades has foolish While new technology especially over decades has proved to be a net gain for workers in general the Luddites proved to be a net gain for workers in general the Luddites were in fact correct that their way of life was threatened were in fact correct that their way of life was threatened Independent weavers became factory hands unskilled Independent weavers became factory hands unskilled workers increasingly women and often children replaced workers increasingly women and often children replaced skilled craftsmen and factory work often involved long hours skilled craftsmen and factory work often involved long hours in brutal conditions The wider society reaps the benefits of in brutal conditions The wider society reaps the benefits of technological change while a narrow group sometimes technological change while a narrow group sometimes disproportionately bears its costs Our analysis also assumes disproportionately bears its costs Our analysis also assumes that markets generally clear The implicit assumption is that that markets generally clear The implicit assumption is that displaced workers move on to new jobs possibly in other forms displaced workers move on to new jobs possibly in other forms of production Markets may have a tendency to clear in the of production Markets may have a tendency to clear in the long run yet workers may find themselves displaced in the long run yet workers may find themselves displaced in the short run say over the course of a business cycleshort run say over the course of a business cycle

Issue 3 Immigration Jobs and Real WagesIssue 3 Immigration Jobs and Real Wages

bull How does an increase in the labor force through immigration or How does an increase in the labor force through immigration or natural population growth affect labor and GDP natural population growth affect labor and GDP

bull One of the emotional issues associated with US immigration One of the emotional issues associated with US immigration policy ndash particularly towards low-wage workers from Mexico ndash policy ndash particularly towards low-wage workers from Mexico ndash is the idea that is the idea that immigrants take jobs away from native immigrants take jobs away from native workers workers We might be tempted to dismiss this fear as another We might be tempted to dismiss this fear as another example of the lump-of-labor fallacy Yet there is a sensible example of the lump-of-labor fallacy Yet there is a sensible intuition behind the argument An increase in the labor force ndash intuition behind the argument An increase in the labor force ndash due either to immigration or to higher population growth rates due either to immigration or to higher population growth rates ndash can be represented as an outward shift of the aggregate labor ndash can be represented as an outward shift of the aggregate labor supply curve as shown in the following Figure Employment supply curve as shown in the following Figure Employment increases but real wages fall It is not then that immigrants increases but real wages fall It is not then that immigrants take jobs away from natives take jobs away from natives Rather they compete for jobsRather they compete for jobs putting downward pressure on real wagesputting downward pressure on real wages

bull Again we must exercise care in interpreting the analysis Again we must exercise care in interpreting the analysis Remember that aggregate labor and average wage rates hide Remember that aggregate labor and average wage rates hide many details of the labor process The incomes of the new many details of the labor process The incomes of the new immigrants immigrants creates demand creates demand for the new production that they for the new production that they make possible Immigrant workers (at least those ndash whether make possible Immigrant workers (at least those ndash whether legal or illegal ndash who have become the focus of the most intense legal or illegal ndash who have become the focus of the most intense political debate) political debate) are likely to possess fewer skills than nativesare likely to possess fewer skills than natives The net effect is that the increased demand for goods and The net effect is that the increased demand for goods and services generated by immigrants is likely to increase the services generated by immigrants is likely to increase the demand for skilled (demand for skilled (and largely nativeand largely native) workers relative to ) workers relative to their supply and so to increase real wages of skilled workers their supply and so to increase real wages of skilled workers Low-skilled immigration may lower the real wage for farm Low-skilled immigration may lower the real wage for farm workers but if anything it would raise the real wage for workers but if anything it would raise the real wage for computer programmerscomputer programmers

Next Task Labor Market in Kuwait

Appendix Is Labor Supply Stable Over Time

bull Statistics on participation rates or average hours for a Statistics on participation rates or average hours for a particular month or year are snapshot of the labor market particular month or year are snapshot of the labor market Can we analyze the effects of that increase on the labor market Can we analyze the effects of that increase on the labor market under the assumption that the labor-supply curves of workers under the assumption that the labor-supply curves of workers remain essentially stableremain essentially stable

bull Data on participation rates in the United States appear to Data on participation rates in the United States appear to support this conjecture (see Figure 811) which shows the support this conjecture (see Figure 811) which shows the overall civilian participation rate trending upward ndash at least overall civilian participation rate trending upward ndash at least from the middle of the 1960sfrom the middle of the 1960s

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

bull The length of the line segment BC measures the The length of the line segment BC measures the TAX WEDGETAX WEDGE between the real wage paid by employers and the after-tax real between the real wage paid by employers and the after-tax real wage received by workewage received by workersrs The The largerlarger the tax wedge the the tax wedge the largerlarger the leftward shift of the labor-supply curve and the the leftward shift of the labor-supply curve and the greater the greater the reductionreduction in labor supplied at any real wage in labor supplied at any real wage

bull The idea that tax increases lower labor supply and conversely The idea that tax increases lower labor supply and conversely that tax cuts increase labor supply was a major tenet of the so-that tax cuts increase labor supply was a major tenet of the so-called called supply-side economicssupply-side economics popular in the early 1980s popular in the early 1980s President Ronald Reagan and his advisors used it to argue that President Ronald Reagan and his advisors used it to argue that cuts in marginal tax rates cuts in marginal tax rates would stimulate people would stimulate people to to workwork harder and to harder and to earn larger earn larger incomesincomes

Adding Realism A Standard WorkweekAdding Realism A Standard Workweek

bull Another way in which the simple analysis of labor supply is Another way in which the simple analysis of labor supply is unrealistic is that many unrealistic is that many workers are not given an option about workers are not given an option about the number of hours they workthe number of hours they work Although people work part- Although people work part-time and overtime either may be voluntary or mandatory time and overtime either may be voluntary or mandatory

bull Assuming that workers are Assuming that workers are not permitted to work more than not permitted to work more than 40 hours a week40 hours a week the following figure includes a constraint of the following figure includes a constraint of 40 hours If the worker were permitted to choose freely then 40 hours If the worker were permitted to choose freely then the labor-supply curve would backward bending curve The the labor-supply curve would backward bending curve The overall effect is to of the standard work week is to reshape the overall effect is to of the standard work week is to reshape the labor-supply curve as indicated by the heavy curve with the labor-supply curve as indicated by the heavy curve with the vertical segment that runs through points A F G D and E vertical segment that runs through points A F G D and E Any worker on this vertical segment is constrainedAny worker on this vertical segment is constrained

The Individual Labor-Supply Curve in PracticeThe Individual Labor-Supply Curve in Practice

bull What does the individual labor-supply curve look like in What does the individual labor-supply curve look like in realityreality It is difficult to answer this question because in reality It is difficult to answer this question because in reality we can observe we can observe only one pointonly one point on the labor-supply curve for a on the labor-supply curve for a single worker single worker at a particular timeat a particular time All the other points are All the other points are conjecturesconjectures about what the worker would supply if faced with about what the worker would supply if faced with different wage rates If we imagine that on average workers are different wage rates If we imagine that on average workers are substantially substantially similarsimilar we might nonetheless get some idea of we might nonetheless get some idea of what the individual labor-supply curve might look likewhat the individual labor-supply curve might look like

bull The The National Longitudinal SurveyNational Longitudinal Survey (Youth) has catalogued the (Youth) has catalogued the work histories of a large sample of individuals starting at a work histories of a large sample of individuals starting at a young age The following figure plots the real-wage rates and young age The following figure plots the real-wage rates and average weekly hours of labor for about average weekly hours of labor for about 1000010000 male workers male workers from this survey for a from this survey for a single periodsingle period with the best fitting flexible with the best fitting flexible line through these points serves as our empirical estimate of the line through these points serves as our empirical estimate of the labor-supply curve for these workerslabor-supply curve for these workers

bull The regression line traces out a shape very The regression line traces out a shape very like the backward-like the backward-bendingbending labor-supply curve with a 40-hour constraint What labor-supply curve with a 40-hour constraint What looks like a vertical line above 40 hours is looks like a vertical line above 40 hours is not really a solid line not really a solid line at all but a reflection of the fact that about at all but a reflection of the fact that about 7500 7500 of the 10000 of the 10000 workers in the sample supply 40 hours per week at a variety of workers in the sample supply 40 hours per week at a variety of wage rates The labor-supply curve traces out a segment above wage rates The labor-supply curve traces out a segment above the 40-hour point that corresponds to the constraintthe 40-hour point that corresponds to the constraint

bull There are There are points to the rightpoints to the right of 40 hours This is reasonable of 40 hours This is reasonable since in the real world workers do since in the real world workers do work overtimework overtime ndash either ndash either because they are supervisors or professionals or because because they are supervisors or professionals or because employers offer them the required time-and-half wage rate employers offer them the required time-and-half wage rate The fit of the regression line is far from perfect points lie on The fit of the regression line is far from perfect points lie on both sides of the line We should interpret it as a both sides of the line We should interpret it as a snapshotsnapshot of of the behavior of the typical worker But ofthe behavior of the typical worker But of course the typical course the typical worker is not any actual worker in particularworker is not any actual worker in particular

THE WORKER CHOOSING TO PARTICIPATETHE WORKER CHOOSING TO PARTICIPATE

bull So far we have examined only one aspect of the workerrsquos So far we have examined only one aspect of the workerrsquos labor-supply decision labor-supply decision how many hours to work for given real how many hours to work for given real wagewage We now take up the second aspect We now take up the second aspect participationparticipation ndash that ndash that is is whether or not to work at allwhether or not to work at all A labor-supply curve that starts A labor-supply curve that starts at the origin and slopes upwards for at least a portion of its at the origin and slopes upwards for at least a portion of its length suggests that even length suggests that even if the wage were very lowif the wage were very low ndash say 1cent ndash say 1cent per hour ndash the worker would work a little bit That is clearly per hour ndash the worker would work a little bit That is clearly unrealisticunrealistic no one would work at all for 1cent per hour no one would work at all for 1cent per hour What What factors determine how high the wage factors determine how high the wage must be to induce a person must be to induce a person to participate in the labor marketto participate in the labor market

bull The labor force The labor force participationparticipation decision is a question of decision is a question of opportunity costopportunity cost Idleness has its charms Before anyone enters Idleness has its charms Before anyone enters the labor force the wage rate must be high enough to overcome the labor force the wage rate must be high enough to overcome them them The opportunity cost of participatingThe opportunity cost of participating in the labor force is in the labor force is sum of sum of

1048766 1048766 the implicit valuethe implicit value the worker places on complete idleness the worker places on complete idleness

1048766 1048766 the explicit coststhe explicit costs of working compared to not working such as of working compared to not working such as clothing transport childcare) andclothing transport childcare) and

1048766 1048766 the explicit losses the explicit losses from working (for instance housework not from working (for instance housework not done)done)

bull The opportunity cost is partly psychological and partly material The opportunity cost is partly psychological and partly material If people were completely If people were completely independentindependent of each other the worker of each other the worker might place a lower value on the opportunity cost of might place a lower value on the opportunity cost of participation because then the choice might be literally between participation because then the choice might be literally between work and starvationwork and starvation

bull But most people are not But most people are not completely independentcompletely independent Whether or Whether or not to participate in the labor force could be a not to participate in the labor force could be a genuine choicegenuine choice and would depend on the and would depend on the real wagereal wage

bull The The RESERVATION WAGE RESERVATION WAGE is defined to be is defined to be the opportunity the opportunity cost of working compared to not workingcost of working compared to not working ndash ndash that is the real wage that is the real wage that is high enough to make it just worthwhile for a worker to that is high enough to make it just worthwhile for a worker to participate in the labor forceparticipate in the labor force

bull Taking account of the opportunity costs of participation affects Taking account of the opportunity costs of participation affects the shape of the labor-supply curve As long as the the shape of the labor-supply curve As long as the real wage is real wage is below the reservationbelow the reservation wage ((wp)R) the worker supplies no wage ((wp)R) the worker supplies no labor at all Above the reservation wage there is a normal labor at all Above the reservation wage there is a normal labor-supply curvelabor-supply curve

bull The following captures the two stages of the labor supply The following captures the two stages of the labor supply decision decision FirstFirst at low wages the worker will at low wages the worker will notnot supply any supply any labor at all and small increases in wages have no effect But labor at all and small increases in wages have no effect But secondsecond as soon as the wage rises enough for the worker to bite as soon as the wage rises enough for the worker to bite the bullet and join the labor force the minimum labor supplied the bullet and join the labor force the minimum labor supplied will be well will be well above zeroabove zero and the worker will decide how many and the worker will decide how many hours to supply above this minimum through the usual process hours to supply above this minimum through the usual process of balancing the opportunity cost of leisure against the desire of balancing the opportunity cost of leisure against the desire for consumption goodsfor consumption goods

AGGREGATE LABOR SUPPLY

bull How can we moveHow can we move from the microeconomics of the labor supply from the microeconomics of the labor supply back to an aggregate relationship usable in macroeconomic back to an aggregate relationship usable in macroeconomic analysis analysis If workers were essentially alikeIf workers were essentially alike the problem would the problem would be easy be easy

bull As we have seen labor supply has two dimensions ndash As we have seen labor supply has two dimensions ndash participationparticipation in the labor force and in the labor force and choice of hourschoice of hours of labor of labor Take the participation decision first If all workers were alike Take the participation decision first If all workers were alike except for except for differences in their reservation wagedifferences in their reservation wage then we could then we could rank them from lowest to highest reservation wage The rank them from lowest to highest reservation wage The aggregate labor-supply (participation) curve is strictly aggregate labor-supply (participation) curve is strictly upwardslopingupwardsloping

bull Of course this is too easy Just as we observed in deriving the Of course this is too easy Just as we observed in deriving the aggregate labor demand curve workers are aggregate labor demand curve workers are not all alikenot all alike Once Once again we must interpret the vertical axis as measuring the again we must interpret the vertical axis as measuring the average real wageaverage real wage that at best provides a kind of index for the that at best provides a kind of index for the level of the wage structure level of the wage structure

bull The The problemproblem remains the remains the samesame when we turn to the choice of when we turn to the choice of hourshours Workers are all different and face a structure of wages Workers are all different and face a structure of wages For each worker individually there is a jump from supplying For each worker individually there is a jump from supplying zero to supplying some positive number of hours zero to supplying some positive number of hours when his own when his own wage rate surpasses their wage rate surpasses their reservation wagereservation wage But in aggregate But in aggregate we are we are unlikely to see such a jumpunlikely to see such a jump Not only are there a variety Not only are there a variety of wages offered at any time but reservation wages differof wages offered at any time but reservation wages differ

Derivation of the Aggregate Labor-supply Curve

bull A curve like the one in this figure can be used to display either A curve like the one in this figure can be used to display either the the participation participation decision or decision or the hoursthe hours The horizontal axis can The horizontal axis can either be used for workers either be used for workers or worker-hoursor worker-hours as measures of the as measures of the labor supply The two meanings are not completely labor supply The two meanings are not completely independent by definition independent by definition

bull workers equiv aggregate worker ndash hours average hours per worker workers equiv aggregate worker ndash hours average hours per worker

The Participation Rate and Average Hours

bull Let us look first at the aggregate participation decision The Let us look first at the aggregate participation decision The aggregate number of workers who have decided to participate aggregate number of workers who have decided to participate is known as the is known as the labor forcelabor force the the civilian labor force over 16 civilian labor force over 16 years of ageyears of age This number excludes uniformed members of the This number excludes uniformed members of the armed services and the small number of workers under 16 armed services and the small number of workers under 16 years old The labor force of course has grown right along years old The labor force of course has grown right along with population with population

bull The participation rateThe participation rate (PR) measures (PR) measures the labor force as its ratio the labor force as its ratio to the relevant populationto the relevant population

bull participation rate = labor forcerelevant population participation rate = labor forcerelevant population

bull ldquoldquonon-institutionalrdquo non-institutionalrdquo excludes people in prison or in homes for excludes people in prison or in homes for the aged) the aged)

bull The aggregate number of hours The aggregate number of hours worked is worked is not as easy not as easy as the as the participation rate to relate to the individual workerrsquos choices participation rate to relate to the individual workerrsquos choices If every worker had the same labor-supply curve we would If every worker had the same labor-supply curve we would have to know the wage offered to each one in order to calculate have to know the wage offered to each one in order to calculate the total number of labor hours supplied In reality workers the total number of labor hours supplied In reality workers are not all alike are not all alike Labor-supply curves may vary systematically Labor-supply curves may vary systematically according to the sex age ethnic group education experience according to the sex age ethnic group education experience or other social or economic characteristics of the workersor other social or economic characteristics of the workers And And within any group the labor-supply curves of individuals are within any group the labor-supply curves of individuals are likely to varylikely to vary

bull In principle In principle if we had a good statistical estimate of the typical if we had a good statistical estimate of the typical distribution of the wagesdistribution of the wages we could make a reasonable we could make a reasonable calculation But statisticians at the Bureau of Labor Statistics calculation But statisticians at the Bureau of Labor Statistics (BLS) do not try to calculate the labor supply in this way (BLS) do not try to calculate the labor supply in this way Instead they Instead they count the number of hours that workers actually count the number of hours that workers actually workwork and the average and the average wages and salaries they are paid wages and salaries they are paid

bull In USA the total hours of labor in 1998 was In USA the total hours of labor in 1998 was 236882236882 million million The average hours of work is The average hours of work is 17211721 hours per year = hours per year = 344344 hours hours per week (assuming a 50 week year) This number is 14 percent per week (assuming a 50 week year) This number is 14 percent below the full time 40-hour week which makes sense since it below the full time 40-hour week which makes sense since it averages over full-time part-time and overtime workers averages over full-time part-time and overtime workers

Labor Market EquilibriumLabor Market Equilibrium

bull MARKET CLEARINGMARKET CLEARING

bull When both demand and supply curves are plotted on the same When both demand and supply curves are plotted on the same diagram the crossing point defines the diagram the crossing point defines the equilibrium real-wage equilibrium real-wage rate and the rate and the equilibrium level of labor employedequilibrium level of labor employed

bull The real wage The real wage looks different looks different from the point of view of the firm from the point of view of the firm and the worker For the and the worker For the firmfirm the relevant real wage is the the relevant real wage is the product-real wage product-real wage defined as defined as the number of units of the good the number of units of the good the firm produces that the wage will purchase the firm produces that the wage will purchase ((price of price of productproduct = = w) w) For the For the workerworker the relevant real wage is the the relevant real wage is the consumption-consumption-real real wagewage defined as defined as the number of typical consumption baskets the number of typical consumption baskets that the wage will purchase that the wage will purchase ((price of price of consumption basket consumption basket = = w)w)

bull For aggregate analysis we might use the For aggregate analysis we might use the Producer Price IndexProducer Price Index or the GDP deflator to approximate the or the GDP deflator to approximate the product priceproduct price and the and the CPICPI to approximate the to approximate the consumption price consumption price

bull Suppose that the product-real wage and the consumption-real Suppose that the product-real wage and the consumption-real wage in the following figure start out with the identical value wage in the following figure start out with the identical value ((wp) at the market-clearing point Awp) at the market-clearing point A Now suppose that Now suppose that imported Japanese cars are a large portion of the typical imported Japanese cars are a large portion of the typical workerrsquos consumption basket workerrsquos consumption basket and that and that ceteris paribus ceteris paribus the price the price of Japanese cars rises sharply This means that the of Japanese cars rises sharply This means that the real wage real wage from the point of view of the from the point of view of the consumer falls to (consumer falls to (wpwpCPICPI ) )11 at point at point

B B on the labor-supply curve (LS) so that the worker would on the labor-supply curve (LS) so that the worker would want to supply less labor (want to supply less labor (LL11))

bull The rise in the price of Japanese cars has no effect on the price The rise in the price of Japanese cars has no effect on the price of their products Nevertheless they see a reduction of labor of their products Nevertheless they see a reduction of labor supply at the original market clearing wage It is as if the supply at the original market clearing wage It is as if the labor-supply curve labor-supply curve has shifted to the left to has shifted to the left to LSLSrsquo which passes rsquo which passes through ((through ((wp) L1) at point C wp) L1) at point C At the original wage rate labor At the original wage rate labor demand exceeds labor supply so firms raise wages in an effort demand exceeds labor supply so firms raise wages in an effort to attract workers until they reach the new market-clearing to attract workers until they reach the new market-clearing wage at point D where they pay (wage at point D where they pay (wpwpPPIPPI ) for labor of L ) for labor of L The The

rise in the price of Japanese cars has the effect of raising the rise in the price of Japanese cars has the effect of raising the wages that firms must pay and reducing labor employedwages that firms must pay and reducing labor employed Higher wages partly compensate workers for the higher costs Higher wages partly compensate workers for the higher costs of consumption but firms can afford to pay those higher wages of consumption but firms can afford to pay those higher wages only if marginal products rise as a result of their using less only if marginal products rise as a result of their using less labor labor

bull The rise in wage rates is not enough to compensate workers The rise in wage rates is not enough to compensate workers fully so the consumption-real wage in equilibrium is (wpfully so the consumption-real wage in equilibrium is (wpCPI CPI ) )

atat point E We can think of import prices as a tax levied on point E We can think of import prices as a tax levied on consumers and of an increase in import prices as widening the consumers and of an increase in import prices as widening the tax wedge Unless the issue that we want to analyze depends on tax wedge Unless the issue that we want to analyze depends on the difference between product- and consumption-real wages the difference between product- and consumption-real wages we will treat the real wage as the same for both labor supply we will treat the real wage as the same for both labor supply and labor demandand labor demand

An Increase in the Price of Consumption GoodsAn Increase in the Price of Consumption GoodsRelative to the Price of OutputRelative to the Price of Output

ANALYZING IDEAL LABOR MARKETSANALYZING IDEAL LABOR MARKETS

bull The aggregate labor-supplylabor-demand diagram provides us The aggregate labor-supplylabor-demand diagram provides us with a powerful tool We now analyze three important with a powerful tool We now analyze three important macroeconomic issues macroeconomic issues

(1) the effect of tax cuts on employment (1) the effect of tax cuts on employment

(2) the effect of technological progress on the well-being of (2) the effect of technological progress on the well-being of workers and workers and

(3) the effect of immigration on existing workers (3) the effect of immigration on existing workers

bull Issue 1 Tax Cuts Issue 1 Tax Cuts What are the effects of a cut in marginal What are the effects of a cut in marginal income-tax rates on employment and the level of GDP in the income-tax rates on employment and the level of GDP in the economyeconomy Recall from section that a lower marginal income-Recall from section that a lower marginal income-tax rate increases labor supply at each real wage (a rightward tax rate increases labor supply at each real wage (a rightward shift of the labor-supply) shift of the labor-supply)

bull Labor-market equilibrium moves from point A to point B in Labor-market equilibrium moves from point A to point B in the lower panel of the following Notice that the amount of the lower panel of the following Notice that the amount of labor available to firms increases so that firms move labor available to firms increases so that firms move production from Arsquo to Brsquo on the labor production function in production from Arsquo to Brsquo on the labor production function in the upper panel Also notice that the real wage falls from (the upper panel Also notice that the real wage falls from (wp)1 wp)1 to (wp)2 Since the cut in taxes increases the number of to (wp)2 Since the cut in taxes increases the number of workers workers willing to work at each wage Workers care about their take-willing to work at each wage Workers care about their take-home pay ndash that is about their home pay ndash that is about their after-tax real wage after-tax real wage This is This is perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 can be greater than the old after-tax real wage (1ndashcan be greater than the old after-tax real wage (1ndashτ1τ1)(wp)1 so )(wp)1 so long as the rise in the take-home share (1 ndash τ) is long as the rise in the take-home share (1 ndash τ) is proportionately greater than the fall in the before-tax real proportionately greater than the fall in the before-tax real wage (wp)wage (wp)

bull The analysis depends on substitution effects dominating The analysis depends on substitution effects dominating income effects which they probably do in aggregate if not for income effects which they probably do in aggregate if not for every worker So the supply-siders of the Reagan years are every worker So the supply-siders of the Reagan years are correct in principle How much output will increase depends on correct in principle How much output will increase depends on how large the substitution effect is If most people work a how large the substitution effect is If most people work a standard 40-hour week the effect could be quite small and the standard 40-hour week the effect could be quite small and the increase in output might also be very small in practiceincrease in output might also be very small in practice

Issue 1 The Effect of a Cut in Marginal Tax RatesIssue 1 The Effect of a Cut in Marginal Tax Rates

Issue 2 Technological Progress and Worker WelfareIssue 2 Technological Progress and Worker Welfare

bull Is technological progress and increasing use of machinery and Is technological progress and increasing use of machinery and other capital beneficial for workersother capital beneficial for workers

bull Technological change or capital accumulation have been Technological change or capital accumulation have been known as ldquoLudditesrdquo (known as ldquoLudditesrdquo (it negatively affects the demand for it negatively affects the demand for laborlabor) To see why the Luddites are wrong ndash at least for ) To see why the Luddites are wrong ndash at least for clearing labor markets ndash recall that technological progress or clearing labor markets ndash recall that technological progress or increased capital both increased capital both shift the labor-demand curve upwardshift the labor-demand curve upward The lower panel of the following figure shows that the effect of The lower panel of the following figure shows that the effect of the increased demand for labor is to increase total employment the increased demand for labor is to increase total employment and the real wage Firms and the real wage Firms can pay a higher real wage can pay a higher real wage because because the additional capital or technological progress the additional capital or technological progress increases the increases the marginal product of labormarginal product of labor

bull The The Ludditesrsquo mistake Ludditesrsquo mistake is most easily seen in the upper panel is most easily seen in the upper panel The Luddite argument assumes that fewer workers will The Luddite argument assumes that fewer workers will produce the same total output Production starts at Arsquo using produce the same total output Production starts at Arsquo using L1 L1 workers to produce Y1 After the upward shift in the production workers to produce Y1 After the upward shift in the production function the same output could be produced using less labor function the same output could be produced using less labor ((L3) at point Arsquorsquo The L3) at point Arsquorsquo The problem is that Arsquorsquo is not an equilibrium problem is that Arsquorsquo is not an equilibrium At that point the marginal product of labor is higher than the At that point the marginal product of labor is higher than the original real wage so a profit-maximizing firm would want to original real wage so a profit-maximizing firm would want to expand production To do this they must hire more labor than expand production To do this they must hire more labor than L3 and indeed they L3 and indeed they find it find it profitable profitable to hire more labor than to hire more labor than the original the original L1 The only way actually to increase labor L1 The only way actually to increase labor is to is to raise the real-wage raise the real-wage rate above its original level Technological rate above its original level Technological progress therefore favors progress therefore favors workers by increasing employment workers by increasing employment and wagesand wages

bull Early in the 19th century hand-woven cloth was very Early in the 19th century hand-woven cloth was very expensive and a worker was lucky to own the clothes on his expensive and a worker was lucky to own the clothes on his back and a spare set for church on Sunday Textiles were one of back and a spare set for church on Sunday Textiles were one of the first industries to benefit from the Industrial Revolution so the first industries to benefit from the Industrial Revolution so that by the end of the 19th century machine-made fabrics and that by the end of the 19th century machine-made fabrics and mass-production made decent clothing in larger quantities mass-production made decent clothing in larger quantities accessible to most of the population of the more developed accessible to most of the population of the more developed countries Similar progress has been made in most forms of countries Similar progress has been made in most forms of production Agricultural production which at the turn of the production Agricultural production which at the turn of the 20th century absorbed half the labor force now absorbs less 20th century absorbed half the labor force now absorbs less than 3 percent while producing more food more cheaply than than 3 percent while producing more food more cheaply than ever ever

bull We must be careful not to dismiss the Luddites as altogether We must be careful not to dismiss the Luddites as altogether foolish While new technology especially over decades has foolish While new technology especially over decades has proved to be a net gain for workers in general the Luddites proved to be a net gain for workers in general the Luddites were in fact correct that their way of life was threatened were in fact correct that their way of life was threatened Independent weavers became factory hands unskilled Independent weavers became factory hands unskilled workers increasingly women and often children replaced workers increasingly women and often children replaced skilled craftsmen and factory work often involved long hours skilled craftsmen and factory work often involved long hours in brutal conditions The wider society reaps the benefits of in brutal conditions The wider society reaps the benefits of technological change while a narrow group sometimes technological change while a narrow group sometimes disproportionately bears its costs Our analysis also assumes disproportionately bears its costs Our analysis also assumes that markets generally clear The implicit assumption is that that markets generally clear The implicit assumption is that displaced workers move on to new jobs possibly in other forms displaced workers move on to new jobs possibly in other forms of production Markets may have a tendency to clear in the of production Markets may have a tendency to clear in the long run yet workers may find themselves displaced in the long run yet workers may find themselves displaced in the short run say over the course of a business cycleshort run say over the course of a business cycle

Issue 3 Immigration Jobs and Real WagesIssue 3 Immigration Jobs and Real Wages

bull How does an increase in the labor force through immigration or How does an increase in the labor force through immigration or natural population growth affect labor and GDP natural population growth affect labor and GDP

bull One of the emotional issues associated with US immigration One of the emotional issues associated with US immigration policy ndash particularly towards low-wage workers from Mexico ndash policy ndash particularly towards low-wage workers from Mexico ndash is the idea that is the idea that immigrants take jobs away from native immigrants take jobs away from native workers workers We might be tempted to dismiss this fear as another We might be tempted to dismiss this fear as another example of the lump-of-labor fallacy Yet there is a sensible example of the lump-of-labor fallacy Yet there is a sensible intuition behind the argument An increase in the labor force ndash intuition behind the argument An increase in the labor force ndash due either to immigration or to higher population growth rates due either to immigration or to higher population growth rates ndash can be represented as an outward shift of the aggregate labor ndash can be represented as an outward shift of the aggregate labor supply curve as shown in the following Figure Employment supply curve as shown in the following Figure Employment increases but real wages fall It is not then that immigrants increases but real wages fall It is not then that immigrants take jobs away from natives take jobs away from natives Rather they compete for jobsRather they compete for jobs putting downward pressure on real wagesputting downward pressure on real wages

bull Again we must exercise care in interpreting the analysis Again we must exercise care in interpreting the analysis Remember that aggregate labor and average wage rates hide Remember that aggregate labor and average wage rates hide many details of the labor process The incomes of the new many details of the labor process The incomes of the new immigrants immigrants creates demand creates demand for the new production that they for the new production that they make possible Immigrant workers (at least those ndash whether make possible Immigrant workers (at least those ndash whether legal or illegal ndash who have become the focus of the most intense legal or illegal ndash who have become the focus of the most intense political debate) political debate) are likely to possess fewer skills than nativesare likely to possess fewer skills than natives The net effect is that the increased demand for goods and The net effect is that the increased demand for goods and services generated by immigrants is likely to increase the services generated by immigrants is likely to increase the demand for skilled (demand for skilled (and largely nativeand largely native) workers relative to ) workers relative to their supply and so to increase real wages of skilled workers their supply and so to increase real wages of skilled workers Low-skilled immigration may lower the real wage for farm Low-skilled immigration may lower the real wage for farm workers but if anything it would raise the real wage for workers but if anything it would raise the real wage for computer programmerscomputer programmers

Next Task Labor Market in Kuwait

Appendix Is Labor Supply Stable Over Time

bull Statistics on participation rates or average hours for a Statistics on participation rates or average hours for a particular month or year are snapshot of the labor market particular month or year are snapshot of the labor market Can we analyze the effects of that increase on the labor market Can we analyze the effects of that increase on the labor market under the assumption that the labor-supply curves of workers under the assumption that the labor-supply curves of workers remain essentially stableremain essentially stable

bull Data on participation rates in the United States appear to Data on participation rates in the United States appear to support this conjecture (see Figure 811) which shows the support this conjecture (see Figure 811) which shows the overall civilian participation rate trending upward ndash at least overall civilian participation rate trending upward ndash at least from the middle of the 1960sfrom the middle of the 1960s

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

Adding Realism A Standard WorkweekAdding Realism A Standard Workweek

bull Another way in which the simple analysis of labor supply is Another way in which the simple analysis of labor supply is unrealistic is that many unrealistic is that many workers are not given an option about workers are not given an option about the number of hours they workthe number of hours they work Although people work part- Although people work part-time and overtime either may be voluntary or mandatory time and overtime either may be voluntary or mandatory

bull Assuming that workers are Assuming that workers are not permitted to work more than not permitted to work more than 40 hours a week40 hours a week the following figure includes a constraint of the following figure includes a constraint of 40 hours If the worker were permitted to choose freely then 40 hours If the worker were permitted to choose freely then the labor-supply curve would backward bending curve The the labor-supply curve would backward bending curve The overall effect is to of the standard work week is to reshape the overall effect is to of the standard work week is to reshape the labor-supply curve as indicated by the heavy curve with the labor-supply curve as indicated by the heavy curve with the vertical segment that runs through points A F G D and E vertical segment that runs through points A F G D and E Any worker on this vertical segment is constrainedAny worker on this vertical segment is constrained

The Individual Labor-Supply Curve in PracticeThe Individual Labor-Supply Curve in Practice

bull What does the individual labor-supply curve look like in What does the individual labor-supply curve look like in realityreality It is difficult to answer this question because in reality It is difficult to answer this question because in reality we can observe we can observe only one pointonly one point on the labor-supply curve for a on the labor-supply curve for a single worker single worker at a particular timeat a particular time All the other points are All the other points are conjecturesconjectures about what the worker would supply if faced with about what the worker would supply if faced with different wage rates If we imagine that on average workers are different wage rates If we imagine that on average workers are substantially substantially similarsimilar we might nonetheless get some idea of we might nonetheless get some idea of what the individual labor-supply curve might look likewhat the individual labor-supply curve might look like

bull The The National Longitudinal SurveyNational Longitudinal Survey (Youth) has catalogued the (Youth) has catalogued the work histories of a large sample of individuals starting at a work histories of a large sample of individuals starting at a young age The following figure plots the real-wage rates and young age The following figure plots the real-wage rates and average weekly hours of labor for about average weekly hours of labor for about 1000010000 male workers male workers from this survey for a from this survey for a single periodsingle period with the best fitting flexible with the best fitting flexible line through these points serves as our empirical estimate of the line through these points serves as our empirical estimate of the labor-supply curve for these workerslabor-supply curve for these workers

bull The regression line traces out a shape very The regression line traces out a shape very like the backward-like the backward-bendingbending labor-supply curve with a 40-hour constraint What labor-supply curve with a 40-hour constraint What looks like a vertical line above 40 hours is looks like a vertical line above 40 hours is not really a solid line not really a solid line at all but a reflection of the fact that about at all but a reflection of the fact that about 7500 7500 of the 10000 of the 10000 workers in the sample supply 40 hours per week at a variety of workers in the sample supply 40 hours per week at a variety of wage rates The labor-supply curve traces out a segment above wage rates The labor-supply curve traces out a segment above the 40-hour point that corresponds to the constraintthe 40-hour point that corresponds to the constraint

bull There are There are points to the rightpoints to the right of 40 hours This is reasonable of 40 hours This is reasonable since in the real world workers do since in the real world workers do work overtimework overtime ndash either ndash either because they are supervisors or professionals or because because they are supervisors or professionals or because employers offer them the required time-and-half wage rate employers offer them the required time-and-half wage rate The fit of the regression line is far from perfect points lie on The fit of the regression line is far from perfect points lie on both sides of the line We should interpret it as a both sides of the line We should interpret it as a snapshotsnapshot of of the behavior of the typical worker But ofthe behavior of the typical worker But of course the typical course the typical worker is not any actual worker in particularworker is not any actual worker in particular

THE WORKER CHOOSING TO PARTICIPATETHE WORKER CHOOSING TO PARTICIPATE

bull So far we have examined only one aspect of the workerrsquos So far we have examined only one aspect of the workerrsquos labor-supply decision labor-supply decision how many hours to work for given real how many hours to work for given real wagewage We now take up the second aspect We now take up the second aspect participationparticipation ndash that ndash that is is whether or not to work at allwhether or not to work at all A labor-supply curve that starts A labor-supply curve that starts at the origin and slopes upwards for at least a portion of its at the origin and slopes upwards for at least a portion of its length suggests that even length suggests that even if the wage were very lowif the wage were very low ndash say 1cent ndash say 1cent per hour ndash the worker would work a little bit That is clearly per hour ndash the worker would work a little bit That is clearly unrealisticunrealistic no one would work at all for 1cent per hour no one would work at all for 1cent per hour What What factors determine how high the wage factors determine how high the wage must be to induce a person must be to induce a person to participate in the labor marketto participate in the labor market

bull The labor force The labor force participationparticipation decision is a question of decision is a question of opportunity costopportunity cost Idleness has its charms Before anyone enters Idleness has its charms Before anyone enters the labor force the wage rate must be high enough to overcome the labor force the wage rate must be high enough to overcome them them The opportunity cost of participatingThe opportunity cost of participating in the labor force is in the labor force is sum of sum of

1048766 1048766 the implicit valuethe implicit value the worker places on complete idleness the worker places on complete idleness

1048766 1048766 the explicit coststhe explicit costs of working compared to not working such as of working compared to not working such as clothing transport childcare) andclothing transport childcare) and

1048766 1048766 the explicit losses the explicit losses from working (for instance housework not from working (for instance housework not done)done)

bull The opportunity cost is partly psychological and partly material The opportunity cost is partly psychological and partly material If people were completely If people were completely independentindependent of each other the worker of each other the worker might place a lower value on the opportunity cost of might place a lower value on the opportunity cost of participation because then the choice might be literally between participation because then the choice might be literally between work and starvationwork and starvation

bull But most people are not But most people are not completely independentcompletely independent Whether or Whether or not to participate in the labor force could be a not to participate in the labor force could be a genuine choicegenuine choice and would depend on the and would depend on the real wagereal wage

bull The The RESERVATION WAGE RESERVATION WAGE is defined to be is defined to be the opportunity the opportunity cost of working compared to not workingcost of working compared to not working ndash ndash that is the real wage that is the real wage that is high enough to make it just worthwhile for a worker to that is high enough to make it just worthwhile for a worker to participate in the labor forceparticipate in the labor force

bull Taking account of the opportunity costs of participation affects Taking account of the opportunity costs of participation affects the shape of the labor-supply curve As long as the the shape of the labor-supply curve As long as the real wage is real wage is below the reservationbelow the reservation wage ((wp)R) the worker supplies no wage ((wp)R) the worker supplies no labor at all Above the reservation wage there is a normal labor at all Above the reservation wage there is a normal labor-supply curvelabor-supply curve

bull The following captures the two stages of the labor supply The following captures the two stages of the labor supply decision decision FirstFirst at low wages the worker will at low wages the worker will notnot supply any supply any labor at all and small increases in wages have no effect But labor at all and small increases in wages have no effect But secondsecond as soon as the wage rises enough for the worker to bite as soon as the wage rises enough for the worker to bite the bullet and join the labor force the minimum labor supplied the bullet and join the labor force the minimum labor supplied will be well will be well above zeroabove zero and the worker will decide how many and the worker will decide how many hours to supply above this minimum through the usual process hours to supply above this minimum through the usual process of balancing the opportunity cost of leisure against the desire of balancing the opportunity cost of leisure against the desire for consumption goodsfor consumption goods

AGGREGATE LABOR SUPPLY

bull How can we moveHow can we move from the microeconomics of the labor supply from the microeconomics of the labor supply back to an aggregate relationship usable in macroeconomic back to an aggregate relationship usable in macroeconomic analysis analysis If workers were essentially alikeIf workers were essentially alike the problem would the problem would be easy be easy

bull As we have seen labor supply has two dimensions ndash As we have seen labor supply has two dimensions ndash participationparticipation in the labor force and in the labor force and choice of hourschoice of hours of labor of labor Take the participation decision first If all workers were alike Take the participation decision first If all workers were alike except for except for differences in their reservation wagedifferences in their reservation wage then we could then we could rank them from lowest to highest reservation wage The rank them from lowest to highest reservation wage The aggregate labor-supply (participation) curve is strictly aggregate labor-supply (participation) curve is strictly upwardslopingupwardsloping

bull Of course this is too easy Just as we observed in deriving the Of course this is too easy Just as we observed in deriving the aggregate labor demand curve workers are aggregate labor demand curve workers are not all alikenot all alike Once Once again we must interpret the vertical axis as measuring the again we must interpret the vertical axis as measuring the average real wageaverage real wage that at best provides a kind of index for the that at best provides a kind of index for the level of the wage structure level of the wage structure

bull The The problemproblem remains the remains the samesame when we turn to the choice of when we turn to the choice of hourshours Workers are all different and face a structure of wages Workers are all different and face a structure of wages For each worker individually there is a jump from supplying For each worker individually there is a jump from supplying zero to supplying some positive number of hours zero to supplying some positive number of hours when his own when his own wage rate surpasses their wage rate surpasses their reservation wagereservation wage But in aggregate But in aggregate we are we are unlikely to see such a jumpunlikely to see such a jump Not only are there a variety Not only are there a variety of wages offered at any time but reservation wages differof wages offered at any time but reservation wages differ

Derivation of the Aggregate Labor-supply Curve

bull A curve like the one in this figure can be used to display either A curve like the one in this figure can be used to display either the the participation participation decision or decision or the hoursthe hours The horizontal axis can The horizontal axis can either be used for workers either be used for workers or worker-hoursor worker-hours as measures of the as measures of the labor supply The two meanings are not completely labor supply The two meanings are not completely independent by definition independent by definition

bull workers equiv aggregate worker ndash hours average hours per worker workers equiv aggregate worker ndash hours average hours per worker

The Participation Rate and Average Hours

bull Let us look first at the aggregate participation decision The Let us look first at the aggregate participation decision The aggregate number of workers who have decided to participate aggregate number of workers who have decided to participate is known as the is known as the labor forcelabor force the the civilian labor force over 16 civilian labor force over 16 years of ageyears of age This number excludes uniformed members of the This number excludes uniformed members of the armed services and the small number of workers under 16 armed services and the small number of workers under 16 years old The labor force of course has grown right along years old The labor force of course has grown right along with population with population

bull The participation rateThe participation rate (PR) measures (PR) measures the labor force as its ratio the labor force as its ratio to the relevant populationto the relevant population

bull participation rate = labor forcerelevant population participation rate = labor forcerelevant population

bull ldquoldquonon-institutionalrdquo non-institutionalrdquo excludes people in prison or in homes for excludes people in prison or in homes for the aged) the aged)

bull The aggregate number of hours The aggregate number of hours worked is worked is not as easy not as easy as the as the participation rate to relate to the individual workerrsquos choices participation rate to relate to the individual workerrsquos choices If every worker had the same labor-supply curve we would If every worker had the same labor-supply curve we would have to know the wage offered to each one in order to calculate have to know the wage offered to each one in order to calculate the total number of labor hours supplied In reality workers the total number of labor hours supplied In reality workers are not all alike are not all alike Labor-supply curves may vary systematically Labor-supply curves may vary systematically according to the sex age ethnic group education experience according to the sex age ethnic group education experience or other social or economic characteristics of the workersor other social or economic characteristics of the workers And And within any group the labor-supply curves of individuals are within any group the labor-supply curves of individuals are likely to varylikely to vary

bull In principle In principle if we had a good statistical estimate of the typical if we had a good statistical estimate of the typical distribution of the wagesdistribution of the wages we could make a reasonable we could make a reasonable calculation But statisticians at the Bureau of Labor Statistics calculation But statisticians at the Bureau of Labor Statistics (BLS) do not try to calculate the labor supply in this way (BLS) do not try to calculate the labor supply in this way Instead they Instead they count the number of hours that workers actually count the number of hours that workers actually workwork and the average and the average wages and salaries they are paid wages and salaries they are paid

bull In USA the total hours of labor in 1998 was In USA the total hours of labor in 1998 was 236882236882 million million The average hours of work is The average hours of work is 17211721 hours per year = hours per year = 344344 hours hours per week (assuming a 50 week year) This number is 14 percent per week (assuming a 50 week year) This number is 14 percent below the full time 40-hour week which makes sense since it below the full time 40-hour week which makes sense since it averages over full-time part-time and overtime workers averages over full-time part-time and overtime workers

Labor Market EquilibriumLabor Market Equilibrium

bull MARKET CLEARINGMARKET CLEARING

bull When both demand and supply curves are plotted on the same When both demand and supply curves are plotted on the same diagram the crossing point defines the diagram the crossing point defines the equilibrium real-wage equilibrium real-wage rate and the rate and the equilibrium level of labor employedequilibrium level of labor employed

bull The real wage The real wage looks different looks different from the point of view of the firm from the point of view of the firm and the worker For the and the worker For the firmfirm the relevant real wage is the the relevant real wage is the product-real wage product-real wage defined as defined as the number of units of the good the number of units of the good the firm produces that the wage will purchase the firm produces that the wage will purchase ((price of price of productproduct = = w) w) For the For the workerworker the relevant real wage is the the relevant real wage is the consumption-consumption-real real wagewage defined as defined as the number of typical consumption baskets the number of typical consumption baskets that the wage will purchase that the wage will purchase ((price of price of consumption basket consumption basket = = w)w)

bull For aggregate analysis we might use the For aggregate analysis we might use the Producer Price IndexProducer Price Index or the GDP deflator to approximate the or the GDP deflator to approximate the product priceproduct price and the and the CPICPI to approximate the to approximate the consumption price consumption price

bull Suppose that the product-real wage and the consumption-real Suppose that the product-real wage and the consumption-real wage in the following figure start out with the identical value wage in the following figure start out with the identical value ((wp) at the market-clearing point Awp) at the market-clearing point A Now suppose that Now suppose that imported Japanese cars are a large portion of the typical imported Japanese cars are a large portion of the typical workerrsquos consumption basket workerrsquos consumption basket and that and that ceteris paribus ceteris paribus the price the price of Japanese cars rises sharply This means that the of Japanese cars rises sharply This means that the real wage real wage from the point of view of the from the point of view of the consumer falls to (consumer falls to (wpwpCPICPI ) )11 at point at point

B B on the labor-supply curve (LS) so that the worker would on the labor-supply curve (LS) so that the worker would want to supply less labor (want to supply less labor (LL11))

bull The rise in the price of Japanese cars has no effect on the price The rise in the price of Japanese cars has no effect on the price of their products Nevertheless they see a reduction of labor of their products Nevertheless they see a reduction of labor supply at the original market clearing wage It is as if the supply at the original market clearing wage It is as if the labor-supply curve labor-supply curve has shifted to the left to has shifted to the left to LSLSrsquo which passes rsquo which passes through ((through ((wp) L1) at point C wp) L1) at point C At the original wage rate labor At the original wage rate labor demand exceeds labor supply so firms raise wages in an effort demand exceeds labor supply so firms raise wages in an effort to attract workers until they reach the new market-clearing to attract workers until they reach the new market-clearing wage at point D where they pay (wage at point D where they pay (wpwpPPIPPI ) for labor of L ) for labor of L The The

rise in the price of Japanese cars has the effect of raising the rise in the price of Japanese cars has the effect of raising the wages that firms must pay and reducing labor employedwages that firms must pay and reducing labor employed Higher wages partly compensate workers for the higher costs Higher wages partly compensate workers for the higher costs of consumption but firms can afford to pay those higher wages of consumption but firms can afford to pay those higher wages only if marginal products rise as a result of their using less only if marginal products rise as a result of their using less labor labor

bull The rise in wage rates is not enough to compensate workers The rise in wage rates is not enough to compensate workers fully so the consumption-real wage in equilibrium is (wpfully so the consumption-real wage in equilibrium is (wpCPI CPI ) )

atat point E We can think of import prices as a tax levied on point E We can think of import prices as a tax levied on consumers and of an increase in import prices as widening the consumers and of an increase in import prices as widening the tax wedge Unless the issue that we want to analyze depends on tax wedge Unless the issue that we want to analyze depends on the difference between product- and consumption-real wages the difference between product- and consumption-real wages we will treat the real wage as the same for both labor supply we will treat the real wage as the same for both labor supply and labor demandand labor demand

An Increase in the Price of Consumption GoodsAn Increase in the Price of Consumption GoodsRelative to the Price of OutputRelative to the Price of Output

ANALYZING IDEAL LABOR MARKETSANALYZING IDEAL LABOR MARKETS

bull The aggregate labor-supplylabor-demand diagram provides us The aggregate labor-supplylabor-demand diagram provides us with a powerful tool We now analyze three important with a powerful tool We now analyze three important macroeconomic issues macroeconomic issues

(1) the effect of tax cuts on employment (1) the effect of tax cuts on employment

(2) the effect of technological progress on the well-being of (2) the effect of technological progress on the well-being of workers and workers and

(3) the effect of immigration on existing workers (3) the effect of immigration on existing workers

bull Issue 1 Tax Cuts Issue 1 Tax Cuts What are the effects of a cut in marginal What are the effects of a cut in marginal income-tax rates on employment and the level of GDP in the income-tax rates on employment and the level of GDP in the economyeconomy Recall from section that a lower marginal income-Recall from section that a lower marginal income-tax rate increases labor supply at each real wage (a rightward tax rate increases labor supply at each real wage (a rightward shift of the labor-supply) shift of the labor-supply)

bull Labor-market equilibrium moves from point A to point B in Labor-market equilibrium moves from point A to point B in the lower panel of the following Notice that the amount of the lower panel of the following Notice that the amount of labor available to firms increases so that firms move labor available to firms increases so that firms move production from Arsquo to Brsquo on the labor production function in production from Arsquo to Brsquo on the labor production function in the upper panel Also notice that the real wage falls from (the upper panel Also notice that the real wage falls from (wp)1 wp)1 to (wp)2 Since the cut in taxes increases the number of to (wp)2 Since the cut in taxes increases the number of workers workers willing to work at each wage Workers care about their take-willing to work at each wage Workers care about their take-home pay ndash that is about their home pay ndash that is about their after-tax real wage after-tax real wage This is This is perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 can be greater than the old after-tax real wage (1ndashcan be greater than the old after-tax real wage (1ndashτ1τ1)(wp)1 so )(wp)1 so long as the rise in the take-home share (1 ndash τ) is long as the rise in the take-home share (1 ndash τ) is proportionately greater than the fall in the before-tax real proportionately greater than the fall in the before-tax real wage (wp)wage (wp)

bull The analysis depends on substitution effects dominating The analysis depends on substitution effects dominating income effects which they probably do in aggregate if not for income effects which they probably do in aggregate if not for every worker So the supply-siders of the Reagan years are every worker So the supply-siders of the Reagan years are correct in principle How much output will increase depends on correct in principle How much output will increase depends on how large the substitution effect is If most people work a how large the substitution effect is If most people work a standard 40-hour week the effect could be quite small and the standard 40-hour week the effect could be quite small and the increase in output might also be very small in practiceincrease in output might also be very small in practice

Issue 1 The Effect of a Cut in Marginal Tax RatesIssue 1 The Effect of a Cut in Marginal Tax Rates

Issue 2 Technological Progress and Worker WelfareIssue 2 Technological Progress and Worker Welfare

bull Is technological progress and increasing use of machinery and Is technological progress and increasing use of machinery and other capital beneficial for workersother capital beneficial for workers

bull Technological change or capital accumulation have been Technological change or capital accumulation have been known as ldquoLudditesrdquo (known as ldquoLudditesrdquo (it negatively affects the demand for it negatively affects the demand for laborlabor) To see why the Luddites are wrong ndash at least for ) To see why the Luddites are wrong ndash at least for clearing labor markets ndash recall that technological progress or clearing labor markets ndash recall that technological progress or increased capital both increased capital both shift the labor-demand curve upwardshift the labor-demand curve upward The lower panel of the following figure shows that the effect of The lower panel of the following figure shows that the effect of the increased demand for labor is to increase total employment the increased demand for labor is to increase total employment and the real wage Firms and the real wage Firms can pay a higher real wage can pay a higher real wage because because the additional capital or technological progress the additional capital or technological progress increases the increases the marginal product of labormarginal product of labor

bull The The Ludditesrsquo mistake Ludditesrsquo mistake is most easily seen in the upper panel is most easily seen in the upper panel The Luddite argument assumes that fewer workers will The Luddite argument assumes that fewer workers will produce the same total output Production starts at Arsquo using produce the same total output Production starts at Arsquo using L1 L1 workers to produce Y1 After the upward shift in the production workers to produce Y1 After the upward shift in the production function the same output could be produced using less labor function the same output could be produced using less labor ((L3) at point Arsquorsquo The L3) at point Arsquorsquo The problem is that Arsquorsquo is not an equilibrium problem is that Arsquorsquo is not an equilibrium At that point the marginal product of labor is higher than the At that point the marginal product of labor is higher than the original real wage so a profit-maximizing firm would want to original real wage so a profit-maximizing firm would want to expand production To do this they must hire more labor than expand production To do this they must hire more labor than L3 and indeed they L3 and indeed they find it find it profitable profitable to hire more labor than to hire more labor than the original the original L1 The only way actually to increase labor L1 The only way actually to increase labor is to is to raise the real-wage raise the real-wage rate above its original level Technological rate above its original level Technological progress therefore favors progress therefore favors workers by increasing employment workers by increasing employment and wagesand wages

bull Early in the 19th century hand-woven cloth was very Early in the 19th century hand-woven cloth was very expensive and a worker was lucky to own the clothes on his expensive and a worker was lucky to own the clothes on his back and a spare set for church on Sunday Textiles were one of back and a spare set for church on Sunday Textiles were one of the first industries to benefit from the Industrial Revolution so the first industries to benefit from the Industrial Revolution so that by the end of the 19th century machine-made fabrics and that by the end of the 19th century machine-made fabrics and mass-production made decent clothing in larger quantities mass-production made decent clothing in larger quantities accessible to most of the population of the more developed accessible to most of the population of the more developed countries Similar progress has been made in most forms of countries Similar progress has been made in most forms of production Agricultural production which at the turn of the production Agricultural production which at the turn of the 20th century absorbed half the labor force now absorbs less 20th century absorbed half the labor force now absorbs less than 3 percent while producing more food more cheaply than than 3 percent while producing more food more cheaply than ever ever

bull We must be careful not to dismiss the Luddites as altogether We must be careful not to dismiss the Luddites as altogether foolish While new technology especially over decades has foolish While new technology especially over decades has proved to be a net gain for workers in general the Luddites proved to be a net gain for workers in general the Luddites were in fact correct that their way of life was threatened were in fact correct that their way of life was threatened Independent weavers became factory hands unskilled Independent weavers became factory hands unskilled workers increasingly women and often children replaced workers increasingly women and often children replaced skilled craftsmen and factory work often involved long hours skilled craftsmen and factory work often involved long hours in brutal conditions The wider society reaps the benefits of in brutal conditions The wider society reaps the benefits of technological change while a narrow group sometimes technological change while a narrow group sometimes disproportionately bears its costs Our analysis also assumes disproportionately bears its costs Our analysis also assumes that markets generally clear The implicit assumption is that that markets generally clear The implicit assumption is that displaced workers move on to new jobs possibly in other forms displaced workers move on to new jobs possibly in other forms of production Markets may have a tendency to clear in the of production Markets may have a tendency to clear in the long run yet workers may find themselves displaced in the long run yet workers may find themselves displaced in the short run say over the course of a business cycleshort run say over the course of a business cycle

Issue 3 Immigration Jobs and Real WagesIssue 3 Immigration Jobs and Real Wages

bull How does an increase in the labor force through immigration or How does an increase in the labor force through immigration or natural population growth affect labor and GDP natural population growth affect labor and GDP

bull One of the emotional issues associated with US immigration One of the emotional issues associated with US immigration policy ndash particularly towards low-wage workers from Mexico ndash policy ndash particularly towards low-wage workers from Mexico ndash is the idea that is the idea that immigrants take jobs away from native immigrants take jobs away from native workers workers We might be tempted to dismiss this fear as another We might be tempted to dismiss this fear as another example of the lump-of-labor fallacy Yet there is a sensible example of the lump-of-labor fallacy Yet there is a sensible intuition behind the argument An increase in the labor force ndash intuition behind the argument An increase in the labor force ndash due either to immigration or to higher population growth rates due either to immigration or to higher population growth rates ndash can be represented as an outward shift of the aggregate labor ndash can be represented as an outward shift of the aggregate labor supply curve as shown in the following Figure Employment supply curve as shown in the following Figure Employment increases but real wages fall It is not then that immigrants increases but real wages fall It is not then that immigrants take jobs away from natives take jobs away from natives Rather they compete for jobsRather they compete for jobs putting downward pressure on real wagesputting downward pressure on real wages

bull Again we must exercise care in interpreting the analysis Again we must exercise care in interpreting the analysis Remember that aggregate labor and average wage rates hide Remember that aggregate labor and average wage rates hide many details of the labor process The incomes of the new many details of the labor process The incomes of the new immigrants immigrants creates demand creates demand for the new production that they for the new production that they make possible Immigrant workers (at least those ndash whether make possible Immigrant workers (at least those ndash whether legal or illegal ndash who have become the focus of the most intense legal or illegal ndash who have become the focus of the most intense political debate) political debate) are likely to possess fewer skills than nativesare likely to possess fewer skills than natives The net effect is that the increased demand for goods and The net effect is that the increased demand for goods and services generated by immigrants is likely to increase the services generated by immigrants is likely to increase the demand for skilled (demand for skilled (and largely nativeand largely native) workers relative to ) workers relative to their supply and so to increase real wages of skilled workers their supply and so to increase real wages of skilled workers Low-skilled immigration may lower the real wage for farm Low-skilled immigration may lower the real wage for farm workers but if anything it would raise the real wage for workers but if anything it would raise the real wage for computer programmerscomputer programmers

Next Task Labor Market in Kuwait

Appendix Is Labor Supply Stable Over Time

bull Statistics on participation rates or average hours for a Statistics on participation rates or average hours for a particular month or year are snapshot of the labor market particular month or year are snapshot of the labor market Can we analyze the effects of that increase on the labor market Can we analyze the effects of that increase on the labor market under the assumption that the labor-supply curves of workers under the assumption that the labor-supply curves of workers remain essentially stableremain essentially stable

bull Data on participation rates in the United States appear to Data on participation rates in the United States appear to support this conjecture (see Figure 811) which shows the support this conjecture (see Figure 811) which shows the overall civilian participation rate trending upward ndash at least overall civilian participation rate trending upward ndash at least from the middle of the 1960sfrom the middle of the 1960s

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

The Individual Labor-Supply Curve in PracticeThe Individual Labor-Supply Curve in Practice

bull What does the individual labor-supply curve look like in What does the individual labor-supply curve look like in realityreality It is difficult to answer this question because in reality It is difficult to answer this question because in reality we can observe we can observe only one pointonly one point on the labor-supply curve for a on the labor-supply curve for a single worker single worker at a particular timeat a particular time All the other points are All the other points are conjecturesconjectures about what the worker would supply if faced with about what the worker would supply if faced with different wage rates If we imagine that on average workers are different wage rates If we imagine that on average workers are substantially substantially similarsimilar we might nonetheless get some idea of we might nonetheless get some idea of what the individual labor-supply curve might look likewhat the individual labor-supply curve might look like

bull The The National Longitudinal SurveyNational Longitudinal Survey (Youth) has catalogued the (Youth) has catalogued the work histories of a large sample of individuals starting at a work histories of a large sample of individuals starting at a young age The following figure plots the real-wage rates and young age The following figure plots the real-wage rates and average weekly hours of labor for about average weekly hours of labor for about 1000010000 male workers male workers from this survey for a from this survey for a single periodsingle period with the best fitting flexible with the best fitting flexible line through these points serves as our empirical estimate of the line through these points serves as our empirical estimate of the labor-supply curve for these workerslabor-supply curve for these workers

bull The regression line traces out a shape very The regression line traces out a shape very like the backward-like the backward-bendingbending labor-supply curve with a 40-hour constraint What labor-supply curve with a 40-hour constraint What looks like a vertical line above 40 hours is looks like a vertical line above 40 hours is not really a solid line not really a solid line at all but a reflection of the fact that about at all but a reflection of the fact that about 7500 7500 of the 10000 of the 10000 workers in the sample supply 40 hours per week at a variety of workers in the sample supply 40 hours per week at a variety of wage rates The labor-supply curve traces out a segment above wage rates The labor-supply curve traces out a segment above the 40-hour point that corresponds to the constraintthe 40-hour point that corresponds to the constraint

bull There are There are points to the rightpoints to the right of 40 hours This is reasonable of 40 hours This is reasonable since in the real world workers do since in the real world workers do work overtimework overtime ndash either ndash either because they are supervisors or professionals or because because they are supervisors or professionals or because employers offer them the required time-and-half wage rate employers offer them the required time-and-half wage rate The fit of the regression line is far from perfect points lie on The fit of the regression line is far from perfect points lie on both sides of the line We should interpret it as a both sides of the line We should interpret it as a snapshotsnapshot of of the behavior of the typical worker But ofthe behavior of the typical worker But of course the typical course the typical worker is not any actual worker in particularworker is not any actual worker in particular

THE WORKER CHOOSING TO PARTICIPATETHE WORKER CHOOSING TO PARTICIPATE

bull So far we have examined only one aspect of the workerrsquos So far we have examined only one aspect of the workerrsquos labor-supply decision labor-supply decision how many hours to work for given real how many hours to work for given real wagewage We now take up the second aspect We now take up the second aspect participationparticipation ndash that ndash that is is whether or not to work at allwhether or not to work at all A labor-supply curve that starts A labor-supply curve that starts at the origin and slopes upwards for at least a portion of its at the origin and slopes upwards for at least a portion of its length suggests that even length suggests that even if the wage were very lowif the wage were very low ndash say 1cent ndash say 1cent per hour ndash the worker would work a little bit That is clearly per hour ndash the worker would work a little bit That is clearly unrealisticunrealistic no one would work at all for 1cent per hour no one would work at all for 1cent per hour What What factors determine how high the wage factors determine how high the wage must be to induce a person must be to induce a person to participate in the labor marketto participate in the labor market

bull The labor force The labor force participationparticipation decision is a question of decision is a question of opportunity costopportunity cost Idleness has its charms Before anyone enters Idleness has its charms Before anyone enters the labor force the wage rate must be high enough to overcome the labor force the wage rate must be high enough to overcome them them The opportunity cost of participatingThe opportunity cost of participating in the labor force is in the labor force is sum of sum of

1048766 1048766 the implicit valuethe implicit value the worker places on complete idleness the worker places on complete idleness

1048766 1048766 the explicit coststhe explicit costs of working compared to not working such as of working compared to not working such as clothing transport childcare) andclothing transport childcare) and

1048766 1048766 the explicit losses the explicit losses from working (for instance housework not from working (for instance housework not done)done)

bull The opportunity cost is partly psychological and partly material The opportunity cost is partly psychological and partly material If people were completely If people were completely independentindependent of each other the worker of each other the worker might place a lower value on the opportunity cost of might place a lower value on the opportunity cost of participation because then the choice might be literally between participation because then the choice might be literally between work and starvationwork and starvation

bull But most people are not But most people are not completely independentcompletely independent Whether or Whether or not to participate in the labor force could be a not to participate in the labor force could be a genuine choicegenuine choice and would depend on the and would depend on the real wagereal wage

bull The The RESERVATION WAGE RESERVATION WAGE is defined to be is defined to be the opportunity the opportunity cost of working compared to not workingcost of working compared to not working ndash ndash that is the real wage that is the real wage that is high enough to make it just worthwhile for a worker to that is high enough to make it just worthwhile for a worker to participate in the labor forceparticipate in the labor force

bull Taking account of the opportunity costs of participation affects Taking account of the opportunity costs of participation affects the shape of the labor-supply curve As long as the the shape of the labor-supply curve As long as the real wage is real wage is below the reservationbelow the reservation wage ((wp)R) the worker supplies no wage ((wp)R) the worker supplies no labor at all Above the reservation wage there is a normal labor at all Above the reservation wage there is a normal labor-supply curvelabor-supply curve

bull The following captures the two stages of the labor supply The following captures the two stages of the labor supply decision decision FirstFirst at low wages the worker will at low wages the worker will notnot supply any supply any labor at all and small increases in wages have no effect But labor at all and small increases in wages have no effect But secondsecond as soon as the wage rises enough for the worker to bite as soon as the wage rises enough for the worker to bite the bullet and join the labor force the minimum labor supplied the bullet and join the labor force the minimum labor supplied will be well will be well above zeroabove zero and the worker will decide how many and the worker will decide how many hours to supply above this minimum through the usual process hours to supply above this minimum through the usual process of balancing the opportunity cost of leisure against the desire of balancing the opportunity cost of leisure against the desire for consumption goodsfor consumption goods

AGGREGATE LABOR SUPPLY

bull How can we moveHow can we move from the microeconomics of the labor supply from the microeconomics of the labor supply back to an aggregate relationship usable in macroeconomic back to an aggregate relationship usable in macroeconomic analysis analysis If workers were essentially alikeIf workers were essentially alike the problem would the problem would be easy be easy

bull As we have seen labor supply has two dimensions ndash As we have seen labor supply has two dimensions ndash participationparticipation in the labor force and in the labor force and choice of hourschoice of hours of labor of labor Take the participation decision first If all workers were alike Take the participation decision first If all workers were alike except for except for differences in their reservation wagedifferences in their reservation wage then we could then we could rank them from lowest to highest reservation wage The rank them from lowest to highest reservation wage The aggregate labor-supply (participation) curve is strictly aggregate labor-supply (participation) curve is strictly upwardslopingupwardsloping

bull Of course this is too easy Just as we observed in deriving the Of course this is too easy Just as we observed in deriving the aggregate labor demand curve workers are aggregate labor demand curve workers are not all alikenot all alike Once Once again we must interpret the vertical axis as measuring the again we must interpret the vertical axis as measuring the average real wageaverage real wage that at best provides a kind of index for the that at best provides a kind of index for the level of the wage structure level of the wage structure

bull The The problemproblem remains the remains the samesame when we turn to the choice of when we turn to the choice of hourshours Workers are all different and face a structure of wages Workers are all different and face a structure of wages For each worker individually there is a jump from supplying For each worker individually there is a jump from supplying zero to supplying some positive number of hours zero to supplying some positive number of hours when his own when his own wage rate surpasses their wage rate surpasses their reservation wagereservation wage But in aggregate But in aggregate we are we are unlikely to see such a jumpunlikely to see such a jump Not only are there a variety Not only are there a variety of wages offered at any time but reservation wages differof wages offered at any time but reservation wages differ

Derivation of the Aggregate Labor-supply Curve

bull A curve like the one in this figure can be used to display either A curve like the one in this figure can be used to display either the the participation participation decision or decision or the hoursthe hours The horizontal axis can The horizontal axis can either be used for workers either be used for workers or worker-hoursor worker-hours as measures of the as measures of the labor supply The two meanings are not completely labor supply The two meanings are not completely independent by definition independent by definition

bull workers equiv aggregate worker ndash hours average hours per worker workers equiv aggregate worker ndash hours average hours per worker

The Participation Rate and Average Hours

bull Let us look first at the aggregate participation decision The Let us look first at the aggregate participation decision The aggregate number of workers who have decided to participate aggregate number of workers who have decided to participate is known as the is known as the labor forcelabor force the the civilian labor force over 16 civilian labor force over 16 years of ageyears of age This number excludes uniformed members of the This number excludes uniformed members of the armed services and the small number of workers under 16 armed services and the small number of workers under 16 years old The labor force of course has grown right along years old The labor force of course has grown right along with population with population

bull The participation rateThe participation rate (PR) measures (PR) measures the labor force as its ratio the labor force as its ratio to the relevant populationto the relevant population

bull participation rate = labor forcerelevant population participation rate = labor forcerelevant population

bull ldquoldquonon-institutionalrdquo non-institutionalrdquo excludes people in prison or in homes for excludes people in prison or in homes for the aged) the aged)

bull The aggregate number of hours The aggregate number of hours worked is worked is not as easy not as easy as the as the participation rate to relate to the individual workerrsquos choices participation rate to relate to the individual workerrsquos choices If every worker had the same labor-supply curve we would If every worker had the same labor-supply curve we would have to know the wage offered to each one in order to calculate have to know the wage offered to each one in order to calculate the total number of labor hours supplied In reality workers the total number of labor hours supplied In reality workers are not all alike are not all alike Labor-supply curves may vary systematically Labor-supply curves may vary systematically according to the sex age ethnic group education experience according to the sex age ethnic group education experience or other social or economic characteristics of the workersor other social or economic characteristics of the workers And And within any group the labor-supply curves of individuals are within any group the labor-supply curves of individuals are likely to varylikely to vary

bull In principle In principle if we had a good statistical estimate of the typical if we had a good statistical estimate of the typical distribution of the wagesdistribution of the wages we could make a reasonable we could make a reasonable calculation But statisticians at the Bureau of Labor Statistics calculation But statisticians at the Bureau of Labor Statistics (BLS) do not try to calculate the labor supply in this way (BLS) do not try to calculate the labor supply in this way Instead they Instead they count the number of hours that workers actually count the number of hours that workers actually workwork and the average and the average wages and salaries they are paid wages and salaries they are paid

bull In USA the total hours of labor in 1998 was In USA the total hours of labor in 1998 was 236882236882 million million The average hours of work is The average hours of work is 17211721 hours per year = hours per year = 344344 hours hours per week (assuming a 50 week year) This number is 14 percent per week (assuming a 50 week year) This number is 14 percent below the full time 40-hour week which makes sense since it below the full time 40-hour week which makes sense since it averages over full-time part-time and overtime workers averages over full-time part-time and overtime workers

Labor Market EquilibriumLabor Market Equilibrium

bull MARKET CLEARINGMARKET CLEARING

bull When both demand and supply curves are plotted on the same When both demand and supply curves are plotted on the same diagram the crossing point defines the diagram the crossing point defines the equilibrium real-wage equilibrium real-wage rate and the rate and the equilibrium level of labor employedequilibrium level of labor employed

bull The real wage The real wage looks different looks different from the point of view of the firm from the point of view of the firm and the worker For the and the worker For the firmfirm the relevant real wage is the the relevant real wage is the product-real wage product-real wage defined as defined as the number of units of the good the number of units of the good the firm produces that the wage will purchase the firm produces that the wage will purchase ((price of price of productproduct = = w) w) For the For the workerworker the relevant real wage is the the relevant real wage is the consumption-consumption-real real wagewage defined as defined as the number of typical consumption baskets the number of typical consumption baskets that the wage will purchase that the wage will purchase ((price of price of consumption basket consumption basket = = w)w)

bull For aggregate analysis we might use the For aggregate analysis we might use the Producer Price IndexProducer Price Index or the GDP deflator to approximate the or the GDP deflator to approximate the product priceproduct price and the and the CPICPI to approximate the to approximate the consumption price consumption price

bull Suppose that the product-real wage and the consumption-real Suppose that the product-real wage and the consumption-real wage in the following figure start out with the identical value wage in the following figure start out with the identical value ((wp) at the market-clearing point Awp) at the market-clearing point A Now suppose that Now suppose that imported Japanese cars are a large portion of the typical imported Japanese cars are a large portion of the typical workerrsquos consumption basket workerrsquos consumption basket and that and that ceteris paribus ceteris paribus the price the price of Japanese cars rises sharply This means that the of Japanese cars rises sharply This means that the real wage real wage from the point of view of the from the point of view of the consumer falls to (consumer falls to (wpwpCPICPI ) )11 at point at point

B B on the labor-supply curve (LS) so that the worker would on the labor-supply curve (LS) so that the worker would want to supply less labor (want to supply less labor (LL11))

bull The rise in the price of Japanese cars has no effect on the price The rise in the price of Japanese cars has no effect on the price of their products Nevertheless they see a reduction of labor of their products Nevertheless they see a reduction of labor supply at the original market clearing wage It is as if the supply at the original market clearing wage It is as if the labor-supply curve labor-supply curve has shifted to the left to has shifted to the left to LSLSrsquo which passes rsquo which passes through ((through ((wp) L1) at point C wp) L1) at point C At the original wage rate labor At the original wage rate labor demand exceeds labor supply so firms raise wages in an effort demand exceeds labor supply so firms raise wages in an effort to attract workers until they reach the new market-clearing to attract workers until they reach the new market-clearing wage at point D where they pay (wage at point D where they pay (wpwpPPIPPI ) for labor of L ) for labor of L The The

rise in the price of Japanese cars has the effect of raising the rise in the price of Japanese cars has the effect of raising the wages that firms must pay and reducing labor employedwages that firms must pay and reducing labor employed Higher wages partly compensate workers for the higher costs Higher wages partly compensate workers for the higher costs of consumption but firms can afford to pay those higher wages of consumption but firms can afford to pay those higher wages only if marginal products rise as a result of their using less only if marginal products rise as a result of their using less labor labor

bull The rise in wage rates is not enough to compensate workers The rise in wage rates is not enough to compensate workers fully so the consumption-real wage in equilibrium is (wpfully so the consumption-real wage in equilibrium is (wpCPI CPI ) )

atat point E We can think of import prices as a tax levied on point E We can think of import prices as a tax levied on consumers and of an increase in import prices as widening the consumers and of an increase in import prices as widening the tax wedge Unless the issue that we want to analyze depends on tax wedge Unless the issue that we want to analyze depends on the difference between product- and consumption-real wages the difference between product- and consumption-real wages we will treat the real wage as the same for both labor supply we will treat the real wage as the same for both labor supply and labor demandand labor demand

An Increase in the Price of Consumption GoodsAn Increase in the Price of Consumption GoodsRelative to the Price of OutputRelative to the Price of Output

ANALYZING IDEAL LABOR MARKETSANALYZING IDEAL LABOR MARKETS

bull The aggregate labor-supplylabor-demand diagram provides us The aggregate labor-supplylabor-demand diagram provides us with a powerful tool We now analyze three important with a powerful tool We now analyze three important macroeconomic issues macroeconomic issues

(1) the effect of tax cuts on employment (1) the effect of tax cuts on employment

(2) the effect of technological progress on the well-being of (2) the effect of technological progress on the well-being of workers and workers and

(3) the effect of immigration on existing workers (3) the effect of immigration on existing workers

bull Issue 1 Tax Cuts Issue 1 Tax Cuts What are the effects of a cut in marginal What are the effects of a cut in marginal income-tax rates on employment and the level of GDP in the income-tax rates on employment and the level of GDP in the economyeconomy Recall from section that a lower marginal income-Recall from section that a lower marginal income-tax rate increases labor supply at each real wage (a rightward tax rate increases labor supply at each real wage (a rightward shift of the labor-supply) shift of the labor-supply)

bull Labor-market equilibrium moves from point A to point B in Labor-market equilibrium moves from point A to point B in the lower panel of the following Notice that the amount of the lower panel of the following Notice that the amount of labor available to firms increases so that firms move labor available to firms increases so that firms move production from Arsquo to Brsquo on the labor production function in production from Arsquo to Brsquo on the labor production function in the upper panel Also notice that the real wage falls from (the upper panel Also notice that the real wage falls from (wp)1 wp)1 to (wp)2 Since the cut in taxes increases the number of to (wp)2 Since the cut in taxes increases the number of workers workers willing to work at each wage Workers care about their take-willing to work at each wage Workers care about their take-home pay ndash that is about their home pay ndash that is about their after-tax real wage after-tax real wage This is This is perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 can be greater than the old after-tax real wage (1ndashcan be greater than the old after-tax real wage (1ndashτ1τ1)(wp)1 so )(wp)1 so long as the rise in the take-home share (1 ndash τ) is long as the rise in the take-home share (1 ndash τ) is proportionately greater than the fall in the before-tax real proportionately greater than the fall in the before-tax real wage (wp)wage (wp)

bull The analysis depends on substitution effects dominating The analysis depends on substitution effects dominating income effects which they probably do in aggregate if not for income effects which they probably do in aggregate if not for every worker So the supply-siders of the Reagan years are every worker So the supply-siders of the Reagan years are correct in principle How much output will increase depends on correct in principle How much output will increase depends on how large the substitution effect is If most people work a how large the substitution effect is If most people work a standard 40-hour week the effect could be quite small and the standard 40-hour week the effect could be quite small and the increase in output might also be very small in practiceincrease in output might also be very small in practice

Issue 1 The Effect of a Cut in Marginal Tax RatesIssue 1 The Effect of a Cut in Marginal Tax Rates

Issue 2 Technological Progress and Worker WelfareIssue 2 Technological Progress and Worker Welfare

bull Is technological progress and increasing use of machinery and Is technological progress and increasing use of machinery and other capital beneficial for workersother capital beneficial for workers

bull Technological change or capital accumulation have been Technological change or capital accumulation have been known as ldquoLudditesrdquo (known as ldquoLudditesrdquo (it negatively affects the demand for it negatively affects the demand for laborlabor) To see why the Luddites are wrong ndash at least for ) To see why the Luddites are wrong ndash at least for clearing labor markets ndash recall that technological progress or clearing labor markets ndash recall that technological progress or increased capital both increased capital both shift the labor-demand curve upwardshift the labor-demand curve upward The lower panel of the following figure shows that the effect of The lower panel of the following figure shows that the effect of the increased demand for labor is to increase total employment the increased demand for labor is to increase total employment and the real wage Firms and the real wage Firms can pay a higher real wage can pay a higher real wage because because the additional capital or technological progress the additional capital or technological progress increases the increases the marginal product of labormarginal product of labor

bull The The Ludditesrsquo mistake Ludditesrsquo mistake is most easily seen in the upper panel is most easily seen in the upper panel The Luddite argument assumes that fewer workers will The Luddite argument assumes that fewer workers will produce the same total output Production starts at Arsquo using produce the same total output Production starts at Arsquo using L1 L1 workers to produce Y1 After the upward shift in the production workers to produce Y1 After the upward shift in the production function the same output could be produced using less labor function the same output could be produced using less labor ((L3) at point Arsquorsquo The L3) at point Arsquorsquo The problem is that Arsquorsquo is not an equilibrium problem is that Arsquorsquo is not an equilibrium At that point the marginal product of labor is higher than the At that point the marginal product of labor is higher than the original real wage so a profit-maximizing firm would want to original real wage so a profit-maximizing firm would want to expand production To do this they must hire more labor than expand production To do this they must hire more labor than L3 and indeed they L3 and indeed they find it find it profitable profitable to hire more labor than to hire more labor than the original the original L1 The only way actually to increase labor L1 The only way actually to increase labor is to is to raise the real-wage raise the real-wage rate above its original level Technological rate above its original level Technological progress therefore favors progress therefore favors workers by increasing employment workers by increasing employment and wagesand wages

bull Early in the 19th century hand-woven cloth was very Early in the 19th century hand-woven cloth was very expensive and a worker was lucky to own the clothes on his expensive and a worker was lucky to own the clothes on his back and a spare set for church on Sunday Textiles were one of back and a spare set for church on Sunday Textiles were one of the first industries to benefit from the Industrial Revolution so the first industries to benefit from the Industrial Revolution so that by the end of the 19th century machine-made fabrics and that by the end of the 19th century machine-made fabrics and mass-production made decent clothing in larger quantities mass-production made decent clothing in larger quantities accessible to most of the population of the more developed accessible to most of the population of the more developed countries Similar progress has been made in most forms of countries Similar progress has been made in most forms of production Agricultural production which at the turn of the production Agricultural production which at the turn of the 20th century absorbed half the labor force now absorbs less 20th century absorbed half the labor force now absorbs less than 3 percent while producing more food more cheaply than than 3 percent while producing more food more cheaply than ever ever

bull We must be careful not to dismiss the Luddites as altogether We must be careful not to dismiss the Luddites as altogether foolish While new technology especially over decades has foolish While new technology especially over decades has proved to be a net gain for workers in general the Luddites proved to be a net gain for workers in general the Luddites were in fact correct that their way of life was threatened were in fact correct that their way of life was threatened Independent weavers became factory hands unskilled Independent weavers became factory hands unskilled workers increasingly women and often children replaced workers increasingly women and often children replaced skilled craftsmen and factory work often involved long hours skilled craftsmen and factory work often involved long hours in brutal conditions The wider society reaps the benefits of in brutal conditions The wider society reaps the benefits of technological change while a narrow group sometimes technological change while a narrow group sometimes disproportionately bears its costs Our analysis also assumes disproportionately bears its costs Our analysis also assumes that markets generally clear The implicit assumption is that that markets generally clear The implicit assumption is that displaced workers move on to new jobs possibly in other forms displaced workers move on to new jobs possibly in other forms of production Markets may have a tendency to clear in the of production Markets may have a tendency to clear in the long run yet workers may find themselves displaced in the long run yet workers may find themselves displaced in the short run say over the course of a business cycleshort run say over the course of a business cycle

Issue 3 Immigration Jobs and Real WagesIssue 3 Immigration Jobs and Real Wages

bull How does an increase in the labor force through immigration or How does an increase in the labor force through immigration or natural population growth affect labor and GDP natural population growth affect labor and GDP

bull One of the emotional issues associated with US immigration One of the emotional issues associated with US immigration policy ndash particularly towards low-wage workers from Mexico ndash policy ndash particularly towards low-wage workers from Mexico ndash is the idea that is the idea that immigrants take jobs away from native immigrants take jobs away from native workers workers We might be tempted to dismiss this fear as another We might be tempted to dismiss this fear as another example of the lump-of-labor fallacy Yet there is a sensible example of the lump-of-labor fallacy Yet there is a sensible intuition behind the argument An increase in the labor force ndash intuition behind the argument An increase in the labor force ndash due either to immigration or to higher population growth rates due either to immigration or to higher population growth rates ndash can be represented as an outward shift of the aggregate labor ndash can be represented as an outward shift of the aggregate labor supply curve as shown in the following Figure Employment supply curve as shown in the following Figure Employment increases but real wages fall It is not then that immigrants increases but real wages fall It is not then that immigrants take jobs away from natives take jobs away from natives Rather they compete for jobsRather they compete for jobs putting downward pressure on real wagesputting downward pressure on real wages

bull Again we must exercise care in interpreting the analysis Again we must exercise care in interpreting the analysis Remember that aggregate labor and average wage rates hide Remember that aggregate labor and average wage rates hide many details of the labor process The incomes of the new many details of the labor process The incomes of the new immigrants immigrants creates demand creates demand for the new production that they for the new production that they make possible Immigrant workers (at least those ndash whether make possible Immigrant workers (at least those ndash whether legal or illegal ndash who have become the focus of the most intense legal or illegal ndash who have become the focus of the most intense political debate) political debate) are likely to possess fewer skills than nativesare likely to possess fewer skills than natives The net effect is that the increased demand for goods and The net effect is that the increased demand for goods and services generated by immigrants is likely to increase the services generated by immigrants is likely to increase the demand for skilled (demand for skilled (and largely nativeand largely native) workers relative to ) workers relative to their supply and so to increase real wages of skilled workers their supply and so to increase real wages of skilled workers Low-skilled immigration may lower the real wage for farm Low-skilled immigration may lower the real wage for farm workers but if anything it would raise the real wage for workers but if anything it would raise the real wage for computer programmerscomputer programmers

Next Task Labor Market in Kuwait

Appendix Is Labor Supply Stable Over Time

bull Statistics on participation rates or average hours for a Statistics on participation rates or average hours for a particular month or year are snapshot of the labor market particular month or year are snapshot of the labor market Can we analyze the effects of that increase on the labor market Can we analyze the effects of that increase on the labor market under the assumption that the labor-supply curves of workers under the assumption that the labor-supply curves of workers remain essentially stableremain essentially stable

bull Data on participation rates in the United States appear to Data on participation rates in the United States appear to support this conjecture (see Figure 811) which shows the support this conjecture (see Figure 811) which shows the overall civilian participation rate trending upward ndash at least overall civilian participation rate trending upward ndash at least from the middle of the 1960sfrom the middle of the 1960s

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

bull The regression line traces out a shape very The regression line traces out a shape very like the backward-like the backward-bendingbending labor-supply curve with a 40-hour constraint What labor-supply curve with a 40-hour constraint What looks like a vertical line above 40 hours is looks like a vertical line above 40 hours is not really a solid line not really a solid line at all but a reflection of the fact that about at all but a reflection of the fact that about 7500 7500 of the 10000 of the 10000 workers in the sample supply 40 hours per week at a variety of workers in the sample supply 40 hours per week at a variety of wage rates The labor-supply curve traces out a segment above wage rates The labor-supply curve traces out a segment above the 40-hour point that corresponds to the constraintthe 40-hour point that corresponds to the constraint

bull There are There are points to the rightpoints to the right of 40 hours This is reasonable of 40 hours This is reasonable since in the real world workers do since in the real world workers do work overtimework overtime ndash either ndash either because they are supervisors or professionals or because because they are supervisors or professionals or because employers offer them the required time-and-half wage rate employers offer them the required time-and-half wage rate The fit of the regression line is far from perfect points lie on The fit of the regression line is far from perfect points lie on both sides of the line We should interpret it as a both sides of the line We should interpret it as a snapshotsnapshot of of the behavior of the typical worker But ofthe behavior of the typical worker But of course the typical course the typical worker is not any actual worker in particularworker is not any actual worker in particular

THE WORKER CHOOSING TO PARTICIPATETHE WORKER CHOOSING TO PARTICIPATE

bull So far we have examined only one aspect of the workerrsquos So far we have examined only one aspect of the workerrsquos labor-supply decision labor-supply decision how many hours to work for given real how many hours to work for given real wagewage We now take up the second aspect We now take up the second aspect participationparticipation ndash that ndash that is is whether or not to work at allwhether or not to work at all A labor-supply curve that starts A labor-supply curve that starts at the origin and slopes upwards for at least a portion of its at the origin and slopes upwards for at least a portion of its length suggests that even length suggests that even if the wage were very lowif the wage were very low ndash say 1cent ndash say 1cent per hour ndash the worker would work a little bit That is clearly per hour ndash the worker would work a little bit That is clearly unrealisticunrealistic no one would work at all for 1cent per hour no one would work at all for 1cent per hour What What factors determine how high the wage factors determine how high the wage must be to induce a person must be to induce a person to participate in the labor marketto participate in the labor market

bull The labor force The labor force participationparticipation decision is a question of decision is a question of opportunity costopportunity cost Idleness has its charms Before anyone enters Idleness has its charms Before anyone enters the labor force the wage rate must be high enough to overcome the labor force the wage rate must be high enough to overcome them them The opportunity cost of participatingThe opportunity cost of participating in the labor force is in the labor force is sum of sum of

1048766 1048766 the implicit valuethe implicit value the worker places on complete idleness the worker places on complete idleness

1048766 1048766 the explicit coststhe explicit costs of working compared to not working such as of working compared to not working such as clothing transport childcare) andclothing transport childcare) and

1048766 1048766 the explicit losses the explicit losses from working (for instance housework not from working (for instance housework not done)done)

bull The opportunity cost is partly psychological and partly material The opportunity cost is partly psychological and partly material If people were completely If people were completely independentindependent of each other the worker of each other the worker might place a lower value on the opportunity cost of might place a lower value on the opportunity cost of participation because then the choice might be literally between participation because then the choice might be literally between work and starvationwork and starvation

bull But most people are not But most people are not completely independentcompletely independent Whether or Whether or not to participate in the labor force could be a not to participate in the labor force could be a genuine choicegenuine choice and would depend on the and would depend on the real wagereal wage

bull The The RESERVATION WAGE RESERVATION WAGE is defined to be is defined to be the opportunity the opportunity cost of working compared to not workingcost of working compared to not working ndash ndash that is the real wage that is the real wage that is high enough to make it just worthwhile for a worker to that is high enough to make it just worthwhile for a worker to participate in the labor forceparticipate in the labor force

bull Taking account of the opportunity costs of participation affects Taking account of the opportunity costs of participation affects the shape of the labor-supply curve As long as the the shape of the labor-supply curve As long as the real wage is real wage is below the reservationbelow the reservation wage ((wp)R) the worker supplies no wage ((wp)R) the worker supplies no labor at all Above the reservation wage there is a normal labor at all Above the reservation wage there is a normal labor-supply curvelabor-supply curve

bull The following captures the two stages of the labor supply The following captures the two stages of the labor supply decision decision FirstFirst at low wages the worker will at low wages the worker will notnot supply any supply any labor at all and small increases in wages have no effect But labor at all and small increases in wages have no effect But secondsecond as soon as the wage rises enough for the worker to bite as soon as the wage rises enough for the worker to bite the bullet and join the labor force the minimum labor supplied the bullet and join the labor force the minimum labor supplied will be well will be well above zeroabove zero and the worker will decide how many and the worker will decide how many hours to supply above this minimum through the usual process hours to supply above this minimum through the usual process of balancing the opportunity cost of leisure against the desire of balancing the opportunity cost of leisure against the desire for consumption goodsfor consumption goods

AGGREGATE LABOR SUPPLY

bull How can we moveHow can we move from the microeconomics of the labor supply from the microeconomics of the labor supply back to an aggregate relationship usable in macroeconomic back to an aggregate relationship usable in macroeconomic analysis analysis If workers were essentially alikeIf workers were essentially alike the problem would the problem would be easy be easy

bull As we have seen labor supply has two dimensions ndash As we have seen labor supply has two dimensions ndash participationparticipation in the labor force and in the labor force and choice of hourschoice of hours of labor of labor Take the participation decision first If all workers were alike Take the participation decision first If all workers were alike except for except for differences in their reservation wagedifferences in their reservation wage then we could then we could rank them from lowest to highest reservation wage The rank them from lowest to highest reservation wage The aggregate labor-supply (participation) curve is strictly aggregate labor-supply (participation) curve is strictly upwardslopingupwardsloping

bull Of course this is too easy Just as we observed in deriving the Of course this is too easy Just as we observed in deriving the aggregate labor demand curve workers are aggregate labor demand curve workers are not all alikenot all alike Once Once again we must interpret the vertical axis as measuring the again we must interpret the vertical axis as measuring the average real wageaverage real wage that at best provides a kind of index for the that at best provides a kind of index for the level of the wage structure level of the wage structure

bull The The problemproblem remains the remains the samesame when we turn to the choice of when we turn to the choice of hourshours Workers are all different and face a structure of wages Workers are all different and face a structure of wages For each worker individually there is a jump from supplying For each worker individually there is a jump from supplying zero to supplying some positive number of hours zero to supplying some positive number of hours when his own when his own wage rate surpasses their wage rate surpasses their reservation wagereservation wage But in aggregate But in aggregate we are we are unlikely to see such a jumpunlikely to see such a jump Not only are there a variety Not only are there a variety of wages offered at any time but reservation wages differof wages offered at any time but reservation wages differ

Derivation of the Aggregate Labor-supply Curve

bull A curve like the one in this figure can be used to display either A curve like the one in this figure can be used to display either the the participation participation decision or decision or the hoursthe hours The horizontal axis can The horizontal axis can either be used for workers either be used for workers or worker-hoursor worker-hours as measures of the as measures of the labor supply The two meanings are not completely labor supply The two meanings are not completely independent by definition independent by definition

bull workers equiv aggregate worker ndash hours average hours per worker workers equiv aggregate worker ndash hours average hours per worker

The Participation Rate and Average Hours

bull Let us look first at the aggregate participation decision The Let us look first at the aggregate participation decision The aggregate number of workers who have decided to participate aggregate number of workers who have decided to participate is known as the is known as the labor forcelabor force the the civilian labor force over 16 civilian labor force over 16 years of ageyears of age This number excludes uniformed members of the This number excludes uniformed members of the armed services and the small number of workers under 16 armed services and the small number of workers under 16 years old The labor force of course has grown right along years old The labor force of course has grown right along with population with population

bull The participation rateThe participation rate (PR) measures (PR) measures the labor force as its ratio the labor force as its ratio to the relevant populationto the relevant population

bull participation rate = labor forcerelevant population participation rate = labor forcerelevant population

bull ldquoldquonon-institutionalrdquo non-institutionalrdquo excludes people in prison or in homes for excludes people in prison or in homes for the aged) the aged)

bull The aggregate number of hours The aggregate number of hours worked is worked is not as easy not as easy as the as the participation rate to relate to the individual workerrsquos choices participation rate to relate to the individual workerrsquos choices If every worker had the same labor-supply curve we would If every worker had the same labor-supply curve we would have to know the wage offered to each one in order to calculate have to know the wage offered to each one in order to calculate the total number of labor hours supplied In reality workers the total number of labor hours supplied In reality workers are not all alike are not all alike Labor-supply curves may vary systematically Labor-supply curves may vary systematically according to the sex age ethnic group education experience according to the sex age ethnic group education experience or other social or economic characteristics of the workersor other social or economic characteristics of the workers And And within any group the labor-supply curves of individuals are within any group the labor-supply curves of individuals are likely to varylikely to vary

bull In principle In principle if we had a good statistical estimate of the typical if we had a good statistical estimate of the typical distribution of the wagesdistribution of the wages we could make a reasonable we could make a reasonable calculation But statisticians at the Bureau of Labor Statistics calculation But statisticians at the Bureau of Labor Statistics (BLS) do not try to calculate the labor supply in this way (BLS) do not try to calculate the labor supply in this way Instead they Instead they count the number of hours that workers actually count the number of hours that workers actually workwork and the average and the average wages and salaries they are paid wages and salaries they are paid

bull In USA the total hours of labor in 1998 was In USA the total hours of labor in 1998 was 236882236882 million million The average hours of work is The average hours of work is 17211721 hours per year = hours per year = 344344 hours hours per week (assuming a 50 week year) This number is 14 percent per week (assuming a 50 week year) This number is 14 percent below the full time 40-hour week which makes sense since it below the full time 40-hour week which makes sense since it averages over full-time part-time and overtime workers averages over full-time part-time and overtime workers

Labor Market EquilibriumLabor Market Equilibrium

bull MARKET CLEARINGMARKET CLEARING

bull When both demand and supply curves are plotted on the same When both demand and supply curves are plotted on the same diagram the crossing point defines the diagram the crossing point defines the equilibrium real-wage equilibrium real-wage rate and the rate and the equilibrium level of labor employedequilibrium level of labor employed

bull The real wage The real wage looks different looks different from the point of view of the firm from the point of view of the firm and the worker For the and the worker For the firmfirm the relevant real wage is the the relevant real wage is the product-real wage product-real wage defined as defined as the number of units of the good the number of units of the good the firm produces that the wage will purchase the firm produces that the wage will purchase ((price of price of productproduct = = w) w) For the For the workerworker the relevant real wage is the the relevant real wage is the consumption-consumption-real real wagewage defined as defined as the number of typical consumption baskets the number of typical consumption baskets that the wage will purchase that the wage will purchase ((price of price of consumption basket consumption basket = = w)w)

bull For aggregate analysis we might use the For aggregate analysis we might use the Producer Price IndexProducer Price Index or the GDP deflator to approximate the or the GDP deflator to approximate the product priceproduct price and the and the CPICPI to approximate the to approximate the consumption price consumption price

bull Suppose that the product-real wage and the consumption-real Suppose that the product-real wage and the consumption-real wage in the following figure start out with the identical value wage in the following figure start out with the identical value ((wp) at the market-clearing point Awp) at the market-clearing point A Now suppose that Now suppose that imported Japanese cars are a large portion of the typical imported Japanese cars are a large portion of the typical workerrsquos consumption basket workerrsquos consumption basket and that and that ceteris paribus ceteris paribus the price the price of Japanese cars rises sharply This means that the of Japanese cars rises sharply This means that the real wage real wage from the point of view of the from the point of view of the consumer falls to (consumer falls to (wpwpCPICPI ) )11 at point at point

B B on the labor-supply curve (LS) so that the worker would on the labor-supply curve (LS) so that the worker would want to supply less labor (want to supply less labor (LL11))

bull The rise in the price of Japanese cars has no effect on the price The rise in the price of Japanese cars has no effect on the price of their products Nevertheless they see a reduction of labor of their products Nevertheless they see a reduction of labor supply at the original market clearing wage It is as if the supply at the original market clearing wage It is as if the labor-supply curve labor-supply curve has shifted to the left to has shifted to the left to LSLSrsquo which passes rsquo which passes through ((through ((wp) L1) at point C wp) L1) at point C At the original wage rate labor At the original wage rate labor demand exceeds labor supply so firms raise wages in an effort demand exceeds labor supply so firms raise wages in an effort to attract workers until they reach the new market-clearing to attract workers until they reach the new market-clearing wage at point D where they pay (wage at point D where they pay (wpwpPPIPPI ) for labor of L ) for labor of L The The

rise in the price of Japanese cars has the effect of raising the rise in the price of Japanese cars has the effect of raising the wages that firms must pay and reducing labor employedwages that firms must pay and reducing labor employed Higher wages partly compensate workers for the higher costs Higher wages partly compensate workers for the higher costs of consumption but firms can afford to pay those higher wages of consumption but firms can afford to pay those higher wages only if marginal products rise as a result of their using less only if marginal products rise as a result of their using less labor labor

bull The rise in wage rates is not enough to compensate workers The rise in wage rates is not enough to compensate workers fully so the consumption-real wage in equilibrium is (wpfully so the consumption-real wage in equilibrium is (wpCPI CPI ) )

atat point E We can think of import prices as a tax levied on point E We can think of import prices as a tax levied on consumers and of an increase in import prices as widening the consumers and of an increase in import prices as widening the tax wedge Unless the issue that we want to analyze depends on tax wedge Unless the issue that we want to analyze depends on the difference between product- and consumption-real wages the difference between product- and consumption-real wages we will treat the real wage as the same for both labor supply we will treat the real wage as the same for both labor supply and labor demandand labor demand

An Increase in the Price of Consumption GoodsAn Increase in the Price of Consumption GoodsRelative to the Price of OutputRelative to the Price of Output

ANALYZING IDEAL LABOR MARKETSANALYZING IDEAL LABOR MARKETS

bull The aggregate labor-supplylabor-demand diagram provides us The aggregate labor-supplylabor-demand diagram provides us with a powerful tool We now analyze three important with a powerful tool We now analyze three important macroeconomic issues macroeconomic issues

(1) the effect of tax cuts on employment (1) the effect of tax cuts on employment

(2) the effect of technological progress on the well-being of (2) the effect of technological progress on the well-being of workers and workers and

(3) the effect of immigration on existing workers (3) the effect of immigration on existing workers

bull Issue 1 Tax Cuts Issue 1 Tax Cuts What are the effects of a cut in marginal What are the effects of a cut in marginal income-tax rates on employment and the level of GDP in the income-tax rates on employment and the level of GDP in the economyeconomy Recall from section that a lower marginal income-Recall from section that a lower marginal income-tax rate increases labor supply at each real wage (a rightward tax rate increases labor supply at each real wage (a rightward shift of the labor-supply) shift of the labor-supply)

bull Labor-market equilibrium moves from point A to point B in Labor-market equilibrium moves from point A to point B in the lower panel of the following Notice that the amount of the lower panel of the following Notice that the amount of labor available to firms increases so that firms move labor available to firms increases so that firms move production from Arsquo to Brsquo on the labor production function in production from Arsquo to Brsquo on the labor production function in the upper panel Also notice that the real wage falls from (the upper panel Also notice that the real wage falls from (wp)1 wp)1 to (wp)2 Since the cut in taxes increases the number of to (wp)2 Since the cut in taxes increases the number of workers workers willing to work at each wage Workers care about their take-willing to work at each wage Workers care about their take-home pay ndash that is about their home pay ndash that is about their after-tax real wage after-tax real wage This is This is perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 can be greater than the old after-tax real wage (1ndashcan be greater than the old after-tax real wage (1ndashτ1τ1)(wp)1 so )(wp)1 so long as the rise in the take-home share (1 ndash τ) is long as the rise in the take-home share (1 ndash τ) is proportionately greater than the fall in the before-tax real proportionately greater than the fall in the before-tax real wage (wp)wage (wp)

bull The analysis depends on substitution effects dominating The analysis depends on substitution effects dominating income effects which they probably do in aggregate if not for income effects which they probably do in aggregate if not for every worker So the supply-siders of the Reagan years are every worker So the supply-siders of the Reagan years are correct in principle How much output will increase depends on correct in principle How much output will increase depends on how large the substitution effect is If most people work a how large the substitution effect is If most people work a standard 40-hour week the effect could be quite small and the standard 40-hour week the effect could be quite small and the increase in output might also be very small in practiceincrease in output might also be very small in practice

Issue 1 The Effect of a Cut in Marginal Tax RatesIssue 1 The Effect of a Cut in Marginal Tax Rates

Issue 2 Technological Progress and Worker WelfareIssue 2 Technological Progress and Worker Welfare

bull Is technological progress and increasing use of machinery and Is technological progress and increasing use of machinery and other capital beneficial for workersother capital beneficial for workers

bull Technological change or capital accumulation have been Technological change or capital accumulation have been known as ldquoLudditesrdquo (known as ldquoLudditesrdquo (it negatively affects the demand for it negatively affects the demand for laborlabor) To see why the Luddites are wrong ndash at least for ) To see why the Luddites are wrong ndash at least for clearing labor markets ndash recall that technological progress or clearing labor markets ndash recall that technological progress or increased capital both increased capital both shift the labor-demand curve upwardshift the labor-demand curve upward The lower panel of the following figure shows that the effect of The lower panel of the following figure shows that the effect of the increased demand for labor is to increase total employment the increased demand for labor is to increase total employment and the real wage Firms and the real wage Firms can pay a higher real wage can pay a higher real wage because because the additional capital or technological progress the additional capital or technological progress increases the increases the marginal product of labormarginal product of labor

bull The The Ludditesrsquo mistake Ludditesrsquo mistake is most easily seen in the upper panel is most easily seen in the upper panel The Luddite argument assumes that fewer workers will The Luddite argument assumes that fewer workers will produce the same total output Production starts at Arsquo using produce the same total output Production starts at Arsquo using L1 L1 workers to produce Y1 After the upward shift in the production workers to produce Y1 After the upward shift in the production function the same output could be produced using less labor function the same output could be produced using less labor ((L3) at point Arsquorsquo The L3) at point Arsquorsquo The problem is that Arsquorsquo is not an equilibrium problem is that Arsquorsquo is not an equilibrium At that point the marginal product of labor is higher than the At that point the marginal product of labor is higher than the original real wage so a profit-maximizing firm would want to original real wage so a profit-maximizing firm would want to expand production To do this they must hire more labor than expand production To do this they must hire more labor than L3 and indeed they L3 and indeed they find it find it profitable profitable to hire more labor than to hire more labor than the original the original L1 The only way actually to increase labor L1 The only way actually to increase labor is to is to raise the real-wage raise the real-wage rate above its original level Technological rate above its original level Technological progress therefore favors progress therefore favors workers by increasing employment workers by increasing employment and wagesand wages

bull Early in the 19th century hand-woven cloth was very Early in the 19th century hand-woven cloth was very expensive and a worker was lucky to own the clothes on his expensive and a worker was lucky to own the clothes on his back and a spare set for church on Sunday Textiles were one of back and a spare set for church on Sunday Textiles were one of the first industries to benefit from the Industrial Revolution so the first industries to benefit from the Industrial Revolution so that by the end of the 19th century machine-made fabrics and that by the end of the 19th century machine-made fabrics and mass-production made decent clothing in larger quantities mass-production made decent clothing in larger quantities accessible to most of the population of the more developed accessible to most of the population of the more developed countries Similar progress has been made in most forms of countries Similar progress has been made in most forms of production Agricultural production which at the turn of the production Agricultural production which at the turn of the 20th century absorbed half the labor force now absorbs less 20th century absorbed half the labor force now absorbs less than 3 percent while producing more food more cheaply than than 3 percent while producing more food more cheaply than ever ever

bull We must be careful not to dismiss the Luddites as altogether We must be careful not to dismiss the Luddites as altogether foolish While new technology especially over decades has foolish While new technology especially over decades has proved to be a net gain for workers in general the Luddites proved to be a net gain for workers in general the Luddites were in fact correct that their way of life was threatened were in fact correct that their way of life was threatened Independent weavers became factory hands unskilled Independent weavers became factory hands unskilled workers increasingly women and often children replaced workers increasingly women and often children replaced skilled craftsmen and factory work often involved long hours skilled craftsmen and factory work often involved long hours in brutal conditions The wider society reaps the benefits of in brutal conditions The wider society reaps the benefits of technological change while a narrow group sometimes technological change while a narrow group sometimes disproportionately bears its costs Our analysis also assumes disproportionately bears its costs Our analysis also assumes that markets generally clear The implicit assumption is that that markets generally clear The implicit assumption is that displaced workers move on to new jobs possibly in other forms displaced workers move on to new jobs possibly in other forms of production Markets may have a tendency to clear in the of production Markets may have a tendency to clear in the long run yet workers may find themselves displaced in the long run yet workers may find themselves displaced in the short run say over the course of a business cycleshort run say over the course of a business cycle

Issue 3 Immigration Jobs and Real WagesIssue 3 Immigration Jobs and Real Wages

bull How does an increase in the labor force through immigration or How does an increase in the labor force through immigration or natural population growth affect labor and GDP natural population growth affect labor and GDP

bull One of the emotional issues associated with US immigration One of the emotional issues associated with US immigration policy ndash particularly towards low-wage workers from Mexico ndash policy ndash particularly towards low-wage workers from Mexico ndash is the idea that is the idea that immigrants take jobs away from native immigrants take jobs away from native workers workers We might be tempted to dismiss this fear as another We might be tempted to dismiss this fear as another example of the lump-of-labor fallacy Yet there is a sensible example of the lump-of-labor fallacy Yet there is a sensible intuition behind the argument An increase in the labor force ndash intuition behind the argument An increase in the labor force ndash due either to immigration or to higher population growth rates due either to immigration or to higher population growth rates ndash can be represented as an outward shift of the aggregate labor ndash can be represented as an outward shift of the aggregate labor supply curve as shown in the following Figure Employment supply curve as shown in the following Figure Employment increases but real wages fall It is not then that immigrants increases but real wages fall It is not then that immigrants take jobs away from natives take jobs away from natives Rather they compete for jobsRather they compete for jobs putting downward pressure on real wagesputting downward pressure on real wages

bull Again we must exercise care in interpreting the analysis Again we must exercise care in interpreting the analysis Remember that aggregate labor and average wage rates hide Remember that aggregate labor and average wage rates hide many details of the labor process The incomes of the new many details of the labor process The incomes of the new immigrants immigrants creates demand creates demand for the new production that they for the new production that they make possible Immigrant workers (at least those ndash whether make possible Immigrant workers (at least those ndash whether legal or illegal ndash who have become the focus of the most intense legal or illegal ndash who have become the focus of the most intense political debate) political debate) are likely to possess fewer skills than nativesare likely to possess fewer skills than natives The net effect is that the increased demand for goods and The net effect is that the increased demand for goods and services generated by immigrants is likely to increase the services generated by immigrants is likely to increase the demand for skilled (demand for skilled (and largely nativeand largely native) workers relative to ) workers relative to their supply and so to increase real wages of skilled workers their supply and so to increase real wages of skilled workers Low-skilled immigration may lower the real wage for farm Low-skilled immigration may lower the real wage for farm workers but if anything it would raise the real wage for workers but if anything it would raise the real wage for computer programmerscomputer programmers

Next Task Labor Market in Kuwait

Appendix Is Labor Supply Stable Over Time

bull Statistics on participation rates or average hours for a Statistics on participation rates or average hours for a particular month or year are snapshot of the labor market particular month or year are snapshot of the labor market Can we analyze the effects of that increase on the labor market Can we analyze the effects of that increase on the labor market under the assumption that the labor-supply curves of workers under the assumption that the labor-supply curves of workers remain essentially stableremain essentially stable

bull Data on participation rates in the United States appear to Data on participation rates in the United States appear to support this conjecture (see Figure 811) which shows the support this conjecture (see Figure 811) which shows the overall civilian participation rate trending upward ndash at least overall civilian participation rate trending upward ndash at least from the middle of the 1960sfrom the middle of the 1960s

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

THE WORKER CHOOSING TO PARTICIPATETHE WORKER CHOOSING TO PARTICIPATE

bull So far we have examined only one aspect of the workerrsquos So far we have examined only one aspect of the workerrsquos labor-supply decision labor-supply decision how many hours to work for given real how many hours to work for given real wagewage We now take up the second aspect We now take up the second aspect participationparticipation ndash that ndash that is is whether or not to work at allwhether or not to work at all A labor-supply curve that starts A labor-supply curve that starts at the origin and slopes upwards for at least a portion of its at the origin and slopes upwards for at least a portion of its length suggests that even length suggests that even if the wage were very lowif the wage were very low ndash say 1cent ndash say 1cent per hour ndash the worker would work a little bit That is clearly per hour ndash the worker would work a little bit That is clearly unrealisticunrealistic no one would work at all for 1cent per hour no one would work at all for 1cent per hour What What factors determine how high the wage factors determine how high the wage must be to induce a person must be to induce a person to participate in the labor marketto participate in the labor market

bull The labor force The labor force participationparticipation decision is a question of decision is a question of opportunity costopportunity cost Idleness has its charms Before anyone enters Idleness has its charms Before anyone enters the labor force the wage rate must be high enough to overcome the labor force the wage rate must be high enough to overcome them them The opportunity cost of participatingThe opportunity cost of participating in the labor force is in the labor force is sum of sum of

1048766 1048766 the implicit valuethe implicit value the worker places on complete idleness the worker places on complete idleness

1048766 1048766 the explicit coststhe explicit costs of working compared to not working such as of working compared to not working such as clothing transport childcare) andclothing transport childcare) and

1048766 1048766 the explicit losses the explicit losses from working (for instance housework not from working (for instance housework not done)done)

bull The opportunity cost is partly psychological and partly material The opportunity cost is partly psychological and partly material If people were completely If people were completely independentindependent of each other the worker of each other the worker might place a lower value on the opportunity cost of might place a lower value on the opportunity cost of participation because then the choice might be literally between participation because then the choice might be literally between work and starvationwork and starvation

bull But most people are not But most people are not completely independentcompletely independent Whether or Whether or not to participate in the labor force could be a not to participate in the labor force could be a genuine choicegenuine choice and would depend on the and would depend on the real wagereal wage

bull The The RESERVATION WAGE RESERVATION WAGE is defined to be is defined to be the opportunity the opportunity cost of working compared to not workingcost of working compared to not working ndash ndash that is the real wage that is the real wage that is high enough to make it just worthwhile for a worker to that is high enough to make it just worthwhile for a worker to participate in the labor forceparticipate in the labor force

bull Taking account of the opportunity costs of participation affects Taking account of the opportunity costs of participation affects the shape of the labor-supply curve As long as the the shape of the labor-supply curve As long as the real wage is real wage is below the reservationbelow the reservation wage ((wp)R) the worker supplies no wage ((wp)R) the worker supplies no labor at all Above the reservation wage there is a normal labor at all Above the reservation wage there is a normal labor-supply curvelabor-supply curve

bull The following captures the two stages of the labor supply The following captures the two stages of the labor supply decision decision FirstFirst at low wages the worker will at low wages the worker will notnot supply any supply any labor at all and small increases in wages have no effect But labor at all and small increases in wages have no effect But secondsecond as soon as the wage rises enough for the worker to bite as soon as the wage rises enough for the worker to bite the bullet and join the labor force the minimum labor supplied the bullet and join the labor force the minimum labor supplied will be well will be well above zeroabove zero and the worker will decide how many and the worker will decide how many hours to supply above this minimum through the usual process hours to supply above this minimum through the usual process of balancing the opportunity cost of leisure against the desire of balancing the opportunity cost of leisure against the desire for consumption goodsfor consumption goods

AGGREGATE LABOR SUPPLY

bull How can we moveHow can we move from the microeconomics of the labor supply from the microeconomics of the labor supply back to an aggregate relationship usable in macroeconomic back to an aggregate relationship usable in macroeconomic analysis analysis If workers were essentially alikeIf workers were essentially alike the problem would the problem would be easy be easy

bull As we have seen labor supply has two dimensions ndash As we have seen labor supply has two dimensions ndash participationparticipation in the labor force and in the labor force and choice of hourschoice of hours of labor of labor Take the participation decision first If all workers were alike Take the participation decision first If all workers were alike except for except for differences in their reservation wagedifferences in their reservation wage then we could then we could rank them from lowest to highest reservation wage The rank them from lowest to highest reservation wage The aggregate labor-supply (participation) curve is strictly aggregate labor-supply (participation) curve is strictly upwardslopingupwardsloping

bull Of course this is too easy Just as we observed in deriving the Of course this is too easy Just as we observed in deriving the aggregate labor demand curve workers are aggregate labor demand curve workers are not all alikenot all alike Once Once again we must interpret the vertical axis as measuring the again we must interpret the vertical axis as measuring the average real wageaverage real wage that at best provides a kind of index for the that at best provides a kind of index for the level of the wage structure level of the wage structure

bull The The problemproblem remains the remains the samesame when we turn to the choice of when we turn to the choice of hourshours Workers are all different and face a structure of wages Workers are all different and face a structure of wages For each worker individually there is a jump from supplying For each worker individually there is a jump from supplying zero to supplying some positive number of hours zero to supplying some positive number of hours when his own when his own wage rate surpasses their wage rate surpasses their reservation wagereservation wage But in aggregate But in aggregate we are we are unlikely to see such a jumpunlikely to see such a jump Not only are there a variety Not only are there a variety of wages offered at any time but reservation wages differof wages offered at any time but reservation wages differ

Derivation of the Aggregate Labor-supply Curve

bull A curve like the one in this figure can be used to display either A curve like the one in this figure can be used to display either the the participation participation decision or decision or the hoursthe hours The horizontal axis can The horizontal axis can either be used for workers either be used for workers or worker-hoursor worker-hours as measures of the as measures of the labor supply The two meanings are not completely labor supply The two meanings are not completely independent by definition independent by definition

bull workers equiv aggregate worker ndash hours average hours per worker workers equiv aggregate worker ndash hours average hours per worker

The Participation Rate and Average Hours

bull Let us look first at the aggregate participation decision The Let us look first at the aggregate participation decision The aggregate number of workers who have decided to participate aggregate number of workers who have decided to participate is known as the is known as the labor forcelabor force the the civilian labor force over 16 civilian labor force over 16 years of ageyears of age This number excludes uniformed members of the This number excludes uniformed members of the armed services and the small number of workers under 16 armed services and the small number of workers under 16 years old The labor force of course has grown right along years old The labor force of course has grown right along with population with population

bull The participation rateThe participation rate (PR) measures (PR) measures the labor force as its ratio the labor force as its ratio to the relevant populationto the relevant population

bull participation rate = labor forcerelevant population participation rate = labor forcerelevant population

bull ldquoldquonon-institutionalrdquo non-institutionalrdquo excludes people in prison or in homes for excludes people in prison or in homes for the aged) the aged)

bull The aggregate number of hours The aggregate number of hours worked is worked is not as easy not as easy as the as the participation rate to relate to the individual workerrsquos choices participation rate to relate to the individual workerrsquos choices If every worker had the same labor-supply curve we would If every worker had the same labor-supply curve we would have to know the wage offered to each one in order to calculate have to know the wage offered to each one in order to calculate the total number of labor hours supplied In reality workers the total number of labor hours supplied In reality workers are not all alike are not all alike Labor-supply curves may vary systematically Labor-supply curves may vary systematically according to the sex age ethnic group education experience according to the sex age ethnic group education experience or other social or economic characteristics of the workersor other social or economic characteristics of the workers And And within any group the labor-supply curves of individuals are within any group the labor-supply curves of individuals are likely to varylikely to vary

bull In principle In principle if we had a good statistical estimate of the typical if we had a good statistical estimate of the typical distribution of the wagesdistribution of the wages we could make a reasonable we could make a reasonable calculation But statisticians at the Bureau of Labor Statistics calculation But statisticians at the Bureau of Labor Statistics (BLS) do not try to calculate the labor supply in this way (BLS) do not try to calculate the labor supply in this way Instead they Instead they count the number of hours that workers actually count the number of hours that workers actually workwork and the average and the average wages and salaries they are paid wages and salaries they are paid

bull In USA the total hours of labor in 1998 was In USA the total hours of labor in 1998 was 236882236882 million million The average hours of work is The average hours of work is 17211721 hours per year = hours per year = 344344 hours hours per week (assuming a 50 week year) This number is 14 percent per week (assuming a 50 week year) This number is 14 percent below the full time 40-hour week which makes sense since it below the full time 40-hour week which makes sense since it averages over full-time part-time and overtime workers averages over full-time part-time and overtime workers

Labor Market EquilibriumLabor Market Equilibrium

bull MARKET CLEARINGMARKET CLEARING

bull When both demand and supply curves are plotted on the same When both demand and supply curves are plotted on the same diagram the crossing point defines the diagram the crossing point defines the equilibrium real-wage equilibrium real-wage rate and the rate and the equilibrium level of labor employedequilibrium level of labor employed

bull The real wage The real wage looks different looks different from the point of view of the firm from the point of view of the firm and the worker For the and the worker For the firmfirm the relevant real wage is the the relevant real wage is the product-real wage product-real wage defined as defined as the number of units of the good the number of units of the good the firm produces that the wage will purchase the firm produces that the wage will purchase ((price of price of productproduct = = w) w) For the For the workerworker the relevant real wage is the the relevant real wage is the consumption-consumption-real real wagewage defined as defined as the number of typical consumption baskets the number of typical consumption baskets that the wage will purchase that the wage will purchase ((price of price of consumption basket consumption basket = = w)w)

bull For aggregate analysis we might use the For aggregate analysis we might use the Producer Price IndexProducer Price Index or the GDP deflator to approximate the or the GDP deflator to approximate the product priceproduct price and the and the CPICPI to approximate the to approximate the consumption price consumption price

bull Suppose that the product-real wage and the consumption-real Suppose that the product-real wage and the consumption-real wage in the following figure start out with the identical value wage in the following figure start out with the identical value ((wp) at the market-clearing point Awp) at the market-clearing point A Now suppose that Now suppose that imported Japanese cars are a large portion of the typical imported Japanese cars are a large portion of the typical workerrsquos consumption basket workerrsquos consumption basket and that and that ceteris paribus ceteris paribus the price the price of Japanese cars rises sharply This means that the of Japanese cars rises sharply This means that the real wage real wage from the point of view of the from the point of view of the consumer falls to (consumer falls to (wpwpCPICPI ) )11 at point at point

B B on the labor-supply curve (LS) so that the worker would on the labor-supply curve (LS) so that the worker would want to supply less labor (want to supply less labor (LL11))

bull The rise in the price of Japanese cars has no effect on the price The rise in the price of Japanese cars has no effect on the price of their products Nevertheless they see a reduction of labor of their products Nevertheless they see a reduction of labor supply at the original market clearing wage It is as if the supply at the original market clearing wage It is as if the labor-supply curve labor-supply curve has shifted to the left to has shifted to the left to LSLSrsquo which passes rsquo which passes through ((through ((wp) L1) at point C wp) L1) at point C At the original wage rate labor At the original wage rate labor demand exceeds labor supply so firms raise wages in an effort demand exceeds labor supply so firms raise wages in an effort to attract workers until they reach the new market-clearing to attract workers until they reach the new market-clearing wage at point D where they pay (wage at point D where they pay (wpwpPPIPPI ) for labor of L ) for labor of L The The

rise in the price of Japanese cars has the effect of raising the rise in the price of Japanese cars has the effect of raising the wages that firms must pay and reducing labor employedwages that firms must pay and reducing labor employed Higher wages partly compensate workers for the higher costs Higher wages partly compensate workers for the higher costs of consumption but firms can afford to pay those higher wages of consumption but firms can afford to pay those higher wages only if marginal products rise as a result of their using less only if marginal products rise as a result of their using less labor labor

bull The rise in wage rates is not enough to compensate workers The rise in wage rates is not enough to compensate workers fully so the consumption-real wage in equilibrium is (wpfully so the consumption-real wage in equilibrium is (wpCPI CPI ) )

atat point E We can think of import prices as a tax levied on point E We can think of import prices as a tax levied on consumers and of an increase in import prices as widening the consumers and of an increase in import prices as widening the tax wedge Unless the issue that we want to analyze depends on tax wedge Unless the issue that we want to analyze depends on the difference between product- and consumption-real wages the difference between product- and consumption-real wages we will treat the real wage as the same for both labor supply we will treat the real wage as the same for both labor supply and labor demandand labor demand

An Increase in the Price of Consumption GoodsAn Increase in the Price of Consumption GoodsRelative to the Price of OutputRelative to the Price of Output

ANALYZING IDEAL LABOR MARKETSANALYZING IDEAL LABOR MARKETS

bull The aggregate labor-supplylabor-demand diagram provides us The aggregate labor-supplylabor-demand diagram provides us with a powerful tool We now analyze three important with a powerful tool We now analyze three important macroeconomic issues macroeconomic issues

(1) the effect of tax cuts on employment (1) the effect of tax cuts on employment

(2) the effect of technological progress on the well-being of (2) the effect of technological progress on the well-being of workers and workers and

(3) the effect of immigration on existing workers (3) the effect of immigration on existing workers

bull Issue 1 Tax Cuts Issue 1 Tax Cuts What are the effects of a cut in marginal What are the effects of a cut in marginal income-tax rates on employment and the level of GDP in the income-tax rates on employment and the level of GDP in the economyeconomy Recall from section that a lower marginal income-Recall from section that a lower marginal income-tax rate increases labor supply at each real wage (a rightward tax rate increases labor supply at each real wage (a rightward shift of the labor-supply) shift of the labor-supply)

bull Labor-market equilibrium moves from point A to point B in Labor-market equilibrium moves from point A to point B in the lower panel of the following Notice that the amount of the lower panel of the following Notice that the amount of labor available to firms increases so that firms move labor available to firms increases so that firms move production from Arsquo to Brsquo on the labor production function in production from Arsquo to Brsquo on the labor production function in the upper panel Also notice that the real wage falls from (the upper panel Also notice that the real wage falls from (wp)1 wp)1 to (wp)2 Since the cut in taxes increases the number of to (wp)2 Since the cut in taxes increases the number of workers workers willing to work at each wage Workers care about their take-willing to work at each wage Workers care about their take-home pay ndash that is about their home pay ndash that is about their after-tax real wage after-tax real wage This is This is perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 can be greater than the old after-tax real wage (1ndashcan be greater than the old after-tax real wage (1ndashτ1τ1)(wp)1 so )(wp)1 so long as the rise in the take-home share (1 ndash τ) is long as the rise in the take-home share (1 ndash τ) is proportionately greater than the fall in the before-tax real proportionately greater than the fall in the before-tax real wage (wp)wage (wp)

bull The analysis depends on substitution effects dominating The analysis depends on substitution effects dominating income effects which they probably do in aggregate if not for income effects which they probably do in aggregate if not for every worker So the supply-siders of the Reagan years are every worker So the supply-siders of the Reagan years are correct in principle How much output will increase depends on correct in principle How much output will increase depends on how large the substitution effect is If most people work a how large the substitution effect is If most people work a standard 40-hour week the effect could be quite small and the standard 40-hour week the effect could be quite small and the increase in output might also be very small in practiceincrease in output might also be very small in practice

Issue 1 The Effect of a Cut in Marginal Tax RatesIssue 1 The Effect of a Cut in Marginal Tax Rates

Issue 2 Technological Progress and Worker WelfareIssue 2 Technological Progress and Worker Welfare

bull Is technological progress and increasing use of machinery and Is technological progress and increasing use of machinery and other capital beneficial for workersother capital beneficial for workers

bull Technological change or capital accumulation have been Technological change or capital accumulation have been known as ldquoLudditesrdquo (known as ldquoLudditesrdquo (it negatively affects the demand for it negatively affects the demand for laborlabor) To see why the Luddites are wrong ndash at least for ) To see why the Luddites are wrong ndash at least for clearing labor markets ndash recall that technological progress or clearing labor markets ndash recall that technological progress or increased capital both increased capital both shift the labor-demand curve upwardshift the labor-demand curve upward The lower panel of the following figure shows that the effect of The lower panel of the following figure shows that the effect of the increased demand for labor is to increase total employment the increased demand for labor is to increase total employment and the real wage Firms and the real wage Firms can pay a higher real wage can pay a higher real wage because because the additional capital or technological progress the additional capital or technological progress increases the increases the marginal product of labormarginal product of labor

bull The The Ludditesrsquo mistake Ludditesrsquo mistake is most easily seen in the upper panel is most easily seen in the upper panel The Luddite argument assumes that fewer workers will The Luddite argument assumes that fewer workers will produce the same total output Production starts at Arsquo using produce the same total output Production starts at Arsquo using L1 L1 workers to produce Y1 After the upward shift in the production workers to produce Y1 After the upward shift in the production function the same output could be produced using less labor function the same output could be produced using less labor ((L3) at point Arsquorsquo The L3) at point Arsquorsquo The problem is that Arsquorsquo is not an equilibrium problem is that Arsquorsquo is not an equilibrium At that point the marginal product of labor is higher than the At that point the marginal product of labor is higher than the original real wage so a profit-maximizing firm would want to original real wage so a profit-maximizing firm would want to expand production To do this they must hire more labor than expand production To do this they must hire more labor than L3 and indeed they L3 and indeed they find it find it profitable profitable to hire more labor than to hire more labor than the original the original L1 The only way actually to increase labor L1 The only way actually to increase labor is to is to raise the real-wage raise the real-wage rate above its original level Technological rate above its original level Technological progress therefore favors progress therefore favors workers by increasing employment workers by increasing employment and wagesand wages

bull Early in the 19th century hand-woven cloth was very Early in the 19th century hand-woven cloth was very expensive and a worker was lucky to own the clothes on his expensive and a worker was lucky to own the clothes on his back and a spare set for church on Sunday Textiles were one of back and a spare set for church on Sunday Textiles were one of the first industries to benefit from the Industrial Revolution so the first industries to benefit from the Industrial Revolution so that by the end of the 19th century machine-made fabrics and that by the end of the 19th century machine-made fabrics and mass-production made decent clothing in larger quantities mass-production made decent clothing in larger quantities accessible to most of the population of the more developed accessible to most of the population of the more developed countries Similar progress has been made in most forms of countries Similar progress has been made in most forms of production Agricultural production which at the turn of the production Agricultural production which at the turn of the 20th century absorbed half the labor force now absorbs less 20th century absorbed half the labor force now absorbs less than 3 percent while producing more food more cheaply than than 3 percent while producing more food more cheaply than ever ever

bull We must be careful not to dismiss the Luddites as altogether We must be careful not to dismiss the Luddites as altogether foolish While new technology especially over decades has foolish While new technology especially over decades has proved to be a net gain for workers in general the Luddites proved to be a net gain for workers in general the Luddites were in fact correct that their way of life was threatened were in fact correct that their way of life was threatened Independent weavers became factory hands unskilled Independent weavers became factory hands unskilled workers increasingly women and often children replaced workers increasingly women and often children replaced skilled craftsmen and factory work often involved long hours skilled craftsmen and factory work often involved long hours in brutal conditions The wider society reaps the benefits of in brutal conditions The wider society reaps the benefits of technological change while a narrow group sometimes technological change while a narrow group sometimes disproportionately bears its costs Our analysis also assumes disproportionately bears its costs Our analysis also assumes that markets generally clear The implicit assumption is that that markets generally clear The implicit assumption is that displaced workers move on to new jobs possibly in other forms displaced workers move on to new jobs possibly in other forms of production Markets may have a tendency to clear in the of production Markets may have a tendency to clear in the long run yet workers may find themselves displaced in the long run yet workers may find themselves displaced in the short run say over the course of a business cycleshort run say over the course of a business cycle

Issue 3 Immigration Jobs and Real WagesIssue 3 Immigration Jobs and Real Wages

bull How does an increase in the labor force through immigration or How does an increase in the labor force through immigration or natural population growth affect labor and GDP natural population growth affect labor and GDP

bull One of the emotional issues associated with US immigration One of the emotional issues associated with US immigration policy ndash particularly towards low-wage workers from Mexico ndash policy ndash particularly towards low-wage workers from Mexico ndash is the idea that is the idea that immigrants take jobs away from native immigrants take jobs away from native workers workers We might be tempted to dismiss this fear as another We might be tempted to dismiss this fear as another example of the lump-of-labor fallacy Yet there is a sensible example of the lump-of-labor fallacy Yet there is a sensible intuition behind the argument An increase in the labor force ndash intuition behind the argument An increase in the labor force ndash due either to immigration or to higher population growth rates due either to immigration or to higher population growth rates ndash can be represented as an outward shift of the aggregate labor ndash can be represented as an outward shift of the aggregate labor supply curve as shown in the following Figure Employment supply curve as shown in the following Figure Employment increases but real wages fall It is not then that immigrants increases but real wages fall It is not then that immigrants take jobs away from natives take jobs away from natives Rather they compete for jobsRather they compete for jobs putting downward pressure on real wagesputting downward pressure on real wages

bull Again we must exercise care in interpreting the analysis Again we must exercise care in interpreting the analysis Remember that aggregate labor and average wage rates hide Remember that aggregate labor and average wage rates hide many details of the labor process The incomes of the new many details of the labor process The incomes of the new immigrants immigrants creates demand creates demand for the new production that they for the new production that they make possible Immigrant workers (at least those ndash whether make possible Immigrant workers (at least those ndash whether legal or illegal ndash who have become the focus of the most intense legal or illegal ndash who have become the focus of the most intense political debate) political debate) are likely to possess fewer skills than nativesare likely to possess fewer skills than natives The net effect is that the increased demand for goods and The net effect is that the increased demand for goods and services generated by immigrants is likely to increase the services generated by immigrants is likely to increase the demand for skilled (demand for skilled (and largely nativeand largely native) workers relative to ) workers relative to their supply and so to increase real wages of skilled workers their supply and so to increase real wages of skilled workers Low-skilled immigration may lower the real wage for farm Low-skilled immigration may lower the real wage for farm workers but if anything it would raise the real wage for workers but if anything it would raise the real wage for computer programmerscomputer programmers

Next Task Labor Market in Kuwait

Appendix Is Labor Supply Stable Over Time

bull Statistics on participation rates or average hours for a Statistics on participation rates or average hours for a particular month or year are snapshot of the labor market particular month or year are snapshot of the labor market Can we analyze the effects of that increase on the labor market Can we analyze the effects of that increase on the labor market under the assumption that the labor-supply curves of workers under the assumption that the labor-supply curves of workers remain essentially stableremain essentially stable

bull Data on participation rates in the United States appear to Data on participation rates in the United States appear to support this conjecture (see Figure 811) which shows the support this conjecture (see Figure 811) which shows the overall civilian participation rate trending upward ndash at least overall civilian participation rate trending upward ndash at least from the middle of the 1960sfrom the middle of the 1960s

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

bull The labor force The labor force participationparticipation decision is a question of decision is a question of opportunity costopportunity cost Idleness has its charms Before anyone enters Idleness has its charms Before anyone enters the labor force the wage rate must be high enough to overcome the labor force the wage rate must be high enough to overcome them them The opportunity cost of participatingThe opportunity cost of participating in the labor force is in the labor force is sum of sum of

1048766 1048766 the implicit valuethe implicit value the worker places on complete idleness the worker places on complete idleness

1048766 1048766 the explicit coststhe explicit costs of working compared to not working such as of working compared to not working such as clothing transport childcare) andclothing transport childcare) and

1048766 1048766 the explicit losses the explicit losses from working (for instance housework not from working (for instance housework not done)done)

bull The opportunity cost is partly psychological and partly material The opportunity cost is partly psychological and partly material If people were completely If people were completely independentindependent of each other the worker of each other the worker might place a lower value on the opportunity cost of might place a lower value on the opportunity cost of participation because then the choice might be literally between participation because then the choice might be literally between work and starvationwork and starvation

bull But most people are not But most people are not completely independentcompletely independent Whether or Whether or not to participate in the labor force could be a not to participate in the labor force could be a genuine choicegenuine choice and would depend on the and would depend on the real wagereal wage

bull The The RESERVATION WAGE RESERVATION WAGE is defined to be is defined to be the opportunity the opportunity cost of working compared to not workingcost of working compared to not working ndash ndash that is the real wage that is the real wage that is high enough to make it just worthwhile for a worker to that is high enough to make it just worthwhile for a worker to participate in the labor forceparticipate in the labor force

bull Taking account of the opportunity costs of participation affects Taking account of the opportunity costs of participation affects the shape of the labor-supply curve As long as the the shape of the labor-supply curve As long as the real wage is real wage is below the reservationbelow the reservation wage ((wp)R) the worker supplies no wage ((wp)R) the worker supplies no labor at all Above the reservation wage there is a normal labor at all Above the reservation wage there is a normal labor-supply curvelabor-supply curve

bull The following captures the two stages of the labor supply The following captures the two stages of the labor supply decision decision FirstFirst at low wages the worker will at low wages the worker will notnot supply any supply any labor at all and small increases in wages have no effect But labor at all and small increases in wages have no effect But secondsecond as soon as the wage rises enough for the worker to bite as soon as the wage rises enough for the worker to bite the bullet and join the labor force the minimum labor supplied the bullet and join the labor force the minimum labor supplied will be well will be well above zeroabove zero and the worker will decide how many and the worker will decide how many hours to supply above this minimum through the usual process hours to supply above this minimum through the usual process of balancing the opportunity cost of leisure against the desire of balancing the opportunity cost of leisure against the desire for consumption goodsfor consumption goods

AGGREGATE LABOR SUPPLY

bull How can we moveHow can we move from the microeconomics of the labor supply from the microeconomics of the labor supply back to an aggregate relationship usable in macroeconomic back to an aggregate relationship usable in macroeconomic analysis analysis If workers were essentially alikeIf workers were essentially alike the problem would the problem would be easy be easy

bull As we have seen labor supply has two dimensions ndash As we have seen labor supply has two dimensions ndash participationparticipation in the labor force and in the labor force and choice of hourschoice of hours of labor of labor Take the participation decision first If all workers were alike Take the participation decision first If all workers were alike except for except for differences in their reservation wagedifferences in their reservation wage then we could then we could rank them from lowest to highest reservation wage The rank them from lowest to highest reservation wage The aggregate labor-supply (participation) curve is strictly aggregate labor-supply (participation) curve is strictly upwardslopingupwardsloping

bull Of course this is too easy Just as we observed in deriving the Of course this is too easy Just as we observed in deriving the aggregate labor demand curve workers are aggregate labor demand curve workers are not all alikenot all alike Once Once again we must interpret the vertical axis as measuring the again we must interpret the vertical axis as measuring the average real wageaverage real wage that at best provides a kind of index for the that at best provides a kind of index for the level of the wage structure level of the wage structure

bull The The problemproblem remains the remains the samesame when we turn to the choice of when we turn to the choice of hourshours Workers are all different and face a structure of wages Workers are all different and face a structure of wages For each worker individually there is a jump from supplying For each worker individually there is a jump from supplying zero to supplying some positive number of hours zero to supplying some positive number of hours when his own when his own wage rate surpasses their wage rate surpasses their reservation wagereservation wage But in aggregate But in aggregate we are we are unlikely to see such a jumpunlikely to see such a jump Not only are there a variety Not only are there a variety of wages offered at any time but reservation wages differof wages offered at any time but reservation wages differ

Derivation of the Aggregate Labor-supply Curve

bull A curve like the one in this figure can be used to display either A curve like the one in this figure can be used to display either the the participation participation decision or decision or the hoursthe hours The horizontal axis can The horizontal axis can either be used for workers either be used for workers or worker-hoursor worker-hours as measures of the as measures of the labor supply The two meanings are not completely labor supply The two meanings are not completely independent by definition independent by definition

bull workers equiv aggregate worker ndash hours average hours per worker workers equiv aggregate worker ndash hours average hours per worker

The Participation Rate and Average Hours

bull Let us look first at the aggregate participation decision The Let us look first at the aggregate participation decision The aggregate number of workers who have decided to participate aggregate number of workers who have decided to participate is known as the is known as the labor forcelabor force the the civilian labor force over 16 civilian labor force over 16 years of ageyears of age This number excludes uniformed members of the This number excludes uniformed members of the armed services and the small number of workers under 16 armed services and the small number of workers under 16 years old The labor force of course has grown right along years old The labor force of course has grown right along with population with population

bull The participation rateThe participation rate (PR) measures (PR) measures the labor force as its ratio the labor force as its ratio to the relevant populationto the relevant population

bull participation rate = labor forcerelevant population participation rate = labor forcerelevant population

bull ldquoldquonon-institutionalrdquo non-institutionalrdquo excludes people in prison or in homes for excludes people in prison or in homes for the aged) the aged)

bull The aggregate number of hours The aggregate number of hours worked is worked is not as easy not as easy as the as the participation rate to relate to the individual workerrsquos choices participation rate to relate to the individual workerrsquos choices If every worker had the same labor-supply curve we would If every worker had the same labor-supply curve we would have to know the wage offered to each one in order to calculate have to know the wage offered to each one in order to calculate the total number of labor hours supplied In reality workers the total number of labor hours supplied In reality workers are not all alike are not all alike Labor-supply curves may vary systematically Labor-supply curves may vary systematically according to the sex age ethnic group education experience according to the sex age ethnic group education experience or other social or economic characteristics of the workersor other social or economic characteristics of the workers And And within any group the labor-supply curves of individuals are within any group the labor-supply curves of individuals are likely to varylikely to vary

bull In principle In principle if we had a good statistical estimate of the typical if we had a good statistical estimate of the typical distribution of the wagesdistribution of the wages we could make a reasonable we could make a reasonable calculation But statisticians at the Bureau of Labor Statistics calculation But statisticians at the Bureau of Labor Statistics (BLS) do not try to calculate the labor supply in this way (BLS) do not try to calculate the labor supply in this way Instead they Instead they count the number of hours that workers actually count the number of hours that workers actually workwork and the average and the average wages and salaries they are paid wages and salaries they are paid

bull In USA the total hours of labor in 1998 was In USA the total hours of labor in 1998 was 236882236882 million million The average hours of work is The average hours of work is 17211721 hours per year = hours per year = 344344 hours hours per week (assuming a 50 week year) This number is 14 percent per week (assuming a 50 week year) This number is 14 percent below the full time 40-hour week which makes sense since it below the full time 40-hour week which makes sense since it averages over full-time part-time and overtime workers averages over full-time part-time and overtime workers

Labor Market EquilibriumLabor Market Equilibrium

bull MARKET CLEARINGMARKET CLEARING

bull When both demand and supply curves are plotted on the same When both demand and supply curves are plotted on the same diagram the crossing point defines the diagram the crossing point defines the equilibrium real-wage equilibrium real-wage rate and the rate and the equilibrium level of labor employedequilibrium level of labor employed

bull The real wage The real wage looks different looks different from the point of view of the firm from the point of view of the firm and the worker For the and the worker For the firmfirm the relevant real wage is the the relevant real wage is the product-real wage product-real wage defined as defined as the number of units of the good the number of units of the good the firm produces that the wage will purchase the firm produces that the wage will purchase ((price of price of productproduct = = w) w) For the For the workerworker the relevant real wage is the the relevant real wage is the consumption-consumption-real real wagewage defined as defined as the number of typical consumption baskets the number of typical consumption baskets that the wage will purchase that the wage will purchase ((price of price of consumption basket consumption basket = = w)w)

bull For aggregate analysis we might use the For aggregate analysis we might use the Producer Price IndexProducer Price Index or the GDP deflator to approximate the or the GDP deflator to approximate the product priceproduct price and the and the CPICPI to approximate the to approximate the consumption price consumption price

bull Suppose that the product-real wage and the consumption-real Suppose that the product-real wage and the consumption-real wage in the following figure start out with the identical value wage in the following figure start out with the identical value ((wp) at the market-clearing point Awp) at the market-clearing point A Now suppose that Now suppose that imported Japanese cars are a large portion of the typical imported Japanese cars are a large portion of the typical workerrsquos consumption basket workerrsquos consumption basket and that and that ceteris paribus ceteris paribus the price the price of Japanese cars rises sharply This means that the of Japanese cars rises sharply This means that the real wage real wage from the point of view of the from the point of view of the consumer falls to (consumer falls to (wpwpCPICPI ) )11 at point at point

B B on the labor-supply curve (LS) so that the worker would on the labor-supply curve (LS) so that the worker would want to supply less labor (want to supply less labor (LL11))

bull The rise in the price of Japanese cars has no effect on the price The rise in the price of Japanese cars has no effect on the price of their products Nevertheless they see a reduction of labor of their products Nevertheless they see a reduction of labor supply at the original market clearing wage It is as if the supply at the original market clearing wage It is as if the labor-supply curve labor-supply curve has shifted to the left to has shifted to the left to LSLSrsquo which passes rsquo which passes through ((through ((wp) L1) at point C wp) L1) at point C At the original wage rate labor At the original wage rate labor demand exceeds labor supply so firms raise wages in an effort demand exceeds labor supply so firms raise wages in an effort to attract workers until they reach the new market-clearing to attract workers until they reach the new market-clearing wage at point D where they pay (wage at point D where they pay (wpwpPPIPPI ) for labor of L ) for labor of L The The

rise in the price of Japanese cars has the effect of raising the rise in the price of Japanese cars has the effect of raising the wages that firms must pay and reducing labor employedwages that firms must pay and reducing labor employed Higher wages partly compensate workers for the higher costs Higher wages partly compensate workers for the higher costs of consumption but firms can afford to pay those higher wages of consumption but firms can afford to pay those higher wages only if marginal products rise as a result of their using less only if marginal products rise as a result of their using less labor labor

bull The rise in wage rates is not enough to compensate workers The rise in wage rates is not enough to compensate workers fully so the consumption-real wage in equilibrium is (wpfully so the consumption-real wage in equilibrium is (wpCPI CPI ) )

atat point E We can think of import prices as a tax levied on point E We can think of import prices as a tax levied on consumers and of an increase in import prices as widening the consumers and of an increase in import prices as widening the tax wedge Unless the issue that we want to analyze depends on tax wedge Unless the issue that we want to analyze depends on the difference between product- and consumption-real wages the difference between product- and consumption-real wages we will treat the real wage as the same for both labor supply we will treat the real wage as the same for both labor supply and labor demandand labor demand

An Increase in the Price of Consumption GoodsAn Increase in the Price of Consumption GoodsRelative to the Price of OutputRelative to the Price of Output

ANALYZING IDEAL LABOR MARKETSANALYZING IDEAL LABOR MARKETS

bull The aggregate labor-supplylabor-demand diagram provides us The aggregate labor-supplylabor-demand diagram provides us with a powerful tool We now analyze three important with a powerful tool We now analyze three important macroeconomic issues macroeconomic issues

(1) the effect of tax cuts on employment (1) the effect of tax cuts on employment

(2) the effect of technological progress on the well-being of (2) the effect of technological progress on the well-being of workers and workers and

(3) the effect of immigration on existing workers (3) the effect of immigration on existing workers

bull Issue 1 Tax Cuts Issue 1 Tax Cuts What are the effects of a cut in marginal What are the effects of a cut in marginal income-tax rates on employment and the level of GDP in the income-tax rates on employment and the level of GDP in the economyeconomy Recall from section that a lower marginal income-Recall from section that a lower marginal income-tax rate increases labor supply at each real wage (a rightward tax rate increases labor supply at each real wage (a rightward shift of the labor-supply) shift of the labor-supply)

bull Labor-market equilibrium moves from point A to point B in Labor-market equilibrium moves from point A to point B in the lower panel of the following Notice that the amount of the lower panel of the following Notice that the amount of labor available to firms increases so that firms move labor available to firms increases so that firms move production from Arsquo to Brsquo on the labor production function in production from Arsquo to Brsquo on the labor production function in the upper panel Also notice that the real wage falls from (the upper panel Also notice that the real wage falls from (wp)1 wp)1 to (wp)2 Since the cut in taxes increases the number of to (wp)2 Since the cut in taxes increases the number of workers workers willing to work at each wage Workers care about their take-willing to work at each wage Workers care about their take-home pay ndash that is about their home pay ndash that is about their after-tax real wage after-tax real wage This is This is perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 can be greater than the old after-tax real wage (1ndashcan be greater than the old after-tax real wage (1ndashτ1τ1)(wp)1 so )(wp)1 so long as the rise in the take-home share (1 ndash τ) is long as the rise in the take-home share (1 ndash τ) is proportionately greater than the fall in the before-tax real proportionately greater than the fall in the before-tax real wage (wp)wage (wp)

bull The analysis depends on substitution effects dominating The analysis depends on substitution effects dominating income effects which they probably do in aggregate if not for income effects which they probably do in aggregate if not for every worker So the supply-siders of the Reagan years are every worker So the supply-siders of the Reagan years are correct in principle How much output will increase depends on correct in principle How much output will increase depends on how large the substitution effect is If most people work a how large the substitution effect is If most people work a standard 40-hour week the effect could be quite small and the standard 40-hour week the effect could be quite small and the increase in output might also be very small in practiceincrease in output might also be very small in practice

Issue 1 The Effect of a Cut in Marginal Tax RatesIssue 1 The Effect of a Cut in Marginal Tax Rates

Issue 2 Technological Progress and Worker WelfareIssue 2 Technological Progress and Worker Welfare

bull Is technological progress and increasing use of machinery and Is technological progress and increasing use of machinery and other capital beneficial for workersother capital beneficial for workers

bull Technological change or capital accumulation have been Technological change or capital accumulation have been known as ldquoLudditesrdquo (known as ldquoLudditesrdquo (it negatively affects the demand for it negatively affects the demand for laborlabor) To see why the Luddites are wrong ndash at least for ) To see why the Luddites are wrong ndash at least for clearing labor markets ndash recall that technological progress or clearing labor markets ndash recall that technological progress or increased capital both increased capital both shift the labor-demand curve upwardshift the labor-demand curve upward The lower panel of the following figure shows that the effect of The lower panel of the following figure shows that the effect of the increased demand for labor is to increase total employment the increased demand for labor is to increase total employment and the real wage Firms and the real wage Firms can pay a higher real wage can pay a higher real wage because because the additional capital or technological progress the additional capital or technological progress increases the increases the marginal product of labormarginal product of labor

bull The The Ludditesrsquo mistake Ludditesrsquo mistake is most easily seen in the upper panel is most easily seen in the upper panel The Luddite argument assumes that fewer workers will The Luddite argument assumes that fewer workers will produce the same total output Production starts at Arsquo using produce the same total output Production starts at Arsquo using L1 L1 workers to produce Y1 After the upward shift in the production workers to produce Y1 After the upward shift in the production function the same output could be produced using less labor function the same output could be produced using less labor ((L3) at point Arsquorsquo The L3) at point Arsquorsquo The problem is that Arsquorsquo is not an equilibrium problem is that Arsquorsquo is not an equilibrium At that point the marginal product of labor is higher than the At that point the marginal product of labor is higher than the original real wage so a profit-maximizing firm would want to original real wage so a profit-maximizing firm would want to expand production To do this they must hire more labor than expand production To do this they must hire more labor than L3 and indeed they L3 and indeed they find it find it profitable profitable to hire more labor than to hire more labor than the original the original L1 The only way actually to increase labor L1 The only way actually to increase labor is to is to raise the real-wage raise the real-wage rate above its original level Technological rate above its original level Technological progress therefore favors progress therefore favors workers by increasing employment workers by increasing employment and wagesand wages

bull Early in the 19th century hand-woven cloth was very Early in the 19th century hand-woven cloth was very expensive and a worker was lucky to own the clothes on his expensive and a worker was lucky to own the clothes on his back and a spare set for church on Sunday Textiles were one of back and a spare set for church on Sunday Textiles were one of the first industries to benefit from the Industrial Revolution so the first industries to benefit from the Industrial Revolution so that by the end of the 19th century machine-made fabrics and that by the end of the 19th century machine-made fabrics and mass-production made decent clothing in larger quantities mass-production made decent clothing in larger quantities accessible to most of the population of the more developed accessible to most of the population of the more developed countries Similar progress has been made in most forms of countries Similar progress has been made in most forms of production Agricultural production which at the turn of the production Agricultural production which at the turn of the 20th century absorbed half the labor force now absorbs less 20th century absorbed half the labor force now absorbs less than 3 percent while producing more food more cheaply than than 3 percent while producing more food more cheaply than ever ever

bull We must be careful not to dismiss the Luddites as altogether We must be careful not to dismiss the Luddites as altogether foolish While new technology especially over decades has foolish While new technology especially over decades has proved to be a net gain for workers in general the Luddites proved to be a net gain for workers in general the Luddites were in fact correct that their way of life was threatened were in fact correct that their way of life was threatened Independent weavers became factory hands unskilled Independent weavers became factory hands unskilled workers increasingly women and often children replaced workers increasingly women and often children replaced skilled craftsmen and factory work often involved long hours skilled craftsmen and factory work often involved long hours in brutal conditions The wider society reaps the benefits of in brutal conditions The wider society reaps the benefits of technological change while a narrow group sometimes technological change while a narrow group sometimes disproportionately bears its costs Our analysis also assumes disproportionately bears its costs Our analysis also assumes that markets generally clear The implicit assumption is that that markets generally clear The implicit assumption is that displaced workers move on to new jobs possibly in other forms displaced workers move on to new jobs possibly in other forms of production Markets may have a tendency to clear in the of production Markets may have a tendency to clear in the long run yet workers may find themselves displaced in the long run yet workers may find themselves displaced in the short run say over the course of a business cycleshort run say over the course of a business cycle

Issue 3 Immigration Jobs and Real WagesIssue 3 Immigration Jobs and Real Wages

bull How does an increase in the labor force through immigration or How does an increase in the labor force through immigration or natural population growth affect labor and GDP natural population growth affect labor and GDP

bull One of the emotional issues associated with US immigration One of the emotional issues associated with US immigration policy ndash particularly towards low-wage workers from Mexico ndash policy ndash particularly towards low-wage workers from Mexico ndash is the idea that is the idea that immigrants take jobs away from native immigrants take jobs away from native workers workers We might be tempted to dismiss this fear as another We might be tempted to dismiss this fear as another example of the lump-of-labor fallacy Yet there is a sensible example of the lump-of-labor fallacy Yet there is a sensible intuition behind the argument An increase in the labor force ndash intuition behind the argument An increase in the labor force ndash due either to immigration or to higher population growth rates due either to immigration or to higher population growth rates ndash can be represented as an outward shift of the aggregate labor ndash can be represented as an outward shift of the aggregate labor supply curve as shown in the following Figure Employment supply curve as shown in the following Figure Employment increases but real wages fall It is not then that immigrants increases but real wages fall It is not then that immigrants take jobs away from natives take jobs away from natives Rather they compete for jobsRather they compete for jobs putting downward pressure on real wagesputting downward pressure on real wages

bull Again we must exercise care in interpreting the analysis Again we must exercise care in interpreting the analysis Remember that aggregate labor and average wage rates hide Remember that aggregate labor and average wage rates hide many details of the labor process The incomes of the new many details of the labor process The incomes of the new immigrants immigrants creates demand creates demand for the new production that they for the new production that they make possible Immigrant workers (at least those ndash whether make possible Immigrant workers (at least those ndash whether legal or illegal ndash who have become the focus of the most intense legal or illegal ndash who have become the focus of the most intense political debate) political debate) are likely to possess fewer skills than nativesare likely to possess fewer skills than natives The net effect is that the increased demand for goods and The net effect is that the increased demand for goods and services generated by immigrants is likely to increase the services generated by immigrants is likely to increase the demand for skilled (demand for skilled (and largely nativeand largely native) workers relative to ) workers relative to their supply and so to increase real wages of skilled workers their supply and so to increase real wages of skilled workers Low-skilled immigration may lower the real wage for farm Low-skilled immigration may lower the real wage for farm workers but if anything it would raise the real wage for workers but if anything it would raise the real wage for computer programmerscomputer programmers

Next Task Labor Market in Kuwait

Appendix Is Labor Supply Stable Over Time

bull Statistics on participation rates or average hours for a Statistics on participation rates or average hours for a particular month or year are snapshot of the labor market particular month or year are snapshot of the labor market Can we analyze the effects of that increase on the labor market Can we analyze the effects of that increase on the labor market under the assumption that the labor-supply curves of workers under the assumption that the labor-supply curves of workers remain essentially stableremain essentially stable

bull Data on participation rates in the United States appear to Data on participation rates in the United States appear to support this conjecture (see Figure 811) which shows the support this conjecture (see Figure 811) which shows the overall civilian participation rate trending upward ndash at least overall civilian participation rate trending upward ndash at least from the middle of the 1960sfrom the middle of the 1960s

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

bull But most people are not But most people are not completely independentcompletely independent Whether or Whether or not to participate in the labor force could be a not to participate in the labor force could be a genuine choicegenuine choice and would depend on the and would depend on the real wagereal wage

bull The The RESERVATION WAGE RESERVATION WAGE is defined to be is defined to be the opportunity the opportunity cost of working compared to not workingcost of working compared to not working ndash ndash that is the real wage that is the real wage that is high enough to make it just worthwhile for a worker to that is high enough to make it just worthwhile for a worker to participate in the labor forceparticipate in the labor force

bull Taking account of the opportunity costs of participation affects Taking account of the opportunity costs of participation affects the shape of the labor-supply curve As long as the the shape of the labor-supply curve As long as the real wage is real wage is below the reservationbelow the reservation wage ((wp)R) the worker supplies no wage ((wp)R) the worker supplies no labor at all Above the reservation wage there is a normal labor at all Above the reservation wage there is a normal labor-supply curvelabor-supply curve

bull The following captures the two stages of the labor supply The following captures the two stages of the labor supply decision decision FirstFirst at low wages the worker will at low wages the worker will notnot supply any supply any labor at all and small increases in wages have no effect But labor at all and small increases in wages have no effect But secondsecond as soon as the wage rises enough for the worker to bite as soon as the wage rises enough for the worker to bite the bullet and join the labor force the minimum labor supplied the bullet and join the labor force the minimum labor supplied will be well will be well above zeroabove zero and the worker will decide how many and the worker will decide how many hours to supply above this minimum through the usual process hours to supply above this minimum through the usual process of balancing the opportunity cost of leisure against the desire of balancing the opportunity cost of leisure against the desire for consumption goodsfor consumption goods

AGGREGATE LABOR SUPPLY

bull How can we moveHow can we move from the microeconomics of the labor supply from the microeconomics of the labor supply back to an aggregate relationship usable in macroeconomic back to an aggregate relationship usable in macroeconomic analysis analysis If workers were essentially alikeIf workers were essentially alike the problem would the problem would be easy be easy

bull As we have seen labor supply has two dimensions ndash As we have seen labor supply has two dimensions ndash participationparticipation in the labor force and in the labor force and choice of hourschoice of hours of labor of labor Take the participation decision first If all workers were alike Take the participation decision first If all workers were alike except for except for differences in their reservation wagedifferences in their reservation wage then we could then we could rank them from lowest to highest reservation wage The rank them from lowest to highest reservation wage The aggregate labor-supply (participation) curve is strictly aggregate labor-supply (participation) curve is strictly upwardslopingupwardsloping

bull Of course this is too easy Just as we observed in deriving the Of course this is too easy Just as we observed in deriving the aggregate labor demand curve workers are aggregate labor demand curve workers are not all alikenot all alike Once Once again we must interpret the vertical axis as measuring the again we must interpret the vertical axis as measuring the average real wageaverage real wage that at best provides a kind of index for the that at best provides a kind of index for the level of the wage structure level of the wage structure

bull The The problemproblem remains the remains the samesame when we turn to the choice of when we turn to the choice of hourshours Workers are all different and face a structure of wages Workers are all different and face a structure of wages For each worker individually there is a jump from supplying For each worker individually there is a jump from supplying zero to supplying some positive number of hours zero to supplying some positive number of hours when his own when his own wage rate surpasses their wage rate surpasses their reservation wagereservation wage But in aggregate But in aggregate we are we are unlikely to see such a jumpunlikely to see such a jump Not only are there a variety Not only are there a variety of wages offered at any time but reservation wages differof wages offered at any time but reservation wages differ

Derivation of the Aggregate Labor-supply Curve

bull A curve like the one in this figure can be used to display either A curve like the one in this figure can be used to display either the the participation participation decision or decision or the hoursthe hours The horizontal axis can The horizontal axis can either be used for workers either be used for workers or worker-hoursor worker-hours as measures of the as measures of the labor supply The two meanings are not completely labor supply The two meanings are not completely independent by definition independent by definition

bull workers equiv aggregate worker ndash hours average hours per worker workers equiv aggregate worker ndash hours average hours per worker

The Participation Rate and Average Hours

bull Let us look first at the aggregate participation decision The Let us look first at the aggregate participation decision The aggregate number of workers who have decided to participate aggregate number of workers who have decided to participate is known as the is known as the labor forcelabor force the the civilian labor force over 16 civilian labor force over 16 years of ageyears of age This number excludes uniformed members of the This number excludes uniformed members of the armed services and the small number of workers under 16 armed services and the small number of workers under 16 years old The labor force of course has grown right along years old The labor force of course has grown right along with population with population

bull The participation rateThe participation rate (PR) measures (PR) measures the labor force as its ratio the labor force as its ratio to the relevant populationto the relevant population

bull participation rate = labor forcerelevant population participation rate = labor forcerelevant population

bull ldquoldquonon-institutionalrdquo non-institutionalrdquo excludes people in prison or in homes for excludes people in prison or in homes for the aged) the aged)

bull The aggregate number of hours The aggregate number of hours worked is worked is not as easy not as easy as the as the participation rate to relate to the individual workerrsquos choices participation rate to relate to the individual workerrsquos choices If every worker had the same labor-supply curve we would If every worker had the same labor-supply curve we would have to know the wage offered to each one in order to calculate have to know the wage offered to each one in order to calculate the total number of labor hours supplied In reality workers the total number of labor hours supplied In reality workers are not all alike are not all alike Labor-supply curves may vary systematically Labor-supply curves may vary systematically according to the sex age ethnic group education experience according to the sex age ethnic group education experience or other social or economic characteristics of the workersor other social or economic characteristics of the workers And And within any group the labor-supply curves of individuals are within any group the labor-supply curves of individuals are likely to varylikely to vary

bull In principle In principle if we had a good statistical estimate of the typical if we had a good statistical estimate of the typical distribution of the wagesdistribution of the wages we could make a reasonable we could make a reasonable calculation But statisticians at the Bureau of Labor Statistics calculation But statisticians at the Bureau of Labor Statistics (BLS) do not try to calculate the labor supply in this way (BLS) do not try to calculate the labor supply in this way Instead they Instead they count the number of hours that workers actually count the number of hours that workers actually workwork and the average and the average wages and salaries they are paid wages and salaries they are paid

bull In USA the total hours of labor in 1998 was In USA the total hours of labor in 1998 was 236882236882 million million The average hours of work is The average hours of work is 17211721 hours per year = hours per year = 344344 hours hours per week (assuming a 50 week year) This number is 14 percent per week (assuming a 50 week year) This number is 14 percent below the full time 40-hour week which makes sense since it below the full time 40-hour week which makes sense since it averages over full-time part-time and overtime workers averages over full-time part-time and overtime workers

Labor Market EquilibriumLabor Market Equilibrium

bull MARKET CLEARINGMARKET CLEARING

bull When both demand and supply curves are plotted on the same When both demand and supply curves are plotted on the same diagram the crossing point defines the diagram the crossing point defines the equilibrium real-wage equilibrium real-wage rate and the rate and the equilibrium level of labor employedequilibrium level of labor employed

bull The real wage The real wage looks different looks different from the point of view of the firm from the point of view of the firm and the worker For the and the worker For the firmfirm the relevant real wage is the the relevant real wage is the product-real wage product-real wage defined as defined as the number of units of the good the number of units of the good the firm produces that the wage will purchase the firm produces that the wage will purchase ((price of price of productproduct = = w) w) For the For the workerworker the relevant real wage is the the relevant real wage is the consumption-consumption-real real wagewage defined as defined as the number of typical consumption baskets the number of typical consumption baskets that the wage will purchase that the wage will purchase ((price of price of consumption basket consumption basket = = w)w)

bull For aggregate analysis we might use the For aggregate analysis we might use the Producer Price IndexProducer Price Index or the GDP deflator to approximate the or the GDP deflator to approximate the product priceproduct price and the and the CPICPI to approximate the to approximate the consumption price consumption price

bull Suppose that the product-real wage and the consumption-real Suppose that the product-real wage and the consumption-real wage in the following figure start out with the identical value wage in the following figure start out with the identical value ((wp) at the market-clearing point Awp) at the market-clearing point A Now suppose that Now suppose that imported Japanese cars are a large portion of the typical imported Japanese cars are a large portion of the typical workerrsquos consumption basket workerrsquos consumption basket and that and that ceteris paribus ceteris paribus the price the price of Japanese cars rises sharply This means that the of Japanese cars rises sharply This means that the real wage real wage from the point of view of the from the point of view of the consumer falls to (consumer falls to (wpwpCPICPI ) )11 at point at point

B B on the labor-supply curve (LS) so that the worker would on the labor-supply curve (LS) so that the worker would want to supply less labor (want to supply less labor (LL11))

bull The rise in the price of Japanese cars has no effect on the price The rise in the price of Japanese cars has no effect on the price of their products Nevertheless they see a reduction of labor of their products Nevertheless they see a reduction of labor supply at the original market clearing wage It is as if the supply at the original market clearing wage It is as if the labor-supply curve labor-supply curve has shifted to the left to has shifted to the left to LSLSrsquo which passes rsquo which passes through ((through ((wp) L1) at point C wp) L1) at point C At the original wage rate labor At the original wage rate labor demand exceeds labor supply so firms raise wages in an effort demand exceeds labor supply so firms raise wages in an effort to attract workers until they reach the new market-clearing to attract workers until they reach the new market-clearing wage at point D where they pay (wage at point D where they pay (wpwpPPIPPI ) for labor of L ) for labor of L The The

rise in the price of Japanese cars has the effect of raising the rise in the price of Japanese cars has the effect of raising the wages that firms must pay and reducing labor employedwages that firms must pay and reducing labor employed Higher wages partly compensate workers for the higher costs Higher wages partly compensate workers for the higher costs of consumption but firms can afford to pay those higher wages of consumption but firms can afford to pay those higher wages only if marginal products rise as a result of their using less only if marginal products rise as a result of their using less labor labor

bull The rise in wage rates is not enough to compensate workers The rise in wage rates is not enough to compensate workers fully so the consumption-real wage in equilibrium is (wpfully so the consumption-real wage in equilibrium is (wpCPI CPI ) )

atat point E We can think of import prices as a tax levied on point E We can think of import prices as a tax levied on consumers and of an increase in import prices as widening the consumers and of an increase in import prices as widening the tax wedge Unless the issue that we want to analyze depends on tax wedge Unless the issue that we want to analyze depends on the difference between product- and consumption-real wages the difference between product- and consumption-real wages we will treat the real wage as the same for both labor supply we will treat the real wage as the same for both labor supply and labor demandand labor demand

An Increase in the Price of Consumption GoodsAn Increase in the Price of Consumption GoodsRelative to the Price of OutputRelative to the Price of Output

ANALYZING IDEAL LABOR MARKETSANALYZING IDEAL LABOR MARKETS

bull The aggregate labor-supplylabor-demand diagram provides us The aggregate labor-supplylabor-demand diagram provides us with a powerful tool We now analyze three important with a powerful tool We now analyze three important macroeconomic issues macroeconomic issues

(1) the effect of tax cuts on employment (1) the effect of tax cuts on employment

(2) the effect of technological progress on the well-being of (2) the effect of technological progress on the well-being of workers and workers and

(3) the effect of immigration on existing workers (3) the effect of immigration on existing workers

bull Issue 1 Tax Cuts Issue 1 Tax Cuts What are the effects of a cut in marginal What are the effects of a cut in marginal income-tax rates on employment and the level of GDP in the income-tax rates on employment and the level of GDP in the economyeconomy Recall from section that a lower marginal income-Recall from section that a lower marginal income-tax rate increases labor supply at each real wage (a rightward tax rate increases labor supply at each real wage (a rightward shift of the labor-supply) shift of the labor-supply)

bull Labor-market equilibrium moves from point A to point B in Labor-market equilibrium moves from point A to point B in the lower panel of the following Notice that the amount of the lower panel of the following Notice that the amount of labor available to firms increases so that firms move labor available to firms increases so that firms move production from Arsquo to Brsquo on the labor production function in production from Arsquo to Brsquo on the labor production function in the upper panel Also notice that the real wage falls from (the upper panel Also notice that the real wage falls from (wp)1 wp)1 to (wp)2 Since the cut in taxes increases the number of to (wp)2 Since the cut in taxes increases the number of workers workers willing to work at each wage Workers care about their take-willing to work at each wage Workers care about their take-home pay ndash that is about their home pay ndash that is about their after-tax real wage after-tax real wage This is This is perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 can be greater than the old after-tax real wage (1ndashcan be greater than the old after-tax real wage (1ndashτ1τ1)(wp)1 so )(wp)1 so long as the rise in the take-home share (1 ndash τ) is long as the rise in the take-home share (1 ndash τ) is proportionately greater than the fall in the before-tax real proportionately greater than the fall in the before-tax real wage (wp)wage (wp)

bull The analysis depends on substitution effects dominating The analysis depends on substitution effects dominating income effects which they probably do in aggregate if not for income effects which they probably do in aggregate if not for every worker So the supply-siders of the Reagan years are every worker So the supply-siders of the Reagan years are correct in principle How much output will increase depends on correct in principle How much output will increase depends on how large the substitution effect is If most people work a how large the substitution effect is If most people work a standard 40-hour week the effect could be quite small and the standard 40-hour week the effect could be quite small and the increase in output might also be very small in practiceincrease in output might also be very small in practice

Issue 1 The Effect of a Cut in Marginal Tax RatesIssue 1 The Effect of a Cut in Marginal Tax Rates

Issue 2 Technological Progress and Worker WelfareIssue 2 Technological Progress and Worker Welfare

bull Is technological progress and increasing use of machinery and Is technological progress and increasing use of machinery and other capital beneficial for workersother capital beneficial for workers

bull Technological change or capital accumulation have been Technological change or capital accumulation have been known as ldquoLudditesrdquo (known as ldquoLudditesrdquo (it negatively affects the demand for it negatively affects the demand for laborlabor) To see why the Luddites are wrong ndash at least for ) To see why the Luddites are wrong ndash at least for clearing labor markets ndash recall that technological progress or clearing labor markets ndash recall that technological progress or increased capital both increased capital both shift the labor-demand curve upwardshift the labor-demand curve upward The lower panel of the following figure shows that the effect of The lower panel of the following figure shows that the effect of the increased demand for labor is to increase total employment the increased demand for labor is to increase total employment and the real wage Firms and the real wage Firms can pay a higher real wage can pay a higher real wage because because the additional capital or technological progress the additional capital or technological progress increases the increases the marginal product of labormarginal product of labor

bull The The Ludditesrsquo mistake Ludditesrsquo mistake is most easily seen in the upper panel is most easily seen in the upper panel The Luddite argument assumes that fewer workers will The Luddite argument assumes that fewer workers will produce the same total output Production starts at Arsquo using produce the same total output Production starts at Arsquo using L1 L1 workers to produce Y1 After the upward shift in the production workers to produce Y1 After the upward shift in the production function the same output could be produced using less labor function the same output could be produced using less labor ((L3) at point Arsquorsquo The L3) at point Arsquorsquo The problem is that Arsquorsquo is not an equilibrium problem is that Arsquorsquo is not an equilibrium At that point the marginal product of labor is higher than the At that point the marginal product of labor is higher than the original real wage so a profit-maximizing firm would want to original real wage so a profit-maximizing firm would want to expand production To do this they must hire more labor than expand production To do this they must hire more labor than L3 and indeed they L3 and indeed they find it find it profitable profitable to hire more labor than to hire more labor than the original the original L1 The only way actually to increase labor L1 The only way actually to increase labor is to is to raise the real-wage raise the real-wage rate above its original level Technological rate above its original level Technological progress therefore favors progress therefore favors workers by increasing employment workers by increasing employment and wagesand wages

bull Early in the 19th century hand-woven cloth was very Early in the 19th century hand-woven cloth was very expensive and a worker was lucky to own the clothes on his expensive and a worker was lucky to own the clothes on his back and a spare set for church on Sunday Textiles were one of back and a spare set for church on Sunday Textiles were one of the first industries to benefit from the Industrial Revolution so the first industries to benefit from the Industrial Revolution so that by the end of the 19th century machine-made fabrics and that by the end of the 19th century machine-made fabrics and mass-production made decent clothing in larger quantities mass-production made decent clothing in larger quantities accessible to most of the population of the more developed accessible to most of the population of the more developed countries Similar progress has been made in most forms of countries Similar progress has been made in most forms of production Agricultural production which at the turn of the production Agricultural production which at the turn of the 20th century absorbed half the labor force now absorbs less 20th century absorbed half the labor force now absorbs less than 3 percent while producing more food more cheaply than than 3 percent while producing more food more cheaply than ever ever

bull We must be careful not to dismiss the Luddites as altogether We must be careful not to dismiss the Luddites as altogether foolish While new technology especially over decades has foolish While new technology especially over decades has proved to be a net gain for workers in general the Luddites proved to be a net gain for workers in general the Luddites were in fact correct that their way of life was threatened were in fact correct that their way of life was threatened Independent weavers became factory hands unskilled Independent weavers became factory hands unskilled workers increasingly women and often children replaced workers increasingly women and often children replaced skilled craftsmen and factory work often involved long hours skilled craftsmen and factory work often involved long hours in brutal conditions The wider society reaps the benefits of in brutal conditions The wider society reaps the benefits of technological change while a narrow group sometimes technological change while a narrow group sometimes disproportionately bears its costs Our analysis also assumes disproportionately bears its costs Our analysis also assumes that markets generally clear The implicit assumption is that that markets generally clear The implicit assumption is that displaced workers move on to new jobs possibly in other forms displaced workers move on to new jobs possibly in other forms of production Markets may have a tendency to clear in the of production Markets may have a tendency to clear in the long run yet workers may find themselves displaced in the long run yet workers may find themselves displaced in the short run say over the course of a business cycleshort run say over the course of a business cycle

Issue 3 Immigration Jobs and Real WagesIssue 3 Immigration Jobs and Real Wages

bull How does an increase in the labor force through immigration or How does an increase in the labor force through immigration or natural population growth affect labor and GDP natural population growth affect labor and GDP

bull One of the emotional issues associated with US immigration One of the emotional issues associated with US immigration policy ndash particularly towards low-wage workers from Mexico ndash policy ndash particularly towards low-wage workers from Mexico ndash is the idea that is the idea that immigrants take jobs away from native immigrants take jobs away from native workers workers We might be tempted to dismiss this fear as another We might be tempted to dismiss this fear as another example of the lump-of-labor fallacy Yet there is a sensible example of the lump-of-labor fallacy Yet there is a sensible intuition behind the argument An increase in the labor force ndash intuition behind the argument An increase in the labor force ndash due either to immigration or to higher population growth rates due either to immigration or to higher population growth rates ndash can be represented as an outward shift of the aggregate labor ndash can be represented as an outward shift of the aggregate labor supply curve as shown in the following Figure Employment supply curve as shown in the following Figure Employment increases but real wages fall It is not then that immigrants increases but real wages fall It is not then that immigrants take jobs away from natives take jobs away from natives Rather they compete for jobsRather they compete for jobs putting downward pressure on real wagesputting downward pressure on real wages

bull Again we must exercise care in interpreting the analysis Again we must exercise care in interpreting the analysis Remember that aggregate labor and average wage rates hide Remember that aggregate labor and average wage rates hide many details of the labor process The incomes of the new many details of the labor process The incomes of the new immigrants immigrants creates demand creates demand for the new production that they for the new production that they make possible Immigrant workers (at least those ndash whether make possible Immigrant workers (at least those ndash whether legal or illegal ndash who have become the focus of the most intense legal or illegal ndash who have become the focus of the most intense political debate) political debate) are likely to possess fewer skills than nativesare likely to possess fewer skills than natives The net effect is that the increased demand for goods and The net effect is that the increased demand for goods and services generated by immigrants is likely to increase the services generated by immigrants is likely to increase the demand for skilled (demand for skilled (and largely nativeand largely native) workers relative to ) workers relative to their supply and so to increase real wages of skilled workers their supply and so to increase real wages of skilled workers Low-skilled immigration may lower the real wage for farm Low-skilled immigration may lower the real wage for farm workers but if anything it would raise the real wage for workers but if anything it would raise the real wage for computer programmerscomputer programmers

Next Task Labor Market in Kuwait

Appendix Is Labor Supply Stable Over Time

bull Statistics on participation rates or average hours for a Statistics on participation rates or average hours for a particular month or year are snapshot of the labor market particular month or year are snapshot of the labor market Can we analyze the effects of that increase on the labor market Can we analyze the effects of that increase on the labor market under the assumption that the labor-supply curves of workers under the assumption that the labor-supply curves of workers remain essentially stableremain essentially stable

bull Data on participation rates in the United States appear to Data on participation rates in the United States appear to support this conjecture (see Figure 811) which shows the support this conjecture (see Figure 811) which shows the overall civilian participation rate trending upward ndash at least overall civilian participation rate trending upward ndash at least from the middle of the 1960sfrom the middle of the 1960s

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

bull The following captures the two stages of the labor supply The following captures the two stages of the labor supply decision decision FirstFirst at low wages the worker will at low wages the worker will notnot supply any supply any labor at all and small increases in wages have no effect But labor at all and small increases in wages have no effect But secondsecond as soon as the wage rises enough for the worker to bite as soon as the wage rises enough for the worker to bite the bullet and join the labor force the minimum labor supplied the bullet and join the labor force the minimum labor supplied will be well will be well above zeroabove zero and the worker will decide how many and the worker will decide how many hours to supply above this minimum through the usual process hours to supply above this minimum through the usual process of balancing the opportunity cost of leisure against the desire of balancing the opportunity cost of leisure against the desire for consumption goodsfor consumption goods

AGGREGATE LABOR SUPPLY

bull How can we moveHow can we move from the microeconomics of the labor supply from the microeconomics of the labor supply back to an aggregate relationship usable in macroeconomic back to an aggregate relationship usable in macroeconomic analysis analysis If workers were essentially alikeIf workers were essentially alike the problem would the problem would be easy be easy

bull As we have seen labor supply has two dimensions ndash As we have seen labor supply has two dimensions ndash participationparticipation in the labor force and in the labor force and choice of hourschoice of hours of labor of labor Take the participation decision first If all workers were alike Take the participation decision first If all workers were alike except for except for differences in their reservation wagedifferences in their reservation wage then we could then we could rank them from lowest to highest reservation wage The rank them from lowest to highest reservation wage The aggregate labor-supply (participation) curve is strictly aggregate labor-supply (participation) curve is strictly upwardslopingupwardsloping

bull Of course this is too easy Just as we observed in deriving the Of course this is too easy Just as we observed in deriving the aggregate labor demand curve workers are aggregate labor demand curve workers are not all alikenot all alike Once Once again we must interpret the vertical axis as measuring the again we must interpret the vertical axis as measuring the average real wageaverage real wage that at best provides a kind of index for the that at best provides a kind of index for the level of the wage structure level of the wage structure

bull The The problemproblem remains the remains the samesame when we turn to the choice of when we turn to the choice of hourshours Workers are all different and face a structure of wages Workers are all different and face a structure of wages For each worker individually there is a jump from supplying For each worker individually there is a jump from supplying zero to supplying some positive number of hours zero to supplying some positive number of hours when his own when his own wage rate surpasses their wage rate surpasses their reservation wagereservation wage But in aggregate But in aggregate we are we are unlikely to see such a jumpunlikely to see such a jump Not only are there a variety Not only are there a variety of wages offered at any time but reservation wages differof wages offered at any time but reservation wages differ

Derivation of the Aggregate Labor-supply Curve

bull A curve like the one in this figure can be used to display either A curve like the one in this figure can be used to display either the the participation participation decision or decision or the hoursthe hours The horizontal axis can The horizontal axis can either be used for workers either be used for workers or worker-hoursor worker-hours as measures of the as measures of the labor supply The two meanings are not completely labor supply The two meanings are not completely independent by definition independent by definition

bull workers equiv aggregate worker ndash hours average hours per worker workers equiv aggregate worker ndash hours average hours per worker

The Participation Rate and Average Hours

bull Let us look first at the aggregate participation decision The Let us look first at the aggregate participation decision The aggregate number of workers who have decided to participate aggregate number of workers who have decided to participate is known as the is known as the labor forcelabor force the the civilian labor force over 16 civilian labor force over 16 years of ageyears of age This number excludes uniformed members of the This number excludes uniformed members of the armed services and the small number of workers under 16 armed services and the small number of workers under 16 years old The labor force of course has grown right along years old The labor force of course has grown right along with population with population

bull The participation rateThe participation rate (PR) measures (PR) measures the labor force as its ratio the labor force as its ratio to the relevant populationto the relevant population

bull participation rate = labor forcerelevant population participation rate = labor forcerelevant population

bull ldquoldquonon-institutionalrdquo non-institutionalrdquo excludes people in prison or in homes for excludes people in prison or in homes for the aged) the aged)

bull The aggregate number of hours The aggregate number of hours worked is worked is not as easy not as easy as the as the participation rate to relate to the individual workerrsquos choices participation rate to relate to the individual workerrsquos choices If every worker had the same labor-supply curve we would If every worker had the same labor-supply curve we would have to know the wage offered to each one in order to calculate have to know the wage offered to each one in order to calculate the total number of labor hours supplied In reality workers the total number of labor hours supplied In reality workers are not all alike are not all alike Labor-supply curves may vary systematically Labor-supply curves may vary systematically according to the sex age ethnic group education experience according to the sex age ethnic group education experience or other social or economic characteristics of the workersor other social or economic characteristics of the workers And And within any group the labor-supply curves of individuals are within any group the labor-supply curves of individuals are likely to varylikely to vary

bull In principle In principle if we had a good statistical estimate of the typical if we had a good statistical estimate of the typical distribution of the wagesdistribution of the wages we could make a reasonable we could make a reasonable calculation But statisticians at the Bureau of Labor Statistics calculation But statisticians at the Bureau of Labor Statistics (BLS) do not try to calculate the labor supply in this way (BLS) do not try to calculate the labor supply in this way Instead they Instead they count the number of hours that workers actually count the number of hours that workers actually workwork and the average and the average wages and salaries they are paid wages and salaries they are paid

bull In USA the total hours of labor in 1998 was In USA the total hours of labor in 1998 was 236882236882 million million The average hours of work is The average hours of work is 17211721 hours per year = hours per year = 344344 hours hours per week (assuming a 50 week year) This number is 14 percent per week (assuming a 50 week year) This number is 14 percent below the full time 40-hour week which makes sense since it below the full time 40-hour week which makes sense since it averages over full-time part-time and overtime workers averages over full-time part-time and overtime workers

Labor Market EquilibriumLabor Market Equilibrium

bull MARKET CLEARINGMARKET CLEARING

bull When both demand and supply curves are plotted on the same When both demand and supply curves are plotted on the same diagram the crossing point defines the diagram the crossing point defines the equilibrium real-wage equilibrium real-wage rate and the rate and the equilibrium level of labor employedequilibrium level of labor employed

bull The real wage The real wage looks different looks different from the point of view of the firm from the point of view of the firm and the worker For the and the worker For the firmfirm the relevant real wage is the the relevant real wage is the product-real wage product-real wage defined as defined as the number of units of the good the number of units of the good the firm produces that the wage will purchase the firm produces that the wage will purchase ((price of price of productproduct = = w) w) For the For the workerworker the relevant real wage is the the relevant real wage is the consumption-consumption-real real wagewage defined as defined as the number of typical consumption baskets the number of typical consumption baskets that the wage will purchase that the wage will purchase ((price of price of consumption basket consumption basket = = w)w)

bull For aggregate analysis we might use the For aggregate analysis we might use the Producer Price IndexProducer Price Index or the GDP deflator to approximate the or the GDP deflator to approximate the product priceproduct price and the and the CPICPI to approximate the to approximate the consumption price consumption price

bull Suppose that the product-real wage and the consumption-real Suppose that the product-real wage and the consumption-real wage in the following figure start out with the identical value wage in the following figure start out with the identical value ((wp) at the market-clearing point Awp) at the market-clearing point A Now suppose that Now suppose that imported Japanese cars are a large portion of the typical imported Japanese cars are a large portion of the typical workerrsquos consumption basket workerrsquos consumption basket and that and that ceteris paribus ceteris paribus the price the price of Japanese cars rises sharply This means that the of Japanese cars rises sharply This means that the real wage real wage from the point of view of the from the point of view of the consumer falls to (consumer falls to (wpwpCPICPI ) )11 at point at point

B B on the labor-supply curve (LS) so that the worker would on the labor-supply curve (LS) so that the worker would want to supply less labor (want to supply less labor (LL11))

bull The rise in the price of Japanese cars has no effect on the price The rise in the price of Japanese cars has no effect on the price of their products Nevertheless they see a reduction of labor of their products Nevertheless they see a reduction of labor supply at the original market clearing wage It is as if the supply at the original market clearing wage It is as if the labor-supply curve labor-supply curve has shifted to the left to has shifted to the left to LSLSrsquo which passes rsquo which passes through ((through ((wp) L1) at point C wp) L1) at point C At the original wage rate labor At the original wage rate labor demand exceeds labor supply so firms raise wages in an effort demand exceeds labor supply so firms raise wages in an effort to attract workers until they reach the new market-clearing to attract workers until they reach the new market-clearing wage at point D where they pay (wage at point D where they pay (wpwpPPIPPI ) for labor of L ) for labor of L The The

rise in the price of Japanese cars has the effect of raising the rise in the price of Japanese cars has the effect of raising the wages that firms must pay and reducing labor employedwages that firms must pay and reducing labor employed Higher wages partly compensate workers for the higher costs Higher wages partly compensate workers for the higher costs of consumption but firms can afford to pay those higher wages of consumption but firms can afford to pay those higher wages only if marginal products rise as a result of their using less only if marginal products rise as a result of their using less labor labor

bull The rise in wage rates is not enough to compensate workers The rise in wage rates is not enough to compensate workers fully so the consumption-real wage in equilibrium is (wpfully so the consumption-real wage in equilibrium is (wpCPI CPI ) )

atat point E We can think of import prices as a tax levied on point E We can think of import prices as a tax levied on consumers and of an increase in import prices as widening the consumers and of an increase in import prices as widening the tax wedge Unless the issue that we want to analyze depends on tax wedge Unless the issue that we want to analyze depends on the difference between product- and consumption-real wages the difference between product- and consumption-real wages we will treat the real wage as the same for both labor supply we will treat the real wage as the same for both labor supply and labor demandand labor demand

An Increase in the Price of Consumption GoodsAn Increase in the Price of Consumption GoodsRelative to the Price of OutputRelative to the Price of Output

ANALYZING IDEAL LABOR MARKETSANALYZING IDEAL LABOR MARKETS

bull The aggregate labor-supplylabor-demand diagram provides us The aggregate labor-supplylabor-demand diagram provides us with a powerful tool We now analyze three important with a powerful tool We now analyze three important macroeconomic issues macroeconomic issues

(1) the effect of tax cuts on employment (1) the effect of tax cuts on employment

(2) the effect of technological progress on the well-being of (2) the effect of technological progress on the well-being of workers and workers and

(3) the effect of immigration on existing workers (3) the effect of immigration on existing workers

bull Issue 1 Tax Cuts Issue 1 Tax Cuts What are the effects of a cut in marginal What are the effects of a cut in marginal income-tax rates on employment and the level of GDP in the income-tax rates on employment and the level of GDP in the economyeconomy Recall from section that a lower marginal income-Recall from section that a lower marginal income-tax rate increases labor supply at each real wage (a rightward tax rate increases labor supply at each real wage (a rightward shift of the labor-supply) shift of the labor-supply)

bull Labor-market equilibrium moves from point A to point B in Labor-market equilibrium moves from point A to point B in the lower panel of the following Notice that the amount of the lower panel of the following Notice that the amount of labor available to firms increases so that firms move labor available to firms increases so that firms move production from Arsquo to Brsquo on the labor production function in production from Arsquo to Brsquo on the labor production function in the upper panel Also notice that the real wage falls from (the upper panel Also notice that the real wage falls from (wp)1 wp)1 to (wp)2 Since the cut in taxes increases the number of to (wp)2 Since the cut in taxes increases the number of workers workers willing to work at each wage Workers care about their take-willing to work at each wage Workers care about their take-home pay ndash that is about their home pay ndash that is about their after-tax real wage after-tax real wage This is This is perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 can be greater than the old after-tax real wage (1ndashcan be greater than the old after-tax real wage (1ndashτ1τ1)(wp)1 so )(wp)1 so long as the rise in the take-home share (1 ndash τ) is long as the rise in the take-home share (1 ndash τ) is proportionately greater than the fall in the before-tax real proportionately greater than the fall in the before-tax real wage (wp)wage (wp)

bull The analysis depends on substitution effects dominating The analysis depends on substitution effects dominating income effects which they probably do in aggregate if not for income effects which they probably do in aggregate if not for every worker So the supply-siders of the Reagan years are every worker So the supply-siders of the Reagan years are correct in principle How much output will increase depends on correct in principle How much output will increase depends on how large the substitution effect is If most people work a how large the substitution effect is If most people work a standard 40-hour week the effect could be quite small and the standard 40-hour week the effect could be quite small and the increase in output might also be very small in practiceincrease in output might also be very small in practice

Issue 1 The Effect of a Cut in Marginal Tax RatesIssue 1 The Effect of a Cut in Marginal Tax Rates

Issue 2 Technological Progress and Worker WelfareIssue 2 Technological Progress and Worker Welfare

bull Is technological progress and increasing use of machinery and Is technological progress and increasing use of machinery and other capital beneficial for workersother capital beneficial for workers

bull Technological change or capital accumulation have been Technological change or capital accumulation have been known as ldquoLudditesrdquo (known as ldquoLudditesrdquo (it negatively affects the demand for it negatively affects the demand for laborlabor) To see why the Luddites are wrong ndash at least for ) To see why the Luddites are wrong ndash at least for clearing labor markets ndash recall that technological progress or clearing labor markets ndash recall that technological progress or increased capital both increased capital both shift the labor-demand curve upwardshift the labor-demand curve upward The lower panel of the following figure shows that the effect of The lower panel of the following figure shows that the effect of the increased demand for labor is to increase total employment the increased demand for labor is to increase total employment and the real wage Firms and the real wage Firms can pay a higher real wage can pay a higher real wage because because the additional capital or technological progress the additional capital or technological progress increases the increases the marginal product of labormarginal product of labor

bull The The Ludditesrsquo mistake Ludditesrsquo mistake is most easily seen in the upper panel is most easily seen in the upper panel The Luddite argument assumes that fewer workers will The Luddite argument assumes that fewer workers will produce the same total output Production starts at Arsquo using produce the same total output Production starts at Arsquo using L1 L1 workers to produce Y1 After the upward shift in the production workers to produce Y1 After the upward shift in the production function the same output could be produced using less labor function the same output could be produced using less labor ((L3) at point Arsquorsquo The L3) at point Arsquorsquo The problem is that Arsquorsquo is not an equilibrium problem is that Arsquorsquo is not an equilibrium At that point the marginal product of labor is higher than the At that point the marginal product of labor is higher than the original real wage so a profit-maximizing firm would want to original real wage so a profit-maximizing firm would want to expand production To do this they must hire more labor than expand production To do this they must hire more labor than L3 and indeed they L3 and indeed they find it find it profitable profitable to hire more labor than to hire more labor than the original the original L1 The only way actually to increase labor L1 The only way actually to increase labor is to is to raise the real-wage raise the real-wage rate above its original level Technological rate above its original level Technological progress therefore favors progress therefore favors workers by increasing employment workers by increasing employment and wagesand wages

bull Early in the 19th century hand-woven cloth was very Early in the 19th century hand-woven cloth was very expensive and a worker was lucky to own the clothes on his expensive and a worker was lucky to own the clothes on his back and a spare set for church on Sunday Textiles were one of back and a spare set for church on Sunday Textiles were one of the first industries to benefit from the Industrial Revolution so the first industries to benefit from the Industrial Revolution so that by the end of the 19th century machine-made fabrics and that by the end of the 19th century machine-made fabrics and mass-production made decent clothing in larger quantities mass-production made decent clothing in larger quantities accessible to most of the population of the more developed accessible to most of the population of the more developed countries Similar progress has been made in most forms of countries Similar progress has been made in most forms of production Agricultural production which at the turn of the production Agricultural production which at the turn of the 20th century absorbed half the labor force now absorbs less 20th century absorbed half the labor force now absorbs less than 3 percent while producing more food more cheaply than than 3 percent while producing more food more cheaply than ever ever

bull We must be careful not to dismiss the Luddites as altogether We must be careful not to dismiss the Luddites as altogether foolish While new technology especially over decades has foolish While new technology especially over decades has proved to be a net gain for workers in general the Luddites proved to be a net gain for workers in general the Luddites were in fact correct that their way of life was threatened were in fact correct that their way of life was threatened Independent weavers became factory hands unskilled Independent weavers became factory hands unskilled workers increasingly women and often children replaced workers increasingly women and often children replaced skilled craftsmen and factory work often involved long hours skilled craftsmen and factory work often involved long hours in brutal conditions The wider society reaps the benefits of in brutal conditions The wider society reaps the benefits of technological change while a narrow group sometimes technological change while a narrow group sometimes disproportionately bears its costs Our analysis also assumes disproportionately bears its costs Our analysis also assumes that markets generally clear The implicit assumption is that that markets generally clear The implicit assumption is that displaced workers move on to new jobs possibly in other forms displaced workers move on to new jobs possibly in other forms of production Markets may have a tendency to clear in the of production Markets may have a tendency to clear in the long run yet workers may find themselves displaced in the long run yet workers may find themselves displaced in the short run say over the course of a business cycleshort run say over the course of a business cycle

Issue 3 Immigration Jobs and Real WagesIssue 3 Immigration Jobs and Real Wages

bull How does an increase in the labor force through immigration or How does an increase in the labor force through immigration or natural population growth affect labor and GDP natural population growth affect labor and GDP

bull One of the emotional issues associated with US immigration One of the emotional issues associated with US immigration policy ndash particularly towards low-wage workers from Mexico ndash policy ndash particularly towards low-wage workers from Mexico ndash is the idea that is the idea that immigrants take jobs away from native immigrants take jobs away from native workers workers We might be tempted to dismiss this fear as another We might be tempted to dismiss this fear as another example of the lump-of-labor fallacy Yet there is a sensible example of the lump-of-labor fallacy Yet there is a sensible intuition behind the argument An increase in the labor force ndash intuition behind the argument An increase in the labor force ndash due either to immigration or to higher population growth rates due either to immigration or to higher population growth rates ndash can be represented as an outward shift of the aggregate labor ndash can be represented as an outward shift of the aggregate labor supply curve as shown in the following Figure Employment supply curve as shown in the following Figure Employment increases but real wages fall It is not then that immigrants increases but real wages fall It is not then that immigrants take jobs away from natives take jobs away from natives Rather they compete for jobsRather they compete for jobs putting downward pressure on real wagesputting downward pressure on real wages

bull Again we must exercise care in interpreting the analysis Again we must exercise care in interpreting the analysis Remember that aggregate labor and average wage rates hide Remember that aggregate labor and average wage rates hide many details of the labor process The incomes of the new many details of the labor process The incomes of the new immigrants immigrants creates demand creates demand for the new production that they for the new production that they make possible Immigrant workers (at least those ndash whether make possible Immigrant workers (at least those ndash whether legal or illegal ndash who have become the focus of the most intense legal or illegal ndash who have become the focus of the most intense political debate) political debate) are likely to possess fewer skills than nativesare likely to possess fewer skills than natives The net effect is that the increased demand for goods and The net effect is that the increased demand for goods and services generated by immigrants is likely to increase the services generated by immigrants is likely to increase the demand for skilled (demand for skilled (and largely nativeand largely native) workers relative to ) workers relative to their supply and so to increase real wages of skilled workers their supply and so to increase real wages of skilled workers Low-skilled immigration may lower the real wage for farm Low-skilled immigration may lower the real wage for farm workers but if anything it would raise the real wage for workers but if anything it would raise the real wage for computer programmerscomputer programmers

Next Task Labor Market in Kuwait

Appendix Is Labor Supply Stable Over Time

bull Statistics on participation rates or average hours for a Statistics on participation rates or average hours for a particular month or year are snapshot of the labor market particular month or year are snapshot of the labor market Can we analyze the effects of that increase on the labor market Can we analyze the effects of that increase on the labor market under the assumption that the labor-supply curves of workers under the assumption that the labor-supply curves of workers remain essentially stableremain essentially stable

bull Data on participation rates in the United States appear to Data on participation rates in the United States appear to support this conjecture (see Figure 811) which shows the support this conjecture (see Figure 811) which shows the overall civilian participation rate trending upward ndash at least overall civilian participation rate trending upward ndash at least from the middle of the 1960sfrom the middle of the 1960s

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

AGGREGATE LABOR SUPPLY

bull How can we moveHow can we move from the microeconomics of the labor supply from the microeconomics of the labor supply back to an aggregate relationship usable in macroeconomic back to an aggregate relationship usable in macroeconomic analysis analysis If workers were essentially alikeIf workers were essentially alike the problem would the problem would be easy be easy

bull As we have seen labor supply has two dimensions ndash As we have seen labor supply has two dimensions ndash participationparticipation in the labor force and in the labor force and choice of hourschoice of hours of labor of labor Take the participation decision first If all workers were alike Take the participation decision first If all workers were alike except for except for differences in their reservation wagedifferences in their reservation wage then we could then we could rank them from lowest to highest reservation wage The rank them from lowest to highest reservation wage The aggregate labor-supply (participation) curve is strictly aggregate labor-supply (participation) curve is strictly upwardslopingupwardsloping

bull Of course this is too easy Just as we observed in deriving the Of course this is too easy Just as we observed in deriving the aggregate labor demand curve workers are aggregate labor demand curve workers are not all alikenot all alike Once Once again we must interpret the vertical axis as measuring the again we must interpret the vertical axis as measuring the average real wageaverage real wage that at best provides a kind of index for the that at best provides a kind of index for the level of the wage structure level of the wage structure

bull The The problemproblem remains the remains the samesame when we turn to the choice of when we turn to the choice of hourshours Workers are all different and face a structure of wages Workers are all different and face a structure of wages For each worker individually there is a jump from supplying For each worker individually there is a jump from supplying zero to supplying some positive number of hours zero to supplying some positive number of hours when his own when his own wage rate surpasses their wage rate surpasses their reservation wagereservation wage But in aggregate But in aggregate we are we are unlikely to see such a jumpunlikely to see such a jump Not only are there a variety Not only are there a variety of wages offered at any time but reservation wages differof wages offered at any time but reservation wages differ

Derivation of the Aggregate Labor-supply Curve

bull A curve like the one in this figure can be used to display either A curve like the one in this figure can be used to display either the the participation participation decision or decision or the hoursthe hours The horizontal axis can The horizontal axis can either be used for workers either be used for workers or worker-hoursor worker-hours as measures of the as measures of the labor supply The two meanings are not completely labor supply The two meanings are not completely independent by definition independent by definition

bull workers equiv aggregate worker ndash hours average hours per worker workers equiv aggregate worker ndash hours average hours per worker

The Participation Rate and Average Hours

bull Let us look first at the aggregate participation decision The Let us look first at the aggregate participation decision The aggregate number of workers who have decided to participate aggregate number of workers who have decided to participate is known as the is known as the labor forcelabor force the the civilian labor force over 16 civilian labor force over 16 years of ageyears of age This number excludes uniformed members of the This number excludes uniformed members of the armed services and the small number of workers under 16 armed services and the small number of workers under 16 years old The labor force of course has grown right along years old The labor force of course has grown right along with population with population

bull The participation rateThe participation rate (PR) measures (PR) measures the labor force as its ratio the labor force as its ratio to the relevant populationto the relevant population

bull participation rate = labor forcerelevant population participation rate = labor forcerelevant population

bull ldquoldquonon-institutionalrdquo non-institutionalrdquo excludes people in prison or in homes for excludes people in prison or in homes for the aged) the aged)

bull The aggregate number of hours The aggregate number of hours worked is worked is not as easy not as easy as the as the participation rate to relate to the individual workerrsquos choices participation rate to relate to the individual workerrsquos choices If every worker had the same labor-supply curve we would If every worker had the same labor-supply curve we would have to know the wage offered to each one in order to calculate have to know the wage offered to each one in order to calculate the total number of labor hours supplied In reality workers the total number of labor hours supplied In reality workers are not all alike are not all alike Labor-supply curves may vary systematically Labor-supply curves may vary systematically according to the sex age ethnic group education experience according to the sex age ethnic group education experience or other social or economic characteristics of the workersor other social or economic characteristics of the workers And And within any group the labor-supply curves of individuals are within any group the labor-supply curves of individuals are likely to varylikely to vary

bull In principle In principle if we had a good statistical estimate of the typical if we had a good statistical estimate of the typical distribution of the wagesdistribution of the wages we could make a reasonable we could make a reasonable calculation But statisticians at the Bureau of Labor Statistics calculation But statisticians at the Bureau of Labor Statistics (BLS) do not try to calculate the labor supply in this way (BLS) do not try to calculate the labor supply in this way Instead they Instead they count the number of hours that workers actually count the number of hours that workers actually workwork and the average and the average wages and salaries they are paid wages and salaries they are paid

bull In USA the total hours of labor in 1998 was In USA the total hours of labor in 1998 was 236882236882 million million The average hours of work is The average hours of work is 17211721 hours per year = hours per year = 344344 hours hours per week (assuming a 50 week year) This number is 14 percent per week (assuming a 50 week year) This number is 14 percent below the full time 40-hour week which makes sense since it below the full time 40-hour week which makes sense since it averages over full-time part-time and overtime workers averages over full-time part-time and overtime workers

Labor Market EquilibriumLabor Market Equilibrium

bull MARKET CLEARINGMARKET CLEARING

bull When both demand and supply curves are plotted on the same When both demand and supply curves are plotted on the same diagram the crossing point defines the diagram the crossing point defines the equilibrium real-wage equilibrium real-wage rate and the rate and the equilibrium level of labor employedequilibrium level of labor employed

bull The real wage The real wage looks different looks different from the point of view of the firm from the point of view of the firm and the worker For the and the worker For the firmfirm the relevant real wage is the the relevant real wage is the product-real wage product-real wage defined as defined as the number of units of the good the number of units of the good the firm produces that the wage will purchase the firm produces that the wage will purchase ((price of price of productproduct = = w) w) For the For the workerworker the relevant real wage is the the relevant real wage is the consumption-consumption-real real wagewage defined as defined as the number of typical consumption baskets the number of typical consumption baskets that the wage will purchase that the wage will purchase ((price of price of consumption basket consumption basket = = w)w)

bull For aggregate analysis we might use the For aggregate analysis we might use the Producer Price IndexProducer Price Index or the GDP deflator to approximate the or the GDP deflator to approximate the product priceproduct price and the and the CPICPI to approximate the to approximate the consumption price consumption price

bull Suppose that the product-real wage and the consumption-real Suppose that the product-real wage and the consumption-real wage in the following figure start out with the identical value wage in the following figure start out with the identical value ((wp) at the market-clearing point Awp) at the market-clearing point A Now suppose that Now suppose that imported Japanese cars are a large portion of the typical imported Japanese cars are a large portion of the typical workerrsquos consumption basket workerrsquos consumption basket and that and that ceteris paribus ceteris paribus the price the price of Japanese cars rises sharply This means that the of Japanese cars rises sharply This means that the real wage real wage from the point of view of the from the point of view of the consumer falls to (consumer falls to (wpwpCPICPI ) )11 at point at point

B B on the labor-supply curve (LS) so that the worker would on the labor-supply curve (LS) so that the worker would want to supply less labor (want to supply less labor (LL11))

bull The rise in the price of Japanese cars has no effect on the price The rise in the price of Japanese cars has no effect on the price of their products Nevertheless they see a reduction of labor of their products Nevertheless they see a reduction of labor supply at the original market clearing wage It is as if the supply at the original market clearing wage It is as if the labor-supply curve labor-supply curve has shifted to the left to has shifted to the left to LSLSrsquo which passes rsquo which passes through ((through ((wp) L1) at point C wp) L1) at point C At the original wage rate labor At the original wage rate labor demand exceeds labor supply so firms raise wages in an effort demand exceeds labor supply so firms raise wages in an effort to attract workers until they reach the new market-clearing to attract workers until they reach the new market-clearing wage at point D where they pay (wage at point D where they pay (wpwpPPIPPI ) for labor of L ) for labor of L The The

rise in the price of Japanese cars has the effect of raising the rise in the price of Japanese cars has the effect of raising the wages that firms must pay and reducing labor employedwages that firms must pay and reducing labor employed Higher wages partly compensate workers for the higher costs Higher wages partly compensate workers for the higher costs of consumption but firms can afford to pay those higher wages of consumption but firms can afford to pay those higher wages only if marginal products rise as a result of their using less only if marginal products rise as a result of their using less labor labor

bull The rise in wage rates is not enough to compensate workers The rise in wage rates is not enough to compensate workers fully so the consumption-real wage in equilibrium is (wpfully so the consumption-real wage in equilibrium is (wpCPI CPI ) )

atat point E We can think of import prices as a tax levied on point E We can think of import prices as a tax levied on consumers and of an increase in import prices as widening the consumers and of an increase in import prices as widening the tax wedge Unless the issue that we want to analyze depends on tax wedge Unless the issue that we want to analyze depends on the difference between product- and consumption-real wages the difference between product- and consumption-real wages we will treat the real wage as the same for both labor supply we will treat the real wage as the same for both labor supply and labor demandand labor demand

An Increase in the Price of Consumption GoodsAn Increase in the Price of Consumption GoodsRelative to the Price of OutputRelative to the Price of Output

ANALYZING IDEAL LABOR MARKETSANALYZING IDEAL LABOR MARKETS

bull The aggregate labor-supplylabor-demand diagram provides us The aggregate labor-supplylabor-demand diagram provides us with a powerful tool We now analyze three important with a powerful tool We now analyze three important macroeconomic issues macroeconomic issues

(1) the effect of tax cuts on employment (1) the effect of tax cuts on employment

(2) the effect of technological progress on the well-being of (2) the effect of technological progress on the well-being of workers and workers and

(3) the effect of immigration on existing workers (3) the effect of immigration on existing workers

bull Issue 1 Tax Cuts Issue 1 Tax Cuts What are the effects of a cut in marginal What are the effects of a cut in marginal income-tax rates on employment and the level of GDP in the income-tax rates on employment and the level of GDP in the economyeconomy Recall from section that a lower marginal income-Recall from section that a lower marginal income-tax rate increases labor supply at each real wage (a rightward tax rate increases labor supply at each real wage (a rightward shift of the labor-supply) shift of the labor-supply)

bull Labor-market equilibrium moves from point A to point B in Labor-market equilibrium moves from point A to point B in the lower panel of the following Notice that the amount of the lower panel of the following Notice that the amount of labor available to firms increases so that firms move labor available to firms increases so that firms move production from Arsquo to Brsquo on the labor production function in production from Arsquo to Brsquo on the labor production function in the upper panel Also notice that the real wage falls from (the upper panel Also notice that the real wage falls from (wp)1 wp)1 to (wp)2 Since the cut in taxes increases the number of to (wp)2 Since the cut in taxes increases the number of workers workers willing to work at each wage Workers care about their take-willing to work at each wage Workers care about their take-home pay ndash that is about their home pay ndash that is about their after-tax real wage after-tax real wage This is This is perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 can be greater than the old after-tax real wage (1ndashcan be greater than the old after-tax real wage (1ndashτ1τ1)(wp)1 so )(wp)1 so long as the rise in the take-home share (1 ndash τ) is long as the rise in the take-home share (1 ndash τ) is proportionately greater than the fall in the before-tax real proportionately greater than the fall in the before-tax real wage (wp)wage (wp)

bull The analysis depends on substitution effects dominating The analysis depends on substitution effects dominating income effects which they probably do in aggregate if not for income effects which they probably do in aggregate if not for every worker So the supply-siders of the Reagan years are every worker So the supply-siders of the Reagan years are correct in principle How much output will increase depends on correct in principle How much output will increase depends on how large the substitution effect is If most people work a how large the substitution effect is If most people work a standard 40-hour week the effect could be quite small and the standard 40-hour week the effect could be quite small and the increase in output might also be very small in practiceincrease in output might also be very small in practice

Issue 1 The Effect of a Cut in Marginal Tax RatesIssue 1 The Effect of a Cut in Marginal Tax Rates

Issue 2 Technological Progress and Worker WelfareIssue 2 Technological Progress and Worker Welfare

bull Is technological progress and increasing use of machinery and Is technological progress and increasing use of machinery and other capital beneficial for workersother capital beneficial for workers

bull Technological change or capital accumulation have been Technological change or capital accumulation have been known as ldquoLudditesrdquo (known as ldquoLudditesrdquo (it negatively affects the demand for it negatively affects the demand for laborlabor) To see why the Luddites are wrong ndash at least for ) To see why the Luddites are wrong ndash at least for clearing labor markets ndash recall that technological progress or clearing labor markets ndash recall that technological progress or increased capital both increased capital both shift the labor-demand curve upwardshift the labor-demand curve upward The lower panel of the following figure shows that the effect of The lower panel of the following figure shows that the effect of the increased demand for labor is to increase total employment the increased demand for labor is to increase total employment and the real wage Firms and the real wage Firms can pay a higher real wage can pay a higher real wage because because the additional capital or technological progress the additional capital or technological progress increases the increases the marginal product of labormarginal product of labor

bull The The Ludditesrsquo mistake Ludditesrsquo mistake is most easily seen in the upper panel is most easily seen in the upper panel The Luddite argument assumes that fewer workers will The Luddite argument assumes that fewer workers will produce the same total output Production starts at Arsquo using produce the same total output Production starts at Arsquo using L1 L1 workers to produce Y1 After the upward shift in the production workers to produce Y1 After the upward shift in the production function the same output could be produced using less labor function the same output could be produced using less labor ((L3) at point Arsquorsquo The L3) at point Arsquorsquo The problem is that Arsquorsquo is not an equilibrium problem is that Arsquorsquo is not an equilibrium At that point the marginal product of labor is higher than the At that point the marginal product of labor is higher than the original real wage so a profit-maximizing firm would want to original real wage so a profit-maximizing firm would want to expand production To do this they must hire more labor than expand production To do this they must hire more labor than L3 and indeed they L3 and indeed they find it find it profitable profitable to hire more labor than to hire more labor than the original the original L1 The only way actually to increase labor L1 The only way actually to increase labor is to is to raise the real-wage raise the real-wage rate above its original level Technological rate above its original level Technological progress therefore favors progress therefore favors workers by increasing employment workers by increasing employment and wagesand wages

bull Early in the 19th century hand-woven cloth was very Early in the 19th century hand-woven cloth was very expensive and a worker was lucky to own the clothes on his expensive and a worker was lucky to own the clothes on his back and a spare set for church on Sunday Textiles were one of back and a spare set for church on Sunday Textiles were one of the first industries to benefit from the Industrial Revolution so the first industries to benefit from the Industrial Revolution so that by the end of the 19th century machine-made fabrics and that by the end of the 19th century machine-made fabrics and mass-production made decent clothing in larger quantities mass-production made decent clothing in larger quantities accessible to most of the population of the more developed accessible to most of the population of the more developed countries Similar progress has been made in most forms of countries Similar progress has been made in most forms of production Agricultural production which at the turn of the production Agricultural production which at the turn of the 20th century absorbed half the labor force now absorbs less 20th century absorbed half the labor force now absorbs less than 3 percent while producing more food more cheaply than than 3 percent while producing more food more cheaply than ever ever

bull We must be careful not to dismiss the Luddites as altogether We must be careful not to dismiss the Luddites as altogether foolish While new technology especially over decades has foolish While new technology especially over decades has proved to be a net gain for workers in general the Luddites proved to be a net gain for workers in general the Luddites were in fact correct that their way of life was threatened were in fact correct that their way of life was threatened Independent weavers became factory hands unskilled Independent weavers became factory hands unskilled workers increasingly women and often children replaced workers increasingly women and often children replaced skilled craftsmen and factory work often involved long hours skilled craftsmen and factory work often involved long hours in brutal conditions The wider society reaps the benefits of in brutal conditions The wider society reaps the benefits of technological change while a narrow group sometimes technological change while a narrow group sometimes disproportionately bears its costs Our analysis also assumes disproportionately bears its costs Our analysis also assumes that markets generally clear The implicit assumption is that that markets generally clear The implicit assumption is that displaced workers move on to new jobs possibly in other forms displaced workers move on to new jobs possibly in other forms of production Markets may have a tendency to clear in the of production Markets may have a tendency to clear in the long run yet workers may find themselves displaced in the long run yet workers may find themselves displaced in the short run say over the course of a business cycleshort run say over the course of a business cycle

Issue 3 Immigration Jobs and Real WagesIssue 3 Immigration Jobs and Real Wages

bull How does an increase in the labor force through immigration or How does an increase in the labor force through immigration or natural population growth affect labor and GDP natural population growth affect labor and GDP

bull One of the emotional issues associated with US immigration One of the emotional issues associated with US immigration policy ndash particularly towards low-wage workers from Mexico ndash policy ndash particularly towards low-wage workers from Mexico ndash is the idea that is the idea that immigrants take jobs away from native immigrants take jobs away from native workers workers We might be tempted to dismiss this fear as another We might be tempted to dismiss this fear as another example of the lump-of-labor fallacy Yet there is a sensible example of the lump-of-labor fallacy Yet there is a sensible intuition behind the argument An increase in the labor force ndash intuition behind the argument An increase in the labor force ndash due either to immigration or to higher population growth rates due either to immigration or to higher population growth rates ndash can be represented as an outward shift of the aggregate labor ndash can be represented as an outward shift of the aggregate labor supply curve as shown in the following Figure Employment supply curve as shown in the following Figure Employment increases but real wages fall It is not then that immigrants increases but real wages fall It is not then that immigrants take jobs away from natives take jobs away from natives Rather they compete for jobsRather they compete for jobs putting downward pressure on real wagesputting downward pressure on real wages

bull Again we must exercise care in interpreting the analysis Again we must exercise care in interpreting the analysis Remember that aggregate labor and average wage rates hide Remember that aggregate labor and average wage rates hide many details of the labor process The incomes of the new many details of the labor process The incomes of the new immigrants immigrants creates demand creates demand for the new production that they for the new production that they make possible Immigrant workers (at least those ndash whether make possible Immigrant workers (at least those ndash whether legal or illegal ndash who have become the focus of the most intense legal or illegal ndash who have become the focus of the most intense political debate) political debate) are likely to possess fewer skills than nativesare likely to possess fewer skills than natives The net effect is that the increased demand for goods and The net effect is that the increased demand for goods and services generated by immigrants is likely to increase the services generated by immigrants is likely to increase the demand for skilled (demand for skilled (and largely nativeand largely native) workers relative to ) workers relative to their supply and so to increase real wages of skilled workers their supply and so to increase real wages of skilled workers Low-skilled immigration may lower the real wage for farm Low-skilled immigration may lower the real wage for farm workers but if anything it would raise the real wage for workers but if anything it would raise the real wage for computer programmerscomputer programmers

Next Task Labor Market in Kuwait

Appendix Is Labor Supply Stable Over Time

bull Statistics on participation rates or average hours for a Statistics on participation rates or average hours for a particular month or year are snapshot of the labor market particular month or year are snapshot of the labor market Can we analyze the effects of that increase on the labor market Can we analyze the effects of that increase on the labor market under the assumption that the labor-supply curves of workers under the assumption that the labor-supply curves of workers remain essentially stableremain essentially stable

bull Data on participation rates in the United States appear to Data on participation rates in the United States appear to support this conjecture (see Figure 811) which shows the support this conjecture (see Figure 811) which shows the overall civilian participation rate trending upward ndash at least overall civilian participation rate trending upward ndash at least from the middle of the 1960sfrom the middle of the 1960s

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

bull Of course this is too easy Just as we observed in deriving the Of course this is too easy Just as we observed in deriving the aggregate labor demand curve workers are aggregate labor demand curve workers are not all alikenot all alike Once Once again we must interpret the vertical axis as measuring the again we must interpret the vertical axis as measuring the average real wageaverage real wage that at best provides a kind of index for the that at best provides a kind of index for the level of the wage structure level of the wage structure

bull The The problemproblem remains the remains the samesame when we turn to the choice of when we turn to the choice of hourshours Workers are all different and face a structure of wages Workers are all different and face a structure of wages For each worker individually there is a jump from supplying For each worker individually there is a jump from supplying zero to supplying some positive number of hours zero to supplying some positive number of hours when his own when his own wage rate surpasses their wage rate surpasses their reservation wagereservation wage But in aggregate But in aggregate we are we are unlikely to see such a jumpunlikely to see such a jump Not only are there a variety Not only are there a variety of wages offered at any time but reservation wages differof wages offered at any time but reservation wages differ

Derivation of the Aggregate Labor-supply Curve

bull A curve like the one in this figure can be used to display either A curve like the one in this figure can be used to display either the the participation participation decision or decision or the hoursthe hours The horizontal axis can The horizontal axis can either be used for workers either be used for workers or worker-hoursor worker-hours as measures of the as measures of the labor supply The two meanings are not completely labor supply The two meanings are not completely independent by definition independent by definition

bull workers equiv aggregate worker ndash hours average hours per worker workers equiv aggregate worker ndash hours average hours per worker

The Participation Rate and Average Hours

bull Let us look first at the aggregate participation decision The Let us look first at the aggregate participation decision The aggregate number of workers who have decided to participate aggregate number of workers who have decided to participate is known as the is known as the labor forcelabor force the the civilian labor force over 16 civilian labor force over 16 years of ageyears of age This number excludes uniformed members of the This number excludes uniformed members of the armed services and the small number of workers under 16 armed services and the small number of workers under 16 years old The labor force of course has grown right along years old The labor force of course has grown right along with population with population

bull The participation rateThe participation rate (PR) measures (PR) measures the labor force as its ratio the labor force as its ratio to the relevant populationto the relevant population

bull participation rate = labor forcerelevant population participation rate = labor forcerelevant population

bull ldquoldquonon-institutionalrdquo non-institutionalrdquo excludes people in prison or in homes for excludes people in prison or in homes for the aged) the aged)

bull The aggregate number of hours The aggregate number of hours worked is worked is not as easy not as easy as the as the participation rate to relate to the individual workerrsquos choices participation rate to relate to the individual workerrsquos choices If every worker had the same labor-supply curve we would If every worker had the same labor-supply curve we would have to know the wage offered to each one in order to calculate have to know the wage offered to each one in order to calculate the total number of labor hours supplied In reality workers the total number of labor hours supplied In reality workers are not all alike are not all alike Labor-supply curves may vary systematically Labor-supply curves may vary systematically according to the sex age ethnic group education experience according to the sex age ethnic group education experience or other social or economic characteristics of the workersor other social or economic characteristics of the workers And And within any group the labor-supply curves of individuals are within any group the labor-supply curves of individuals are likely to varylikely to vary

bull In principle In principle if we had a good statistical estimate of the typical if we had a good statistical estimate of the typical distribution of the wagesdistribution of the wages we could make a reasonable we could make a reasonable calculation But statisticians at the Bureau of Labor Statistics calculation But statisticians at the Bureau of Labor Statistics (BLS) do not try to calculate the labor supply in this way (BLS) do not try to calculate the labor supply in this way Instead they Instead they count the number of hours that workers actually count the number of hours that workers actually workwork and the average and the average wages and salaries they are paid wages and salaries they are paid

bull In USA the total hours of labor in 1998 was In USA the total hours of labor in 1998 was 236882236882 million million The average hours of work is The average hours of work is 17211721 hours per year = hours per year = 344344 hours hours per week (assuming a 50 week year) This number is 14 percent per week (assuming a 50 week year) This number is 14 percent below the full time 40-hour week which makes sense since it below the full time 40-hour week which makes sense since it averages over full-time part-time and overtime workers averages over full-time part-time and overtime workers

Labor Market EquilibriumLabor Market Equilibrium

bull MARKET CLEARINGMARKET CLEARING

bull When both demand and supply curves are plotted on the same When both demand and supply curves are plotted on the same diagram the crossing point defines the diagram the crossing point defines the equilibrium real-wage equilibrium real-wage rate and the rate and the equilibrium level of labor employedequilibrium level of labor employed

bull The real wage The real wage looks different looks different from the point of view of the firm from the point of view of the firm and the worker For the and the worker For the firmfirm the relevant real wage is the the relevant real wage is the product-real wage product-real wage defined as defined as the number of units of the good the number of units of the good the firm produces that the wage will purchase the firm produces that the wage will purchase ((price of price of productproduct = = w) w) For the For the workerworker the relevant real wage is the the relevant real wage is the consumption-consumption-real real wagewage defined as defined as the number of typical consumption baskets the number of typical consumption baskets that the wage will purchase that the wage will purchase ((price of price of consumption basket consumption basket = = w)w)

bull For aggregate analysis we might use the For aggregate analysis we might use the Producer Price IndexProducer Price Index or the GDP deflator to approximate the or the GDP deflator to approximate the product priceproduct price and the and the CPICPI to approximate the to approximate the consumption price consumption price

bull Suppose that the product-real wage and the consumption-real Suppose that the product-real wage and the consumption-real wage in the following figure start out with the identical value wage in the following figure start out with the identical value ((wp) at the market-clearing point Awp) at the market-clearing point A Now suppose that Now suppose that imported Japanese cars are a large portion of the typical imported Japanese cars are a large portion of the typical workerrsquos consumption basket workerrsquos consumption basket and that and that ceteris paribus ceteris paribus the price the price of Japanese cars rises sharply This means that the of Japanese cars rises sharply This means that the real wage real wage from the point of view of the from the point of view of the consumer falls to (consumer falls to (wpwpCPICPI ) )11 at point at point

B B on the labor-supply curve (LS) so that the worker would on the labor-supply curve (LS) so that the worker would want to supply less labor (want to supply less labor (LL11))

bull The rise in the price of Japanese cars has no effect on the price The rise in the price of Japanese cars has no effect on the price of their products Nevertheless they see a reduction of labor of their products Nevertheless they see a reduction of labor supply at the original market clearing wage It is as if the supply at the original market clearing wage It is as if the labor-supply curve labor-supply curve has shifted to the left to has shifted to the left to LSLSrsquo which passes rsquo which passes through ((through ((wp) L1) at point C wp) L1) at point C At the original wage rate labor At the original wage rate labor demand exceeds labor supply so firms raise wages in an effort demand exceeds labor supply so firms raise wages in an effort to attract workers until they reach the new market-clearing to attract workers until they reach the new market-clearing wage at point D where they pay (wage at point D where they pay (wpwpPPIPPI ) for labor of L ) for labor of L The The

rise in the price of Japanese cars has the effect of raising the rise in the price of Japanese cars has the effect of raising the wages that firms must pay and reducing labor employedwages that firms must pay and reducing labor employed Higher wages partly compensate workers for the higher costs Higher wages partly compensate workers for the higher costs of consumption but firms can afford to pay those higher wages of consumption but firms can afford to pay those higher wages only if marginal products rise as a result of their using less only if marginal products rise as a result of their using less labor labor

bull The rise in wage rates is not enough to compensate workers The rise in wage rates is not enough to compensate workers fully so the consumption-real wage in equilibrium is (wpfully so the consumption-real wage in equilibrium is (wpCPI CPI ) )

atat point E We can think of import prices as a tax levied on point E We can think of import prices as a tax levied on consumers and of an increase in import prices as widening the consumers and of an increase in import prices as widening the tax wedge Unless the issue that we want to analyze depends on tax wedge Unless the issue that we want to analyze depends on the difference between product- and consumption-real wages the difference between product- and consumption-real wages we will treat the real wage as the same for both labor supply we will treat the real wage as the same for both labor supply and labor demandand labor demand

An Increase in the Price of Consumption GoodsAn Increase in the Price of Consumption GoodsRelative to the Price of OutputRelative to the Price of Output

ANALYZING IDEAL LABOR MARKETSANALYZING IDEAL LABOR MARKETS

bull The aggregate labor-supplylabor-demand diagram provides us The aggregate labor-supplylabor-demand diagram provides us with a powerful tool We now analyze three important with a powerful tool We now analyze three important macroeconomic issues macroeconomic issues

(1) the effect of tax cuts on employment (1) the effect of tax cuts on employment

(2) the effect of technological progress on the well-being of (2) the effect of technological progress on the well-being of workers and workers and

(3) the effect of immigration on existing workers (3) the effect of immigration on existing workers

bull Issue 1 Tax Cuts Issue 1 Tax Cuts What are the effects of a cut in marginal What are the effects of a cut in marginal income-tax rates on employment and the level of GDP in the income-tax rates on employment and the level of GDP in the economyeconomy Recall from section that a lower marginal income-Recall from section that a lower marginal income-tax rate increases labor supply at each real wage (a rightward tax rate increases labor supply at each real wage (a rightward shift of the labor-supply) shift of the labor-supply)

bull Labor-market equilibrium moves from point A to point B in Labor-market equilibrium moves from point A to point B in the lower panel of the following Notice that the amount of the lower panel of the following Notice that the amount of labor available to firms increases so that firms move labor available to firms increases so that firms move production from Arsquo to Brsquo on the labor production function in production from Arsquo to Brsquo on the labor production function in the upper panel Also notice that the real wage falls from (the upper panel Also notice that the real wage falls from (wp)1 wp)1 to (wp)2 Since the cut in taxes increases the number of to (wp)2 Since the cut in taxes increases the number of workers workers willing to work at each wage Workers care about their take-willing to work at each wage Workers care about their take-home pay ndash that is about their home pay ndash that is about their after-tax real wage after-tax real wage This is This is perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 can be greater than the old after-tax real wage (1ndashcan be greater than the old after-tax real wage (1ndashτ1τ1)(wp)1 so )(wp)1 so long as the rise in the take-home share (1 ndash τ) is long as the rise in the take-home share (1 ndash τ) is proportionately greater than the fall in the before-tax real proportionately greater than the fall in the before-tax real wage (wp)wage (wp)

bull The analysis depends on substitution effects dominating The analysis depends on substitution effects dominating income effects which they probably do in aggregate if not for income effects which they probably do in aggregate if not for every worker So the supply-siders of the Reagan years are every worker So the supply-siders of the Reagan years are correct in principle How much output will increase depends on correct in principle How much output will increase depends on how large the substitution effect is If most people work a how large the substitution effect is If most people work a standard 40-hour week the effect could be quite small and the standard 40-hour week the effect could be quite small and the increase in output might also be very small in practiceincrease in output might also be very small in practice

Issue 1 The Effect of a Cut in Marginal Tax RatesIssue 1 The Effect of a Cut in Marginal Tax Rates

Issue 2 Technological Progress and Worker WelfareIssue 2 Technological Progress and Worker Welfare

bull Is technological progress and increasing use of machinery and Is technological progress and increasing use of machinery and other capital beneficial for workersother capital beneficial for workers

bull Technological change or capital accumulation have been Technological change or capital accumulation have been known as ldquoLudditesrdquo (known as ldquoLudditesrdquo (it negatively affects the demand for it negatively affects the demand for laborlabor) To see why the Luddites are wrong ndash at least for ) To see why the Luddites are wrong ndash at least for clearing labor markets ndash recall that technological progress or clearing labor markets ndash recall that technological progress or increased capital both increased capital both shift the labor-demand curve upwardshift the labor-demand curve upward The lower panel of the following figure shows that the effect of The lower panel of the following figure shows that the effect of the increased demand for labor is to increase total employment the increased demand for labor is to increase total employment and the real wage Firms and the real wage Firms can pay a higher real wage can pay a higher real wage because because the additional capital or technological progress the additional capital or technological progress increases the increases the marginal product of labormarginal product of labor

bull The The Ludditesrsquo mistake Ludditesrsquo mistake is most easily seen in the upper panel is most easily seen in the upper panel The Luddite argument assumes that fewer workers will The Luddite argument assumes that fewer workers will produce the same total output Production starts at Arsquo using produce the same total output Production starts at Arsquo using L1 L1 workers to produce Y1 After the upward shift in the production workers to produce Y1 After the upward shift in the production function the same output could be produced using less labor function the same output could be produced using less labor ((L3) at point Arsquorsquo The L3) at point Arsquorsquo The problem is that Arsquorsquo is not an equilibrium problem is that Arsquorsquo is not an equilibrium At that point the marginal product of labor is higher than the At that point the marginal product of labor is higher than the original real wage so a profit-maximizing firm would want to original real wage so a profit-maximizing firm would want to expand production To do this they must hire more labor than expand production To do this they must hire more labor than L3 and indeed they L3 and indeed they find it find it profitable profitable to hire more labor than to hire more labor than the original the original L1 The only way actually to increase labor L1 The only way actually to increase labor is to is to raise the real-wage raise the real-wage rate above its original level Technological rate above its original level Technological progress therefore favors progress therefore favors workers by increasing employment workers by increasing employment and wagesand wages

bull Early in the 19th century hand-woven cloth was very Early in the 19th century hand-woven cloth was very expensive and a worker was lucky to own the clothes on his expensive and a worker was lucky to own the clothes on his back and a spare set for church on Sunday Textiles were one of back and a spare set for church on Sunday Textiles were one of the first industries to benefit from the Industrial Revolution so the first industries to benefit from the Industrial Revolution so that by the end of the 19th century machine-made fabrics and that by the end of the 19th century machine-made fabrics and mass-production made decent clothing in larger quantities mass-production made decent clothing in larger quantities accessible to most of the population of the more developed accessible to most of the population of the more developed countries Similar progress has been made in most forms of countries Similar progress has been made in most forms of production Agricultural production which at the turn of the production Agricultural production which at the turn of the 20th century absorbed half the labor force now absorbs less 20th century absorbed half the labor force now absorbs less than 3 percent while producing more food more cheaply than than 3 percent while producing more food more cheaply than ever ever

bull We must be careful not to dismiss the Luddites as altogether We must be careful not to dismiss the Luddites as altogether foolish While new technology especially over decades has foolish While new technology especially over decades has proved to be a net gain for workers in general the Luddites proved to be a net gain for workers in general the Luddites were in fact correct that their way of life was threatened were in fact correct that their way of life was threatened Independent weavers became factory hands unskilled Independent weavers became factory hands unskilled workers increasingly women and often children replaced workers increasingly women and often children replaced skilled craftsmen and factory work often involved long hours skilled craftsmen and factory work often involved long hours in brutal conditions The wider society reaps the benefits of in brutal conditions The wider society reaps the benefits of technological change while a narrow group sometimes technological change while a narrow group sometimes disproportionately bears its costs Our analysis also assumes disproportionately bears its costs Our analysis also assumes that markets generally clear The implicit assumption is that that markets generally clear The implicit assumption is that displaced workers move on to new jobs possibly in other forms displaced workers move on to new jobs possibly in other forms of production Markets may have a tendency to clear in the of production Markets may have a tendency to clear in the long run yet workers may find themselves displaced in the long run yet workers may find themselves displaced in the short run say over the course of a business cycleshort run say over the course of a business cycle

Issue 3 Immigration Jobs and Real WagesIssue 3 Immigration Jobs and Real Wages

bull How does an increase in the labor force through immigration or How does an increase in the labor force through immigration or natural population growth affect labor and GDP natural population growth affect labor and GDP

bull One of the emotional issues associated with US immigration One of the emotional issues associated with US immigration policy ndash particularly towards low-wage workers from Mexico ndash policy ndash particularly towards low-wage workers from Mexico ndash is the idea that is the idea that immigrants take jobs away from native immigrants take jobs away from native workers workers We might be tempted to dismiss this fear as another We might be tempted to dismiss this fear as another example of the lump-of-labor fallacy Yet there is a sensible example of the lump-of-labor fallacy Yet there is a sensible intuition behind the argument An increase in the labor force ndash intuition behind the argument An increase in the labor force ndash due either to immigration or to higher population growth rates due either to immigration or to higher population growth rates ndash can be represented as an outward shift of the aggregate labor ndash can be represented as an outward shift of the aggregate labor supply curve as shown in the following Figure Employment supply curve as shown in the following Figure Employment increases but real wages fall It is not then that immigrants increases but real wages fall It is not then that immigrants take jobs away from natives take jobs away from natives Rather they compete for jobsRather they compete for jobs putting downward pressure on real wagesputting downward pressure on real wages

bull Again we must exercise care in interpreting the analysis Again we must exercise care in interpreting the analysis Remember that aggregate labor and average wage rates hide Remember that aggregate labor and average wage rates hide many details of the labor process The incomes of the new many details of the labor process The incomes of the new immigrants immigrants creates demand creates demand for the new production that they for the new production that they make possible Immigrant workers (at least those ndash whether make possible Immigrant workers (at least those ndash whether legal or illegal ndash who have become the focus of the most intense legal or illegal ndash who have become the focus of the most intense political debate) political debate) are likely to possess fewer skills than nativesare likely to possess fewer skills than natives The net effect is that the increased demand for goods and The net effect is that the increased demand for goods and services generated by immigrants is likely to increase the services generated by immigrants is likely to increase the demand for skilled (demand for skilled (and largely nativeand largely native) workers relative to ) workers relative to their supply and so to increase real wages of skilled workers their supply and so to increase real wages of skilled workers Low-skilled immigration may lower the real wage for farm Low-skilled immigration may lower the real wage for farm workers but if anything it would raise the real wage for workers but if anything it would raise the real wage for computer programmerscomputer programmers

Next Task Labor Market in Kuwait

Appendix Is Labor Supply Stable Over Time

bull Statistics on participation rates or average hours for a Statistics on participation rates or average hours for a particular month or year are snapshot of the labor market particular month or year are snapshot of the labor market Can we analyze the effects of that increase on the labor market Can we analyze the effects of that increase on the labor market under the assumption that the labor-supply curves of workers under the assumption that the labor-supply curves of workers remain essentially stableremain essentially stable

bull Data on participation rates in the United States appear to Data on participation rates in the United States appear to support this conjecture (see Figure 811) which shows the support this conjecture (see Figure 811) which shows the overall civilian participation rate trending upward ndash at least overall civilian participation rate trending upward ndash at least from the middle of the 1960sfrom the middle of the 1960s

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

Derivation of the Aggregate Labor-supply Curve

bull A curve like the one in this figure can be used to display either A curve like the one in this figure can be used to display either the the participation participation decision or decision or the hoursthe hours The horizontal axis can The horizontal axis can either be used for workers either be used for workers or worker-hoursor worker-hours as measures of the as measures of the labor supply The two meanings are not completely labor supply The two meanings are not completely independent by definition independent by definition

bull workers equiv aggregate worker ndash hours average hours per worker workers equiv aggregate worker ndash hours average hours per worker

The Participation Rate and Average Hours

bull Let us look first at the aggregate participation decision The Let us look first at the aggregate participation decision The aggregate number of workers who have decided to participate aggregate number of workers who have decided to participate is known as the is known as the labor forcelabor force the the civilian labor force over 16 civilian labor force over 16 years of ageyears of age This number excludes uniformed members of the This number excludes uniformed members of the armed services and the small number of workers under 16 armed services and the small number of workers under 16 years old The labor force of course has grown right along years old The labor force of course has grown right along with population with population

bull The participation rateThe participation rate (PR) measures (PR) measures the labor force as its ratio the labor force as its ratio to the relevant populationto the relevant population

bull participation rate = labor forcerelevant population participation rate = labor forcerelevant population

bull ldquoldquonon-institutionalrdquo non-institutionalrdquo excludes people in prison or in homes for excludes people in prison or in homes for the aged) the aged)

bull The aggregate number of hours The aggregate number of hours worked is worked is not as easy not as easy as the as the participation rate to relate to the individual workerrsquos choices participation rate to relate to the individual workerrsquos choices If every worker had the same labor-supply curve we would If every worker had the same labor-supply curve we would have to know the wage offered to each one in order to calculate have to know the wage offered to each one in order to calculate the total number of labor hours supplied In reality workers the total number of labor hours supplied In reality workers are not all alike are not all alike Labor-supply curves may vary systematically Labor-supply curves may vary systematically according to the sex age ethnic group education experience according to the sex age ethnic group education experience or other social or economic characteristics of the workersor other social or economic characteristics of the workers And And within any group the labor-supply curves of individuals are within any group the labor-supply curves of individuals are likely to varylikely to vary

bull In principle In principle if we had a good statistical estimate of the typical if we had a good statistical estimate of the typical distribution of the wagesdistribution of the wages we could make a reasonable we could make a reasonable calculation But statisticians at the Bureau of Labor Statistics calculation But statisticians at the Bureau of Labor Statistics (BLS) do not try to calculate the labor supply in this way (BLS) do not try to calculate the labor supply in this way Instead they Instead they count the number of hours that workers actually count the number of hours that workers actually workwork and the average and the average wages and salaries they are paid wages and salaries they are paid

bull In USA the total hours of labor in 1998 was In USA the total hours of labor in 1998 was 236882236882 million million The average hours of work is The average hours of work is 17211721 hours per year = hours per year = 344344 hours hours per week (assuming a 50 week year) This number is 14 percent per week (assuming a 50 week year) This number is 14 percent below the full time 40-hour week which makes sense since it below the full time 40-hour week which makes sense since it averages over full-time part-time and overtime workers averages over full-time part-time and overtime workers

Labor Market EquilibriumLabor Market Equilibrium

bull MARKET CLEARINGMARKET CLEARING

bull When both demand and supply curves are plotted on the same When both demand and supply curves are plotted on the same diagram the crossing point defines the diagram the crossing point defines the equilibrium real-wage equilibrium real-wage rate and the rate and the equilibrium level of labor employedequilibrium level of labor employed

bull The real wage The real wage looks different looks different from the point of view of the firm from the point of view of the firm and the worker For the and the worker For the firmfirm the relevant real wage is the the relevant real wage is the product-real wage product-real wage defined as defined as the number of units of the good the number of units of the good the firm produces that the wage will purchase the firm produces that the wage will purchase ((price of price of productproduct = = w) w) For the For the workerworker the relevant real wage is the the relevant real wage is the consumption-consumption-real real wagewage defined as defined as the number of typical consumption baskets the number of typical consumption baskets that the wage will purchase that the wage will purchase ((price of price of consumption basket consumption basket = = w)w)

bull For aggregate analysis we might use the For aggregate analysis we might use the Producer Price IndexProducer Price Index or the GDP deflator to approximate the or the GDP deflator to approximate the product priceproduct price and the and the CPICPI to approximate the to approximate the consumption price consumption price

bull Suppose that the product-real wage and the consumption-real Suppose that the product-real wage and the consumption-real wage in the following figure start out with the identical value wage in the following figure start out with the identical value ((wp) at the market-clearing point Awp) at the market-clearing point A Now suppose that Now suppose that imported Japanese cars are a large portion of the typical imported Japanese cars are a large portion of the typical workerrsquos consumption basket workerrsquos consumption basket and that and that ceteris paribus ceteris paribus the price the price of Japanese cars rises sharply This means that the of Japanese cars rises sharply This means that the real wage real wage from the point of view of the from the point of view of the consumer falls to (consumer falls to (wpwpCPICPI ) )11 at point at point

B B on the labor-supply curve (LS) so that the worker would on the labor-supply curve (LS) so that the worker would want to supply less labor (want to supply less labor (LL11))

bull The rise in the price of Japanese cars has no effect on the price The rise in the price of Japanese cars has no effect on the price of their products Nevertheless they see a reduction of labor of their products Nevertheless they see a reduction of labor supply at the original market clearing wage It is as if the supply at the original market clearing wage It is as if the labor-supply curve labor-supply curve has shifted to the left to has shifted to the left to LSLSrsquo which passes rsquo which passes through ((through ((wp) L1) at point C wp) L1) at point C At the original wage rate labor At the original wage rate labor demand exceeds labor supply so firms raise wages in an effort demand exceeds labor supply so firms raise wages in an effort to attract workers until they reach the new market-clearing to attract workers until they reach the new market-clearing wage at point D where they pay (wage at point D where they pay (wpwpPPIPPI ) for labor of L ) for labor of L The The

rise in the price of Japanese cars has the effect of raising the rise in the price of Japanese cars has the effect of raising the wages that firms must pay and reducing labor employedwages that firms must pay and reducing labor employed Higher wages partly compensate workers for the higher costs Higher wages partly compensate workers for the higher costs of consumption but firms can afford to pay those higher wages of consumption but firms can afford to pay those higher wages only if marginal products rise as a result of their using less only if marginal products rise as a result of their using less labor labor

bull The rise in wage rates is not enough to compensate workers The rise in wage rates is not enough to compensate workers fully so the consumption-real wage in equilibrium is (wpfully so the consumption-real wage in equilibrium is (wpCPI CPI ) )

atat point E We can think of import prices as a tax levied on point E We can think of import prices as a tax levied on consumers and of an increase in import prices as widening the consumers and of an increase in import prices as widening the tax wedge Unless the issue that we want to analyze depends on tax wedge Unless the issue that we want to analyze depends on the difference between product- and consumption-real wages the difference between product- and consumption-real wages we will treat the real wage as the same for both labor supply we will treat the real wage as the same for both labor supply and labor demandand labor demand

An Increase in the Price of Consumption GoodsAn Increase in the Price of Consumption GoodsRelative to the Price of OutputRelative to the Price of Output

ANALYZING IDEAL LABOR MARKETSANALYZING IDEAL LABOR MARKETS

bull The aggregate labor-supplylabor-demand diagram provides us The aggregate labor-supplylabor-demand diagram provides us with a powerful tool We now analyze three important with a powerful tool We now analyze three important macroeconomic issues macroeconomic issues

(1) the effect of tax cuts on employment (1) the effect of tax cuts on employment

(2) the effect of technological progress on the well-being of (2) the effect of technological progress on the well-being of workers and workers and

(3) the effect of immigration on existing workers (3) the effect of immigration on existing workers

bull Issue 1 Tax Cuts Issue 1 Tax Cuts What are the effects of a cut in marginal What are the effects of a cut in marginal income-tax rates on employment and the level of GDP in the income-tax rates on employment and the level of GDP in the economyeconomy Recall from section that a lower marginal income-Recall from section that a lower marginal income-tax rate increases labor supply at each real wage (a rightward tax rate increases labor supply at each real wage (a rightward shift of the labor-supply) shift of the labor-supply)

bull Labor-market equilibrium moves from point A to point B in Labor-market equilibrium moves from point A to point B in the lower panel of the following Notice that the amount of the lower panel of the following Notice that the amount of labor available to firms increases so that firms move labor available to firms increases so that firms move production from Arsquo to Brsquo on the labor production function in production from Arsquo to Brsquo on the labor production function in the upper panel Also notice that the real wage falls from (the upper panel Also notice that the real wage falls from (wp)1 wp)1 to (wp)2 Since the cut in taxes increases the number of to (wp)2 Since the cut in taxes increases the number of workers workers willing to work at each wage Workers care about their take-willing to work at each wage Workers care about their take-home pay ndash that is about their home pay ndash that is about their after-tax real wage after-tax real wage This is This is perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 can be greater than the old after-tax real wage (1ndashcan be greater than the old after-tax real wage (1ndashτ1τ1)(wp)1 so )(wp)1 so long as the rise in the take-home share (1 ndash τ) is long as the rise in the take-home share (1 ndash τ) is proportionately greater than the fall in the before-tax real proportionately greater than the fall in the before-tax real wage (wp)wage (wp)

bull The analysis depends on substitution effects dominating The analysis depends on substitution effects dominating income effects which they probably do in aggregate if not for income effects which they probably do in aggregate if not for every worker So the supply-siders of the Reagan years are every worker So the supply-siders of the Reagan years are correct in principle How much output will increase depends on correct in principle How much output will increase depends on how large the substitution effect is If most people work a how large the substitution effect is If most people work a standard 40-hour week the effect could be quite small and the standard 40-hour week the effect could be quite small and the increase in output might also be very small in practiceincrease in output might also be very small in practice

Issue 1 The Effect of a Cut in Marginal Tax RatesIssue 1 The Effect of a Cut in Marginal Tax Rates

Issue 2 Technological Progress and Worker WelfareIssue 2 Technological Progress and Worker Welfare

bull Is technological progress and increasing use of machinery and Is technological progress and increasing use of machinery and other capital beneficial for workersother capital beneficial for workers

bull Technological change or capital accumulation have been Technological change or capital accumulation have been known as ldquoLudditesrdquo (known as ldquoLudditesrdquo (it negatively affects the demand for it negatively affects the demand for laborlabor) To see why the Luddites are wrong ndash at least for ) To see why the Luddites are wrong ndash at least for clearing labor markets ndash recall that technological progress or clearing labor markets ndash recall that technological progress or increased capital both increased capital both shift the labor-demand curve upwardshift the labor-demand curve upward The lower panel of the following figure shows that the effect of The lower panel of the following figure shows that the effect of the increased demand for labor is to increase total employment the increased demand for labor is to increase total employment and the real wage Firms and the real wage Firms can pay a higher real wage can pay a higher real wage because because the additional capital or technological progress the additional capital or technological progress increases the increases the marginal product of labormarginal product of labor

bull The The Ludditesrsquo mistake Ludditesrsquo mistake is most easily seen in the upper panel is most easily seen in the upper panel The Luddite argument assumes that fewer workers will The Luddite argument assumes that fewer workers will produce the same total output Production starts at Arsquo using produce the same total output Production starts at Arsquo using L1 L1 workers to produce Y1 After the upward shift in the production workers to produce Y1 After the upward shift in the production function the same output could be produced using less labor function the same output could be produced using less labor ((L3) at point Arsquorsquo The L3) at point Arsquorsquo The problem is that Arsquorsquo is not an equilibrium problem is that Arsquorsquo is not an equilibrium At that point the marginal product of labor is higher than the At that point the marginal product of labor is higher than the original real wage so a profit-maximizing firm would want to original real wage so a profit-maximizing firm would want to expand production To do this they must hire more labor than expand production To do this they must hire more labor than L3 and indeed they L3 and indeed they find it find it profitable profitable to hire more labor than to hire more labor than the original the original L1 The only way actually to increase labor L1 The only way actually to increase labor is to is to raise the real-wage raise the real-wage rate above its original level Technological rate above its original level Technological progress therefore favors progress therefore favors workers by increasing employment workers by increasing employment and wagesand wages

bull Early in the 19th century hand-woven cloth was very Early in the 19th century hand-woven cloth was very expensive and a worker was lucky to own the clothes on his expensive and a worker was lucky to own the clothes on his back and a spare set for church on Sunday Textiles were one of back and a spare set for church on Sunday Textiles were one of the first industries to benefit from the Industrial Revolution so the first industries to benefit from the Industrial Revolution so that by the end of the 19th century machine-made fabrics and that by the end of the 19th century machine-made fabrics and mass-production made decent clothing in larger quantities mass-production made decent clothing in larger quantities accessible to most of the population of the more developed accessible to most of the population of the more developed countries Similar progress has been made in most forms of countries Similar progress has been made in most forms of production Agricultural production which at the turn of the production Agricultural production which at the turn of the 20th century absorbed half the labor force now absorbs less 20th century absorbed half the labor force now absorbs less than 3 percent while producing more food more cheaply than than 3 percent while producing more food more cheaply than ever ever

bull We must be careful not to dismiss the Luddites as altogether We must be careful not to dismiss the Luddites as altogether foolish While new technology especially over decades has foolish While new technology especially over decades has proved to be a net gain for workers in general the Luddites proved to be a net gain for workers in general the Luddites were in fact correct that their way of life was threatened were in fact correct that their way of life was threatened Independent weavers became factory hands unskilled Independent weavers became factory hands unskilled workers increasingly women and often children replaced workers increasingly women and often children replaced skilled craftsmen and factory work often involved long hours skilled craftsmen and factory work often involved long hours in brutal conditions The wider society reaps the benefits of in brutal conditions The wider society reaps the benefits of technological change while a narrow group sometimes technological change while a narrow group sometimes disproportionately bears its costs Our analysis also assumes disproportionately bears its costs Our analysis also assumes that markets generally clear The implicit assumption is that that markets generally clear The implicit assumption is that displaced workers move on to new jobs possibly in other forms displaced workers move on to new jobs possibly in other forms of production Markets may have a tendency to clear in the of production Markets may have a tendency to clear in the long run yet workers may find themselves displaced in the long run yet workers may find themselves displaced in the short run say over the course of a business cycleshort run say over the course of a business cycle

Issue 3 Immigration Jobs and Real WagesIssue 3 Immigration Jobs and Real Wages

bull How does an increase in the labor force through immigration or How does an increase in the labor force through immigration or natural population growth affect labor and GDP natural population growth affect labor and GDP

bull One of the emotional issues associated with US immigration One of the emotional issues associated with US immigration policy ndash particularly towards low-wage workers from Mexico ndash policy ndash particularly towards low-wage workers from Mexico ndash is the idea that is the idea that immigrants take jobs away from native immigrants take jobs away from native workers workers We might be tempted to dismiss this fear as another We might be tempted to dismiss this fear as another example of the lump-of-labor fallacy Yet there is a sensible example of the lump-of-labor fallacy Yet there is a sensible intuition behind the argument An increase in the labor force ndash intuition behind the argument An increase in the labor force ndash due either to immigration or to higher population growth rates due either to immigration or to higher population growth rates ndash can be represented as an outward shift of the aggregate labor ndash can be represented as an outward shift of the aggregate labor supply curve as shown in the following Figure Employment supply curve as shown in the following Figure Employment increases but real wages fall It is not then that immigrants increases but real wages fall It is not then that immigrants take jobs away from natives take jobs away from natives Rather they compete for jobsRather they compete for jobs putting downward pressure on real wagesputting downward pressure on real wages

bull Again we must exercise care in interpreting the analysis Again we must exercise care in interpreting the analysis Remember that aggregate labor and average wage rates hide Remember that aggregate labor and average wage rates hide many details of the labor process The incomes of the new many details of the labor process The incomes of the new immigrants immigrants creates demand creates demand for the new production that they for the new production that they make possible Immigrant workers (at least those ndash whether make possible Immigrant workers (at least those ndash whether legal or illegal ndash who have become the focus of the most intense legal or illegal ndash who have become the focus of the most intense political debate) political debate) are likely to possess fewer skills than nativesare likely to possess fewer skills than natives The net effect is that the increased demand for goods and The net effect is that the increased demand for goods and services generated by immigrants is likely to increase the services generated by immigrants is likely to increase the demand for skilled (demand for skilled (and largely nativeand largely native) workers relative to ) workers relative to their supply and so to increase real wages of skilled workers their supply and so to increase real wages of skilled workers Low-skilled immigration may lower the real wage for farm Low-skilled immigration may lower the real wage for farm workers but if anything it would raise the real wage for workers but if anything it would raise the real wage for computer programmerscomputer programmers

Next Task Labor Market in Kuwait

Appendix Is Labor Supply Stable Over Time

bull Statistics on participation rates or average hours for a Statistics on participation rates or average hours for a particular month or year are snapshot of the labor market particular month or year are snapshot of the labor market Can we analyze the effects of that increase on the labor market Can we analyze the effects of that increase on the labor market under the assumption that the labor-supply curves of workers under the assumption that the labor-supply curves of workers remain essentially stableremain essentially stable

bull Data on participation rates in the United States appear to Data on participation rates in the United States appear to support this conjecture (see Figure 811) which shows the support this conjecture (see Figure 811) which shows the overall civilian participation rate trending upward ndash at least overall civilian participation rate trending upward ndash at least from the middle of the 1960sfrom the middle of the 1960s

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

bull A curve like the one in this figure can be used to display either A curve like the one in this figure can be used to display either the the participation participation decision or decision or the hoursthe hours The horizontal axis can The horizontal axis can either be used for workers either be used for workers or worker-hoursor worker-hours as measures of the as measures of the labor supply The two meanings are not completely labor supply The two meanings are not completely independent by definition independent by definition

bull workers equiv aggregate worker ndash hours average hours per worker workers equiv aggregate worker ndash hours average hours per worker

The Participation Rate and Average Hours

bull Let us look first at the aggregate participation decision The Let us look first at the aggregate participation decision The aggregate number of workers who have decided to participate aggregate number of workers who have decided to participate is known as the is known as the labor forcelabor force the the civilian labor force over 16 civilian labor force over 16 years of ageyears of age This number excludes uniformed members of the This number excludes uniformed members of the armed services and the small number of workers under 16 armed services and the small number of workers under 16 years old The labor force of course has grown right along years old The labor force of course has grown right along with population with population

bull The participation rateThe participation rate (PR) measures (PR) measures the labor force as its ratio the labor force as its ratio to the relevant populationto the relevant population

bull participation rate = labor forcerelevant population participation rate = labor forcerelevant population

bull ldquoldquonon-institutionalrdquo non-institutionalrdquo excludes people in prison or in homes for excludes people in prison or in homes for the aged) the aged)

bull The aggregate number of hours The aggregate number of hours worked is worked is not as easy not as easy as the as the participation rate to relate to the individual workerrsquos choices participation rate to relate to the individual workerrsquos choices If every worker had the same labor-supply curve we would If every worker had the same labor-supply curve we would have to know the wage offered to each one in order to calculate have to know the wage offered to each one in order to calculate the total number of labor hours supplied In reality workers the total number of labor hours supplied In reality workers are not all alike are not all alike Labor-supply curves may vary systematically Labor-supply curves may vary systematically according to the sex age ethnic group education experience according to the sex age ethnic group education experience or other social or economic characteristics of the workersor other social or economic characteristics of the workers And And within any group the labor-supply curves of individuals are within any group the labor-supply curves of individuals are likely to varylikely to vary

bull In principle In principle if we had a good statistical estimate of the typical if we had a good statistical estimate of the typical distribution of the wagesdistribution of the wages we could make a reasonable we could make a reasonable calculation But statisticians at the Bureau of Labor Statistics calculation But statisticians at the Bureau of Labor Statistics (BLS) do not try to calculate the labor supply in this way (BLS) do not try to calculate the labor supply in this way Instead they Instead they count the number of hours that workers actually count the number of hours that workers actually workwork and the average and the average wages and salaries they are paid wages and salaries they are paid

bull In USA the total hours of labor in 1998 was In USA the total hours of labor in 1998 was 236882236882 million million The average hours of work is The average hours of work is 17211721 hours per year = hours per year = 344344 hours hours per week (assuming a 50 week year) This number is 14 percent per week (assuming a 50 week year) This number is 14 percent below the full time 40-hour week which makes sense since it below the full time 40-hour week which makes sense since it averages over full-time part-time and overtime workers averages over full-time part-time and overtime workers

Labor Market EquilibriumLabor Market Equilibrium

bull MARKET CLEARINGMARKET CLEARING

bull When both demand and supply curves are plotted on the same When both demand and supply curves are plotted on the same diagram the crossing point defines the diagram the crossing point defines the equilibrium real-wage equilibrium real-wage rate and the rate and the equilibrium level of labor employedequilibrium level of labor employed

bull The real wage The real wage looks different looks different from the point of view of the firm from the point of view of the firm and the worker For the and the worker For the firmfirm the relevant real wage is the the relevant real wage is the product-real wage product-real wage defined as defined as the number of units of the good the number of units of the good the firm produces that the wage will purchase the firm produces that the wage will purchase ((price of price of productproduct = = w) w) For the For the workerworker the relevant real wage is the the relevant real wage is the consumption-consumption-real real wagewage defined as defined as the number of typical consumption baskets the number of typical consumption baskets that the wage will purchase that the wage will purchase ((price of price of consumption basket consumption basket = = w)w)

bull For aggregate analysis we might use the For aggregate analysis we might use the Producer Price IndexProducer Price Index or the GDP deflator to approximate the or the GDP deflator to approximate the product priceproduct price and the and the CPICPI to approximate the to approximate the consumption price consumption price

bull Suppose that the product-real wage and the consumption-real Suppose that the product-real wage and the consumption-real wage in the following figure start out with the identical value wage in the following figure start out with the identical value ((wp) at the market-clearing point Awp) at the market-clearing point A Now suppose that Now suppose that imported Japanese cars are a large portion of the typical imported Japanese cars are a large portion of the typical workerrsquos consumption basket workerrsquos consumption basket and that and that ceteris paribus ceteris paribus the price the price of Japanese cars rises sharply This means that the of Japanese cars rises sharply This means that the real wage real wage from the point of view of the from the point of view of the consumer falls to (consumer falls to (wpwpCPICPI ) )11 at point at point

B B on the labor-supply curve (LS) so that the worker would on the labor-supply curve (LS) so that the worker would want to supply less labor (want to supply less labor (LL11))

bull The rise in the price of Japanese cars has no effect on the price The rise in the price of Japanese cars has no effect on the price of their products Nevertheless they see a reduction of labor of their products Nevertheless they see a reduction of labor supply at the original market clearing wage It is as if the supply at the original market clearing wage It is as if the labor-supply curve labor-supply curve has shifted to the left to has shifted to the left to LSLSrsquo which passes rsquo which passes through ((through ((wp) L1) at point C wp) L1) at point C At the original wage rate labor At the original wage rate labor demand exceeds labor supply so firms raise wages in an effort demand exceeds labor supply so firms raise wages in an effort to attract workers until they reach the new market-clearing to attract workers until they reach the new market-clearing wage at point D where they pay (wage at point D where they pay (wpwpPPIPPI ) for labor of L ) for labor of L The The

rise in the price of Japanese cars has the effect of raising the rise in the price of Japanese cars has the effect of raising the wages that firms must pay and reducing labor employedwages that firms must pay and reducing labor employed Higher wages partly compensate workers for the higher costs Higher wages partly compensate workers for the higher costs of consumption but firms can afford to pay those higher wages of consumption but firms can afford to pay those higher wages only if marginal products rise as a result of their using less only if marginal products rise as a result of their using less labor labor

bull The rise in wage rates is not enough to compensate workers The rise in wage rates is not enough to compensate workers fully so the consumption-real wage in equilibrium is (wpfully so the consumption-real wage in equilibrium is (wpCPI CPI ) )

atat point E We can think of import prices as a tax levied on point E We can think of import prices as a tax levied on consumers and of an increase in import prices as widening the consumers and of an increase in import prices as widening the tax wedge Unless the issue that we want to analyze depends on tax wedge Unless the issue that we want to analyze depends on the difference between product- and consumption-real wages the difference between product- and consumption-real wages we will treat the real wage as the same for both labor supply we will treat the real wage as the same for both labor supply and labor demandand labor demand

An Increase in the Price of Consumption GoodsAn Increase in the Price of Consumption GoodsRelative to the Price of OutputRelative to the Price of Output

ANALYZING IDEAL LABOR MARKETSANALYZING IDEAL LABOR MARKETS

bull The aggregate labor-supplylabor-demand diagram provides us The aggregate labor-supplylabor-demand diagram provides us with a powerful tool We now analyze three important with a powerful tool We now analyze three important macroeconomic issues macroeconomic issues

(1) the effect of tax cuts on employment (1) the effect of tax cuts on employment

(2) the effect of technological progress on the well-being of (2) the effect of technological progress on the well-being of workers and workers and

(3) the effect of immigration on existing workers (3) the effect of immigration on existing workers

bull Issue 1 Tax Cuts Issue 1 Tax Cuts What are the effects of a cut in marginal What are the effects of a cut in marginal income-tax rates on employment and the level of GDP in the income-tax rates on employment and the level of GDP in the economyeconomy Recall from section that a lower marginal income-Recall from section that a lower marginal income-tax rate increases labor supply at each real wage (a rightward tax rate increases labor supply at each real wage (a rightward shift of the labor-supply) shift of the labor-supply)

bull Labor-market equilibrium moves from point A to point B in Labor-market equilibrium moves from point A to point B in the lower panel of the following Notice that the amount of the lower panel of the following Notice that the amount of labor available to firms increases so that firms move labor available to firms increases so that firms move production from Arsquo to Brsquo on the labor production function in production from Arsquo to Brsquo on the labor production function in the upper panel Also notice that the real wage falls from (the upper panel Also notice that the real wage falls from (wp)1 wp)1 to (wp)2 Since the cut in taxes increases the number of to (wp)2 Since the cut in taxes increases the number of workers workers willing to work at each wage Workers care about their take-willing to work at each wage Workers care about their take-home pay ndash that is about their home pay ndash that is about their after-tax real wage after-tax real wage This is This is perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 can be greater than the old after-tax real wage (1ndashcan be greater than the old after-tax real wage (1ndashτ1τ1)(wp)1 so )(wp)1 so long as the rise in the take-home share (1 ndash τ) is long as the rise in the take-home share (1 ndash τ) is proportionately greater than the fall in the before-tax real proportionately greater than the fall in the before-tax real wage (wp)wage (wp)

bull The analysis depends on substitution effects dominating The analysis depends on substitution effects dominating income effects which they probably do in aggregate if not for income effects which they probably do in aggregate if not for every worker So the supply-siders of the Reagan years are every worker So the supply-siders of the Reagan years are correct in principle How much output will increase depends on correct in principle How much output will increase depends on how large the substitution effect is If most people work a how large the substitution effect is If most people work a standard 40-hour week the effect could be quite small and the standard 40-hour week the effect could be quite small and the increase in output might also be very small in practiceincrease in output might also be very small in practice

Issue 1 The Effect of a Cut in Marginal Tax RatesIssue 1 The Effect of a Cut in Marginal Tax Rates

Issue 2 Technological Progress and Worker WelfareIssue 2 Technological Progress and Worker Welfare

bull Is technological progress and increasing use of machinery and Is technological progress and increasing use of machinery and other capital beneficial for workersother capital beneficial for workers

bull Technological change or capital accumulation have been Technological change or capital accumulation have been known as ldquoLudditesrdquo (known as ldquoLudditesrdquo (it negatively affects the demand for it negatively affects the demand for laborlabor) To see why the Luddites are wrong ndash at least for ) To see why the Luddites are wrong ndash at least for clearing labor markets ndash recall that technological progress or clearing labor markets ndash recall that technological progress or increased capital both increased capital both shift the labor-demand curve upwardshift the labor-demand curve upward The lower panel of the following figure shows that the effect of The lower panel of the following figure shows that the effect of the increased demand for labor is to increase total employment the increased demand for labor is to increase total employment and the real wage Firms and the real wage Firms can pay a higher real wage can pay a higher real wage because because the additional capital or technological progress the additional capital or technological progress increases the increases the marginal product of labormarginal product of labor

bull The The Ludditesrsquo mistake Ludditesrsquo mistake is most easily seen in the upper panel is most easily seen in the upper panel The Luddite argument assumes that fewer workers will The Luddite argument assumes that fewer workers will produce the same total output Production starts at Arsquo using produce the same total output Production starts at Arsquo using L1 L1 workers to produce Y1 After the upward shift in the production workers to produce Y1 After the upward shift in the production function the same output could be produced using less labor function the same output could be produced using less labor ((L3) at point Arsquorsquo The L3) at point Arsquorsquo The problem is that Arsquorsquo is not an equilibrium problem is that Arsquorsquo is not an equilibrium At that point the marginal product of labor is higher than the At that point the marginal product of labor is higher than the original real wage so a profit-maximizing firm would want to original real wage so a profit-maximizing firm would want to expand production To do this they must hire more labor than expand production To do this they must hire more labor than L3 and indeed they L3 and indeed they find it find it profitable profitable to hire more labor than to hire more labor than the original the original L1 The only way actually to increase labor L1 The only way actually to increase labor is to is to raise the real-wage raise the real-wage rate above its original level Technological rate above its original level Technological progress therefore favors progress therefore favors workers by increasing employment workers by increasing employment and wagesand wages

bull Early in the 19th century hand-woven cloth was very Early in the 19th century hand-woven cloth was very expensive and a worker was lucky to own the clothes on his expensive and a worker was lucky to own the clothes on his back and a spare set for church on Sunday Textiles were one of back and a spare set for church on Sunday Textiles were one of the first industries to benefit from the Industrial Revolution so the first industries to benefit from the Industrial Revolution so that by the end of the 19th century machine-made fabrics and that by the end of the 19th century machine-made fabrics and mass-production made decent clothing in larger quantities mass-production made decent clothing in larger quantities accessible to most of the population of the more developed accessible to most of the population of the more developed countries Similar progress has been made in most forms of countries Similar progress has been made in most forms of production Agricultural production which at the turn of the production Agricultural production which at the turn of the 20th century absorbed half the labor force now absorbs less 20th century absorbed half the labor force now absorbs less than 3 percent while producing more food more cheaply than than 3 percent while producing more food more cheaply than ever ever

bull We must be careful not to dismiss the Luddites as altogether We must be careful not to dismiss the Luddites as altogether foolish While new technology especially over decades has foolish While new technology especially over decades has proved to be a net gain for workers in general the Luddites proved to be a net gain for workers in general the Luddites were in fact correct that their way of life was threatened were in fact correct that their way of life was threatened Independent weavers became factory hands unskilled Independent weavers became factory hands unskilled workers increasingly women and often children replaced workers increasingly women and often children replaced skilled craftsmen and factory work often involved long hours skilled craftsmen and factory work often involved long hours in brutal conditions The wider society reaps the benefits of in brutal conditions The wider society reaps the benefits of technological change while a narrow group sometimes technological change while a narrow group sometimes disproportionately bears its costs Our analysis also assumes disproportionately bears its costs Our analysis also assumes that markets generally clear The implicit assumption is that that markets generally clear The implicit assumption is that displaced workers move on to new jobs possibly in other forms displaced workers move on to new jobs possibly in other forms of production Markets may have a tendency to clear in the of production Markets may have a tendency to clear in the long run yet workers may find themselves displaced in the long run yet workers may find themselves displaced in the short run say over the course of a business cycleshort run say over the course of a business cycle

Issue 3 Immigration Jobs and Real WagesIssue 3 Immigration Jobs and Real Wages

bull How does an increase in the labor force through immigration or How does an increase in the labor force through immigration or natural population growth affect labor and GDP natural population growth affect labor and GDP

bull One of the emotional issues associated with US immigration One of the emotional issues associated with US immigration policy ndash particularly towards low-wage workers from Mexico ndash policy ndash particularly towards low-wage workers from Mexico ndash is the idea that is the idea that immigrants take jobs away from native immigrants take jobs away from native workers workers We might be tempted to dismiss this fear as another We might be tempted to dismiss this fear as another example of the lump-of-labor fallacy Yet there is a sensible example of the lump-of-labor fallacy Yet there is a sensible intuition behind the argument An increase in the labor force ndash intuition behind the argument An increase in the labor force ndash due either to immigration or to higher population growth rates due either to immigration or to higher population growth rates ndash can be represented as an outward shift of the aggregate labor ndash can be represented as an outward shift of the aggregate labor supply curve as shown in the following Figure Employment supply curve as shown in the following Figure Employment increases but real wages fall It is not then that immigrants increases but real wages fall It is not then that immigrants take jobs away from natives take jobs away from natives Rather they compete for jobsRather they compete for jobs putting downward pressure on real wagesputting downward pressure on real wages

bull Again we must exercise care in interpreting the analysis Again we must exercise care in interpreting the analysis Remember that aggregate labor and average wage rates hide Remember that aggregate labor and average wage rates hide many details of the labor process The incomes of the new many details of the labor process The incomes of the new immigrants immigrants creates demand creates demand for the new production that they for the new production that they make possible Immigrant workers (at least those ndash whether make possible Immigrant workers (at least those ndash whether legal or illegal ndash who have become the focus of the most intense legal or illegal ndash who have become the focus of the most intense political debate) political debate) are likely to possess fewer skills than nativesare likely to possess fewer skills than natives The net effect is that the increased demand for goods and The net effect is that the increased demand for goods and services generated by immigrants is likely to increase the services generated by immigrants is likely to increase the demand for skilled (demand for skilled (and largely nativeand largely native) workers relative to ) workers relative to their supply and so to increase real wages of skilled workers their supply and so to increase real wages of skilled workers Low-skilled immigration may lower the real wage for farm Low-skilled immigration may lower the real wage for farm workers but if anything it would raise the real wage for workers but if anything it would raise the real wage for computer programmerscomputer programmers

Next Task Labor Market in Kuwait

Appendix Is Labor Supply Stable Over Time

bull Statistics on participation rates or average hours for a Statistics on participation rates or average hours for a particular month or year are snapshot of the labor market particular month or year are snapshot of the labor market Can we analyze the effects of that increase on the labor market Can we analyze the effects of that increase on the labor market under the assumption that the labor-supply curves of workers under the assumption that the labor-supply curves of workers remain essentially stableremain essentially stable

bull Data on participation rates in the United States appear to Data on participation rates in the United States appear to support this conjecture (see Figure 811) which shows the support this conjecture (see Figure 811) which shows the overall civilian participation rate trending upward ndash at least overall civilian participation rate trending upward ndash at least from the middle of the 1960sfrom the middle of the 1960s

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

The Participation Rate and Average Hours

bull Let us look first at the aggregate participation decision The Let us look first at the aggregate participation decision The aggregate number of workers who have decided to participate aggregate number of workers who have decided to participate is known as the is known as the labor forcelabor force the the civilian labor force over 16 civilian labor force over 16 years of ageyears of age This number excludes uniformed members of the This number excludes uniformed members of the armed services and the small number of workers under 16 armed services and the small number of workers under 16 years old The labor force of course has grown right along years old The labor force of course has grown right along with population with population

bull The participation rateThe participation rate (PR) measures (PR) measures the labor force as its ratio the labor force as its ratio to the relevant populationto the relevant population

bull participation rate = labor forcerelevant population participation rate = labor forcerelevant population

bull ldquoldquonon-institutionalrdquo non-institutionalrdquo excludes people in prison or in homes for excludes people in prison or in homes for the aged) the aged)

bull The aggregate number of hours The aggregate number of hours worked is worked is not as easy not as easy as the as the participation rate to relate to the individual workerrsquos choices participation rate to relate to the individual workerrsquos choices If every worker had the same labor-supply curve we would If every worker had the same labor-supply curve we would have to know the wage offered to each one in order to calculate have to know the wage offered to each one in order to calculate the total number of labor hours supplied In reality workers the total number of labor hours supplied In reality workers are not all alike are not all alike Labor-supply curves may vary systematically Labor-supply curves may vary systematically according to the sex age ethnic group education experience according to the sex age ethnic group education experience or other social or economic characteristics of the workersor other social or economic characteristics of the workers And And within any group the labor-supply curves of individuals are within any group the labor-supply curves of individuals are likely to varylikely to vary

bull In principle In principle if we had a good statistical estimate of the typical if we had a good statistical estimate of the typical distribution of the wagesdistribution of the wages we could make a reasonable we could make a reasonable calculation But statisticians at the Bureau of Labor Statistics calculation But statisticians at the Bureau of Labor Statistics (BLS) do not try to calculate the labor supply in this way (BLS) do not try to calculate the labor supply in this way Instead they Instead they count the number of hours that workers actually count the number of hours that workers actually workwork and the average and the average wages and salaries they are paid wages and salaries they are paid

bull In USA the total hours of labor in 1998 was In USA the total hours of labor in 1998 was 236882236882 million million The average hours of work is The average hours of work is 17211721 hours per year = hours per year = 344344 hours hours per week (assuming a 50 week year) This number is 14 percent per week (assuming a 50 week year) This number is 14 percent below the full time 40-hour week which makes sense since it below the full time 40-hour week which makes sense since it averages over full-time part-time and overtime workers averages over full-time part-time and overtime workers

Labor Market EquilibriumLabor Market Equilibrium

bull MARKET CLEARINGMARKET CLEARING

bull When both demand and supply curves are plotted on the same When both demand and supply curves are plotted on the same diagram the crossing point defines the diagram the crossing point defines the equilibrium real-wage equilibrium real-wage rate and the rate and the equilibrium level of labor employedequilibrium level of labor employed

bull The real wage The real wage looks different looks different from the point of view of the firm from the point of view of the firm and the worker For the and the worker For the firmfirm the relevant real wage is the the relevant real wage is the product-real wage product-real wage defined as defined as the number of units of the good the number of units of the good the firm produces that the wage will purchase the firm produces that the wage will purchase ((price of price of productproduct = = w) w) For the For the workerworker the relevant real wage is the the relevant real wage is the consumption-consumption-real real wagewage defined as defined as the number of typical consumption baskets the number of typical consumption baskets that the wage will purchase that the wage will purchase ((price of price of consumption basket consumption basket = = w)w)

bull For aggregate analysis we might use the For aggregate analysis we might use the Producer Price IndexProducer Price Index or the GDP deflator to approximate the or the GDP deflator to approximate the product priceproduct price and the and the CPICPI to approximate the to approximate the consumption price consumption price

bull Suppose that the product-real wage and the consumption-real Suppose that the product-real wage and the consumption-real wage in the following figure start out with the identical value wage in the following figure start out with the identical value ((wp) at the market-clearing point Awp) at the market-clearing point A Now suppose that Now suppose that imported Japanese cars are a large portion of the typical imported Japanese cars are a large portion of the typical workerrsquos consumption basket workerrsquos consumption basket and that and that ceteris paribus ceteris paribus the price the price of Japanese cars rises sharply This means that the of Japanese cars rises sharply This means that the real wage real wage from the point of view of the from the point of view of the consumer falls to (consumer falls to (wpwpCPICPI ) )11 at point at point

B B on the labor-supply curve (LS) so that the worker would on the labor-supply curve (LS) so that the worker would want to supply less labor (want to supply less labor (LL11))

bull The rise in the price of Japanese cars has no effect on the price The rise in the price of Japanese cars has no effect on the price of their products Nevertheless they see a reduction of labor of their products Nevertheless they see a reduction of labor supply at the original market clearing wage It is as if the supply at the original market clearing wage It is as if the labor-supply curve labor-supply curve has shifted to the left to has shifted to the left to LSLSrsquo which passes rsquo which passes through ((through ((wp) L1) at point C wp) L1) at point C At the original wage rate labor At the original wage rate labor demand exceeds labor supply so firms raise wages in an effort demand exceeds labor supply so firms raise wages in an effort to attract workers until they reach the new market-clearing to attract workers until they reach the new market-clearing wage at point D where they pay (wage at point D where they pay (wpwpPPIPPI ) for labor of L ) for labor of L The The

rise in the price of Japanese cars has the effect of raising the rise in the price of Japanese cars has the effect of raising the wages that firms must pay and reducing labor employedwages that firms must pay and reducing labor employed Higher wages partly compensate workers for the higher costs Higher wages partly compensate workers for the higher costs of consumption but firms can afford to pay those higher wages of consumption but firms can afford to pay those higher wages only if marginal products rise as a result of their using less only if marginal products rise as a result of their using less labor labor

bull The rise in wage rates is not enough to compensate workers The rise in wage rates is not enough to compensate workers fully so the consumption-real wage in equilibrium is (wpfully so the consumption-real wage in equilibrium is (wpCPI CPI ) )

atat point E We can think of import prices as a tax levied on point E We can think of import prices as a tax levied on consumers and of an increase in import prices as widening the consumers and of an increase in import prices as widening the tax wedge Unless the issue that we want to analyze depends on tax wedge Unless the issue that we want to analyze depends on the difference between product- and consumption-real wages the difference between product- and consumption-real wages we will treat the real wage as the same for both labor supply we will treat the real wage as the same for both labor supply and labor demandand labor demand

An Increase in the Price of Consumption GoodsAn Increase in the Price of Consumption GoodsRelative to the Price of OutputRelative to the Price of Output

ANALYZING IDEAL LABOR MARKETSANALYZING IDEAL LABOR MARKETS

bull The aggregate labor-supplylabor-demand diagram provides us The aggregate labor-supplylabor-demand diagram provides us with a powerful tool We now analyze three important with a powerful tool We now analyze three important macroeconomic issues macroeconomic issues

(1) the effect of tax cuts on employment (1) the effect of tax cuts on employment

(2) the effect of technological progress on the well-being of (2) the effect of technological progress on the well-being of workers and workers and

(3) the effect of immigration on existing workers (3) the effect of immigration on existing workers

bull Issue 1 Tax Cuts Issue 1 Tax Cuts What are the effects of a cut in marginal What are the effects of a cut in marginal income-tax rates on employment and the level of GDP in the income-tax rates on employment and the level of GDP in the economyeconomy Recall from section that a lower marginal income-Recall from section that a lower marginal income-tax rate increases labor supply at each real wage (a rightward tax rate increases labor supply at each real wage (a rightward shift of the labor-supply) shift of the labor-supply)

bull Labor-market equilibrium moves from point A to point B in Labor-market equilibrium moves from point A to point B in the lower panel of the following Notice that the amount of the lower panel of the following Notice that the amount of labor available to firms increases so that firms move labor available to firms increases so that firms move production from Arsquo to Brsquo on the labor production function in production from Arsquo to Brsquo on the labor production function in the upper panel Also notice that the real wage falls from (the upper panel Also notice that the real wage falls from (wp)1 wp)1 to (wp)2 Since the cut in taxes increases the number of to (wp)2 Since the cut in taxes increases the number of workers workers willing to work at each wage Workers care about their take-willing to work at each wage Workers care about their take-home pay ndash that is about their home pay ndash that is about their after-tax real wage after-tax real wage This is This is perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 can be greater than the old after-tax real wage (1ndashcan be greater than the old after-tax real wage (1ndashτ1τ1)(wp)1 so )(wp)1 so long as the rise in the take-home share (1 ndash τ) is long as the rise in the take-home share (1 ndash τ) is proportionately greater than the fall in the before-tax real proportionately greater than the fall in the before-tax real wage (wp)wage (wp)

bull The analysis depends on substitution effects dominating The analysis depends on substitution effects dominating income effects which they probably do in aggregate if not for income effects which they probably do in aggregate if not for every worker So the supply-siders of the Reagan years are every worker So the supply-siders of the Reagan years are correct in principle How much output will increase depends on correct in principle How much output will increase depends on how large the substitution effect is If most people work a how large the substitution effect is If most people work a standard 40-hour week the effect could be quite small and the standard 40-hour week the effect could be quite small and the increase in output might also be very small in practiceincrease in output might also be very small in practice

Issue 1 The Effect of a Cut in Marginal Tax RatesIssue 1 The Effect of a Cut in Marginal Tax Rates

Issue 2 Technological Progress and Worker WelfareIssue 2 Technological Progress and Worker Welfare

bull Is technological progress and increasing use of machinery and Is technological progress and increasing use of machinery and other capital beneficial for workersother capital beneficial for workers

bull Technological change or capital accumulation have been Technological change or capital accumulation have been known as ldquoLudditesrdquo (known as ldquoLudditesrdquo (it negatively affects the demand for it negatively affects the demand for laborlabor) To see why the Luddites are wrong ndash at least for ) To see why the Luddites are wrong ndash at least for clearing labor markets ndash recall that technological progress or clearing labor markets ndash recall that technological progress or increased capital both increased capital both shift the labor-demand curve upwardshift the labor-demand curve upward The lower panel of the following figure shows that the effect of The lower panel of the following figure shows that the effect of the increased demand for labor is to increase total employment the increased demand for labor is to increase total employment and the real wage Firms and the real wage Firms can pay a higher real wage can pay a higher real wage because because the additional capital or technological progress the additional capital or technological progress increases the increases the marginal product of labormarginal product of labor

bull The The Ludditesrsquo mistake Ludditesrsquo mistake is most easily seen in the upper panel is most easily seen in the upper panel The Luddite argument assumes that fewer workers will The Luddite argument assumes that fewer workers will produce the same total output Production starts at Arsquo using produce the same total output Production starts at Arsquo using L1 L1 workers to produce Y1 After the upward shift in the production workers to produce Y1 After the upward shift in the production function the same output could be produced using less labor function the same output could be produced using less labor ((L3) at point Arsquorsquo The L3) at point Arsquorsquo The problem is that Arsquorsquo is not an equilibrium problem is that Arsquorsquo is not an equilibrium At that point the marginal product of labor is higher than the At that point the marginal product of labor is higher than the original real wage so a profit-maximizing firm would want to original real wage so a profit-maximizing firm would want to expand production To do this they must hire more labor than expand production To do this they must hire more labor than L3 and indeed they L3 and indeed they find it find it profitable profitable to hire more labor than to hire more labor than the original the original L1 The only way actually to increase labor L1 The only way actually to increase labor is to is to raise the real-wage raise the real-wage rate above its original level Technological rate above its original level Technological progress therefore favors progress therefore favors workers by increasing employment workers by increasing employment and wagesand wages

bull Early in the 19th century hand-woven cloth was very Early in the 19th century hand-woven cloth was very expensive and a worker was lucky to own the clothes on his expensive and a worker was lucky to own the clothes on his back and a spare set for church on Sunday Textiles were one of back and a spare set for church on Sunday Textiles were one of the first industries to benefit from the Industrial Revolution so the first industries to benefit from the Industrial Revolution so that by the end of the 19th century machine-made fabrics and that by the end of the 19th century machine-made fabrics and mass-production made decent clothing in larger quantities mass-production made decent clothing in larger quantities accessible to most of the population of the more developed accessible to most of the population of the more developed countries Similar progress has been made in most forms of countries Similar progress has been made in most forms of production Agricultural production which at the turn of the production Agricultural production which at the turn of the 20th century absorbed half the labor force now absorbs less 20th century absorbed half the labor force now absorbs less than 3 percent while producing more food more cheaply than than 3 percent while producing more food more cheaply than ever ever

bull We must be careful not to dismiss the Luddites as altogether We must be careful not to dismiss the Luddites as altogether foolish While new technology especially over decades has foolish While new technology especially over decades has proved to be a net gain for workers in general the Luddites proved to be a net gain for workers in general the Luddites were in fact correct that their way of life was threatened were in fact correct that their way of life was threatened Independent weavers became factory hands unskilled Independent weavers became factory hands unskilled workers increasingly women and often children replaced workers increasingly women and often children replaced skilled craftsmen and factory work often involved long hours skilled craftsmen and factory work often involved long hours in brutal conditions The wider society reaps the benefits of in brutal conditions The wider society reaps the benefits of technological change while a narrow group sometimes technological change while a narrow group sometimes disproportionately bears its costs Our analysis also assumes disproportionately bears its costs Our analysis also assumes that markets generally clear The implicit assumption is that that markets generally clear The implicit assumption is that displaced workers move on to new jobs possibly in other forms displaced workers move on to new jobs possibly in other forms of production Markets may have a tendency to clear in the of production Markets may have a tendency to clear in the long run yet workers may find themselves displaced in the long run yet workers may find themselves displaced in the short run say over the course of a business cycleshort run say over the course of a business cycle

Issue 3 Immigration Jobs and Real WagesIssue 3 Immigration Jobs and Real Wages

bull How does an increase in the labor force through immigration or How does an increase in the labor force through immigration or natural population growth affect labor and GDP natural population growth affect labor and GDP

bull One of the emotional issues associated with US immigration One of the emotional issues associated with US immigration policy ndash particularly towards low-wage workers from Mexico ndash policy ndash particularly towards low-wage workers from Mexico ndash is the idea that is the idea that immigrants take jobs away from native immigrants take jobs away from native workers workers We might be tempted to dismiss this fear as another We might be tempted to dismiss this fear as another example of the lump-of-labor fallacy Yet there is a sensible example of the lump-of-labor fallacy Yet there is a sensible intuition behind the argument An increase in the labor force ndash intuition behind the argument An increase in the labor force ndash due either to immigration or to higher population growth rates due either to immigration or to higher population growth rates ndash can be represented as an outward shift of the aggregate labor ndash can be represented as an outward shift of the aggregate labor supply curve as shown in the following Figure Employment supply curve as shown in the following Figure Employment increases but real wages fall It is not then that immigrants increases but real wages fall It is not then that immigrants take jobs away from natives take jobs away from natives Rather they compete for jobsRather they compete for jobs putting downward pressure on real wagesputting downward pressure on real wages

bull Again we must exercise care in interpreting the analysis Again we must exercise care in interpreting the analysis Remember that aggregate labor and average wage rates hide Remember that aggregate labor and average wage rates hide many details of the labor process The incomes of the new many details of the labor process The incomes of the new immigrants immigrants creates demand creates demand for the new production that they for the new production that they make possible Immigrant workers (at least those ndash whether make possible Immigrant workers (at least those ndash whether legal or illegal ndash who have become the focus of the most intense legal or illegal ndash who have become the focus of the most intense political debate) political debate) are likely to possess fewer skills than nativesare likely to possess fewer skills than natives The net effect is that the increased demand for goods and The net effect is that the increased demand for goods and services generated by immigrants is likely to increase the services generated by immigrants is likely to increase the demand for skilled (demand for skilled (and largely nativeand largely native) workers relative to ) workers relative to their supply and so to increase real wages of skilled workers their supply and so to increase real wages of skilled workers Low-skilled immigration may lower the real wage for farm Low-skilled immigration may lower the real wage for farm workers but if anything it would raise the real wage for workers but if anything it would raise the real wage for computer programmerscomputer programmers

Next Task Labor Market in Kuwait

Appendix Is Labor Supply Stable Over Time

bull Statistics on participation rates or average hours for a Statistics on participation rates or average hours for a particular month or year are snapshot of the labor market particular month or year are snapshot of the labor market Can we analyze the effects of that increase on the labor market Can we analyze the effects of that increase on the labor market under the assumption that the labor-supply curves of workers under the assumption that the labor-supply curves of workers remain essentially stableremain essentially stable

bull Data on participation rates in the United States appear to Data on participation rates in the United States appear to support this conjecture (see Figure 811) which shows the support this conjecture (see Figure 811) which shows the overall civilian participation rate trending upward ndash at least overall civilian participation rate trending upward ndash at least from the middle of the 1960sfrom the middle of the 1960s

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

bull The aggregate number of hours The aggregate number of hours worked is worked is not as easy not as easy as the as the participation rate to relate to the individual workerrsquos choices participation rate to relate to the individual workerrsquos choices If every worker had the same labor-supply curve we would If every worker had the same labor-supply curve we would have to know the wage offered to each one in order to calculate have to know the wage offered to each one in order to calculate the total number of labor hours supplied In reality workers the total number of labor hours supplied In reality workers are not all alike are not all alike Labor-supply curves may vary systematically Labor-supply curves may vary systematically according to the sex age ethnic group education experience according to the sex age ethnic group education experience or other social or economic characteristics of the workersor other social or economic characteristics of the workers And And within any group the labor-supply curves of individuals are within any group the labor-supply curves of individuals are likely to varylikely to vary

bull In principle In principle if we had a good statistical estimate of the typical if we had a good statistical estimate of the typical distribution of the wagesdistribution of the wages we could make a reasonable we could make a reasonable calculation But statisticians at the Bureau of Labor Statistics calculation But statisticians at the Bureau of Labor Statistics (BLS) do not try to calculate the labor supply in this way (BLS) do not try to calculate the labor supply in this way Instead they Instead they count the number of hours that workers actually count the number of hours that workers actually workwork and the average and the average wages and salaries they are paid wages and salaries they are paid

bull In USA the total hours of labor in 1998 was In USA the total hours of labor in 1998 was 236882236882 million million The average hours of work is The average hours of work is 17211721 hours per year = hours per year = 344344 hours hours per week (assuming a 50 week year) This number is 14 percent per week (assuming a 50 week year) This number is 14 percent below the full time 40-hour week which makes sense since it below the full time 40-hour week which makes sense since it averages over full-time part-time and overtime workers averages over full-time part-time and overtime workers

Labor Market EquilibriumLabor Market Equilibrium

bull MARKET CLEARINGMARKET CLEARING

bull When both demand and supply curves are plotted on the same When both demand and supply curves are plotted on the same diagram the crossing point defines the diagram the crossing point defines the equilibrium real-wage equilibrium real-wage rate and the rate and the equilibrium level of labor employedequilibrium level of labor employed

bull The real wage The real wage looks different looks different from the point of view of the firm from the point of view of the firm and the worker For the and the worker For the firmfirm the relevant real wage is the the relevant real wage is the product-real wage product-real wage defined as defined as the number of units of the good the number of units of the good the firm produces that the wage will purchase the firm produces that the wage will purchase ((price of price of productproduct = = w) w) For the For the workerworker the relevant real wage is the the relevant real wage is the consumption-consumption-real real wagewage defined as defined as the number of typical consumption baskets the number of typical consumption baskets that the wage will purchase that the wage will purchase ((price of price of consumption basket consumption basket = = w)w)

bull For aggregate analysis we might use the For aggregate analysis we might use the Producer Price IndexProducer Price Index or the GDP deflator to approximate the or the GDP deflator to approximate the product priceproduct price and the and the CPICPI to approximate the to approximate the consumption price consumption price

bull Suppose that the product-real wage and the consumption-real Suppose that the product-real wage and the consumption-real wage in the following figure start out with the identical value wage in the following figure start out with the identical value ((wp) at the market-clearing point Awp) at the market-clearing point A Now suppose that Now suppose that imported Japanese cars are a large portion of the typical imported Japanese cars are a large portion of the typical workerrsquos consumption basket workerrsquos consumption basket and that and that ceteris paribus ceteris paribus the price the price of Japanese cars rises sharply This means that the of Japanese cars rises sharply This means that the real wage real wage from the point of view of the from the point of view of the consumer falls to (consumer falls to (wpwpCPICPI ) )11 at point at point

B B on the labor-supply curve (LS) so that the worker would on the labor-supply curve (LS) so that the worker would want to supply less labor (want to supply less labor (LL11))

bull The rise in the price of Japanese cars has no effect on the price The rise in the price of Japanese cars has no effect on the price of their products Nevertheless they see a reduction of labor of their products Nevertheless they see a reduction of labor supply at the original market clearing wage It is as if the supply at the original market clearing wage It is as if the labor-supply curve labor-supply curve has shifted to the left to has shifted to the left to LSLSrsquo which passes rsquo which passes through ((through ((wp) L1) at point C wp) L1) at point C At the original wage rate labor At the original wage rate labor demand exceeds labor supply so firms raise wages in an effort demand exceeds labor supply so firms raise wages in an effort to attract workers until they reach the new market-clearing to attract workers until they reach the new market-clearing wage at point D where they pay (wage at point D where they pay (wpwpPPIPPI ) for labor of L ) for labor of L The The

rise in the price of Japanese cars has the effect of raising the rise in the price of Japanese cars has the effect of raising the wages that firms must pay and reducing labor employedwages that firms must pay and reducing labor employed Higher wages partly compensate workers for the higher costs Higher wages partly compensate workers for the higher costs of consumption but firms can afford to pay those higher wages of consumption but firms can afford to pay those higher wages only if marginal products rise as a result of their using less only if marginal products rise as a result of their using less labor labor

bull The rise in wage rates is not enough to compensate workers The rise in wage rates is not enough to compensate workers fully so the consumption-real wage in equilibrium is (wpfully so the consumption-real wage in equilibrium is (wpCPI CPI ) )

atat point E We can think of import prices as a tax levied on point E We can think of import prices as a tax levied on consumers and of an increase in import prices as widening the consumers and of an increase in import prices as widening the tax wedge Unless the issue that we want to analyze depends on tax wedge Unless the issue that we want to analyze depends on the difference between product- and consumption-real wages the difference between product- and consumption-real wages we will treat the real wage as the same for both labor supply we will treat the real wage as the same for both labor supply and labor demandand labor demand

An Increase in the Price of Consumption GoodsAn Increase in the Price of Consumption GoodsRelative to the Price of OutputRelative to the Price of Output

ANALYZING IDEAL LABOR MARKETSANALYZING IDEAL LABOR MARKETS

bull The aggregate labor-supplylabor-demand diagram provides us The aggregate labor-supplylabor-demand diagram provides us with a powerful tool We now analyze three important with a powerful tool We now analyze three important macroeconomic issues macroeconomic issues

(1) the effect of tax cuts on employment (1) the effect of tax cuts on employment

(2) the effect of technological progress on the well-being of (2) the effect of technological progress on the well-being of workers and workers and

(3) the effect of immigration on existing workers (3) the effect of immigration on existing workers

bull Issue 1 Tax Cuts Issue 1 Tax Cuts What are the effects of a cut in marginal What are the effects of a cut in marginal income-tax rates on employment and the level of GDP in the income-tax rates on employment and the level of GDP in the economyeconomy Recall from section that a lower marginal income-Recall from section that a lower marginal income-tax rate increases labor supply at each real wage (a rightward tax rate increases labor supply at each real wage (a rightward shift of the labor-supply) shift of the labor-supply)

bull Labor-market equilibrium moves from point A to point B in Labor-market equilibrium moves from point A to point B in the lower panel of the following Notice that the amount of the lower panel of the following Notice that the amount of labor available to firms increases so that firms move labor available to firms increases so that firms move production from Arsquo to Brsquo on the labor production function in production from Arsquo to Brsquo on the labor production function in the upper panel Also notice that the real wage falls from (the upper panel Also notice that the real wage falls from (wp)1 wp)1 to (wp)2 Since the cut in taxes increases the number of to (wp)2 Since the cut in taxes increases the number of workers workers willing to work at each wage Workers care about their take-willing to work at each wage Workers care about their take-home pay ndash that is about their home pay ndash that is about their after-tax real wage after-tax real wage This is This is perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 can be greater than the old after-tax real wage (1ndashcan be greater than the old after-tax real wage (1ndashτ1τ1)(wp)1 so )(wp)1 so long as the rise in the take-home share (1 ndash τ) is long as the rise in the take-home share (1 ndash τ) is proportionately greater than the fall in the before-tax real proportionately greater than the fall in the before-tax real wage (wp)wage (wp)

bull The analysis depends on substitution effects dominating The analysis depends on substitution effects dominating income effects which they probably do in aggregate if not for income effects which they probably do in aggregate if not for every worker So the supply-siders of the Reagan years are every worker So the supply-siders of the Reagan years are correct in principle How much output will increase depends on correct in principle How much output will increase depends on how large the substitution effect is If most people work a how large the substitution effect is If most people work a standard 40-hour week the effect could be quite small and the standard 40-hour week the effect could be quite small and the increase in output might also be very small in practiceincrease in output might also be very small in practice

Issue 1 The Effect of a Cut in Marginal Tax RatesIssue 1 The Effect of a Cut in Marginal Tax Rates

Issue 2 Technological Progress and Worker WelfareIssue 2 Technological Progress and Worker Welfare

bull Is technological progress and increasing use of machinery and Is technological progress and increasing use of machinery and other capital beneficial for workersother capital beneficial for workers

bull Technological change or capital accumulation have been Technological change or capital accumulation have been known as ldquoLudditesrdquo (known as ldquoLudditesrdquo (it negatively affects the demand for it negatively affects the demand for laborlabor) To see why the Luddites are wrong ndash at least for ) To see why the Luddites are wrong ndash at least for clearing labor markets ndash recall that technological progress or clearing labor markets ndash recall that technological progress or increased capital both increased capital both shift the labor-demand curve upwardshift the labor-demand curve upward The lower panel of the following figure shows that the effect of The lower panel of the following figure shows that the effect of the increased demand for labor is to increase total employment the increased demand for labor is to increase total employment and the real wage Firms and the real wage Firms can pay a higher real wage can pay a higher real wage because because the additional capital or technological progress the additional capital or technological progress increases the increases the marginal product of labormarginal product of labor

bull The The Ludditesrsquo mistake Ludditesrsquo mistake is most easily seen in the upper panel is most easily seen in the upper panel The Luddite argument assumes that fewer workers will The Luddite argument assumes that fewer workers will produce the same total output Production starts at Arsquo using produce the same total output Production starts at Arsquo using L1 L1 workers to produce Y1 After the upward shift in the production workers to produce Y1 After the upward shift in the production function the same output could be produced using less labor function the same output could be produced using less labor ((L3) at point Arsquorsquo The L3) at point Arsquorsquo The problem is that Arsquorsquo is not an equilibrium problem is that Arsquorsquo is not an equilibrium At that point the marginal product of labor is higher than the At that point the marginal product of labor is higher than the original real wage so a profit-maximizing firm would want to original real wage so a profit-maximizing firm would want to expand production To do this they must hire more labor than expand production To do this they must hire more labor than L3 and indeed they L3 and indeed they find it find it profitable profitable to hire more labor than to hire more labor than the original the original L1 The only way actually to increase labor L1 The only way actually to increase labor is to is to raise the real-wage raise the real-wage rate above its original level Technological rate above its original level Technological progress therefore favors progress therefore favors workers by increasing employment workers by increasing employment and wagesand wages

bull Early in the 19th century hand-woven cloth was very Early in the 19th century hand-woven cloth was very expensive and a worker was lucky to own the clothes on his expensive and a worker was lucky to own the clothes on his back and a spare set for church on Sunday Textiles were one of back and a spare set for church on Sunday Textiles were one of the first industries to benefit from the Industrial Revolution so the first industries to benefit from the Industrial Revolution so that by the end of the 19th century machine-made fabrics and that by the end of the 19th century machine-made fabrics and mass-production made decent clothing in larger quantities mass-production made decent clothing in larger quantities accessible to most of the population of the more developed accessible to most of the population of the more developed countries Similar progress has been made in most forms of countries Similar progress has been made in most forms of production Agricultural production which at the turn of the production Agricultural production which at the turn of the 20th century absorbed half the labor force now absorbs less 20th century absorbed half the labor force now absorbs less than 3 percent while producing more food more cheaply than than 3 percent while producing more food more cheaply than ever ever

bull We must be careful not to dismiss the Luddites as altogether We must be careful not to dismiss the Luddites as altogether foolish While new technology especially over decades has foolish While new technology especially over decades has proved to be a net gain for workers in general the Luddites proved to be a net gain for workers in general the Luddites were in fact correct that their way of life was threatened were in fact correct that their way of life was threatened Independent weavers became factory hands unskilled Independent weavers became factory hands unskilled workers increasingly women and often children replaced workers increasingly women and often children replaced skilled craftsmen and factory work often involved long hours skilled craftsmen and factory work often involved long hours in brutal conditions The wider society reaps the benefits of in brutal conditions The wider society reaps the benefits of technological change while a narrow group sometimes technological change while a narrow group sometimes disproportionately bears its costs Our analysis also assumes disproportionately bears its costs Our analysis also assumes that markets generally clear The implicit assumption is that that markets generally clear The implicit assumption is that displaced workers move on to new jobs possibly in other forms displaced workers move on to new jobs possibly in other forms of production Markets may have a tendency to clear in the of production Markets may have a tendency to clear in the long run yet workers may find themselves displaced in the long run yet workers may find themselves displaced in the short run say over the course of a business cycleshort run say over the course of a business cycle

Issue 3 Immigration Jobs and Real WagesIssue 3 Immigration Jobs and Real Wages

bull How does an increase in the labor force through immigration or How does an increase in the labor force through immigration or natural population growth affect labor and GDP natural population growth affect labor and GDP

bull One of the emotional issues associated with US immigration One of the emotional issues associated with US immigration policy ndash particularly towards low-wage workers from Mexico ndash policy ndash particularly towards low-wage workers from Mexico ndash is the idea that is the idea that immigrants take jobs away from native immigrants take jobs away from native workers workers We might be tempted to dismiss this fear as another We might be tempted to dismiss this fear as another example of the lump-of-labor fallacy Yet there is a sensible example of the lump-of-labor fallacy Yet there is a sensible intuition behind the argument An increase in the labor force ndash intuition behind the argument An increase in the labor force ndash due either to immigration or to higher population growth rates due either to immigration or to higher population growth rates ndash can be represented as an outward shift of the aggregate labor ndash can be represented as an outward shift of the aggregate labor supply curve as shown in the following Figure Employment supply curve as shown in the following Figure Employment increases but real wages fall It is not then that immigrants increases but real wages fall It is not then that immigrants take jobs away from natives take jobs away from natives Rather they compete for jobsRather they compete for jobs putting downward pressure on real wagesputting downward pressure on real wages

bull Again we must exercise care in interpreting the analysis Again we must exercise care in interpreting the analysis Remember that aggregate labor and average wage rates hide Remember that aggregate labor and average wage rates hide many details of the labor process The incomes of the new many details of the labor process The incomes of the new immigrants immigrants creates demand creates demand for the new production that they for the new production that they make possible Immigrant workers (at least those ndash whether make possible Immigrant workers (at least those ndash whether legal or illegal ndash who have become the focus of the most intense legal or illegal ndash who have become the focus of the most intense political debate) political debate) are likely to possess fewer skills than nativesare likely to possess fewer skills than natives The net effect is that the increased demand for goods and The net effect is that the increased demand for goods and services generated by immigrants is likely to increase the services generated by immigrants is likely to increase the demand for skilled (demand for skilled (and largely nativeand largely native) workers relative to ) workers relative to their supply and so to increase real wages of skilled workers their supply and so to increase real wages of skilled workers Low-skilled immigration may lower the real wage for farm Low-skilled immigration may lower the real wage for farm workers but if anything it would raise the real wage for workers but if anything it would raise the real wage for computer programmerscomputer programmers

Next Task Labor Market in Kuwait

Appendix Is Labor Supply Stable Over Time

bull Statistics on participation rates or average hours for a Statistics on participation rates or average hours for a particular month or year are snapshot of the labor market particular month or year are snapshot of the labor market Can we analyze the effects of that increase on the labor market Can we analyze the effects of that increase on the labor market under the assumption that the labor-supply curves of workers under the assumption that the labor-supply curves of workers remain essentially stableremain essentially stable

bull Data on participation rates in the United States appear to Data on participation rates in the United States appear to support this conjecture (see Figure 811) which shows the support this conjecture (see Figure 811) which shows the overall civilian participation rate trending upward ndash at least overall civilian participation rate trending upward ndash at least from the middle of the 1960sfrom the middle of the 1960s

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

bull In principle In principle if we had a good statistical estimate of the typical if we had a good statistical estimate of the typical distribution of the wagesdistribution of the wages we could make a reasonable we could make a reasonable calculation But statisticians at the Bureau of Labor Statistics calculation But statisticians at the Bureau of Labor Statistics (BLS) do not try to calculate the labor supply in this way (BLS) do not try to calculate the labor supply in this way Instead they Instead they count the number of hours that workers actually count the number of hours that workers actually workwork and the average and the average wages and salaries they are paid wages and salaries they are paid

bull In USA the total hours of labor in 1998 was In USA the total hours of labor in 1998 was 236882236882 million million The average hours of work is The average hours of work is 17211721 hours per year = hours per year = 344344 hours hours per week (assuming a 50 week year) This number is 14 percent per week (assuming a 50 week year) This number is 14 percent below the full time 40-hour week which makes sense since it below the full time 40-hour week which makes sense since it averages over full-time part-time and overtime workers averages over full-time part-time and overtime workers

Labor Market EquilibriumLabor Market Equilibrium

bull MARKET CLEARINGMARKET CLEARING

bull When both demand and supply curves are plotted on the same When both demand and supply curves are plotted on the same diagram the crossing point defines the diagram the crossing point defines the equilibrium real-wage equilibrium real-wage rate and the rate and the equilibrium level of labor employedequilibrium level of labor employed

bull The real wage The real wage looks different looks different from the point of view of the firm from the point of view of the firm and the worker For the and the worker For the firmfirm the relevant real wage is the the relevant real wage is the product-real wage product-real wage defined as defined as the number of units of the good the number of units of the good the firm produces that the wage will purchase the firm produces that the wage will purchase ((price of price of productproduct = = w) w) For the For the workerworker the relevant real wage is the the relevant real wage is the consumption-consumption-real real wagewage defined as defined as the number of typical consumption baskets the number of typical consumption baskets that the wage will purchase that the wage will purchase ((price of price of consumption basket consumption basket = = w)w)

bull For aggregate analysis we might use the For aggregate analysis we might use the Producer Price IndexProducer Price Index or the GDP deflator to approximate the or the GDP deflator to approximate the product priceproduct price and the and the CPICPI to approximate the to approximate the consumption price consumption price

bull Suppose that the product-real wage and the consumption-real Suppose that the product-real wage and the consumption-real wage in the following figure start out with the identical value wage in the following figure start out with the identical value ((wp) at the market-clearing point Awp) at the market-clearing point A Now suppose that Now suppose that imported Japanese cars are a large portion of the typical imported Japanese cars are a large portion of the typical workerrsquos consumption basket workerrsquos consumption basket and that and that ceteris paribus ceteris paribus the price the price of Japanese cars rises sharply This means that the of Japanese cars rises sharply This means that the real wage real wage from the point of view of the from the point of view of the consumer falls to (consumer falls to (wpwpCPICPI ) )11 at point at point

B B on the labor-supply curve (LS) so that the worker would on the labor-supply curve (LS) so that the worker would want to supply less labor (want to supply less labor (LL11))

bull The rise in the price of Japanese cars has no effect on the price The rise in the price of Japanese cars has no effect on the price of their products Nevertheless they see a reduction of labor of their products Nevertheless they see a reduction of labor supply at the original market clearing wage It is as if the supply at the original market clearing wage It is as if the labor-supply curve labor-supply curve has shifted to the left to has shifted to the left to LSLSrsquo which passes rsquo which passes through ((through ((wp) L1) at point C wp) L1) at point C At the original wage rate labor At the original wage rate labor demand exceeds labor supply so firms raise wages in an effort demand exceeds labor supply so firms raise wages in an effort to attract workers until they reach the new market-clearing to attract workers until they reach the new market-clearing wage at point D where they pay (wage at point D where they pay (wpwpPPIPPI ) for labor of L ) for labor of L The The

rise in the price of Japanese cars has the effect of raising the rise in the price of Japanese cars has the effect of raising the wages that firms must pay and reducing labor employedwages that firms must pay and reducing labor employed Higher wages partly compensate workers for the higher costs Higher wages partly compensate workers for the higher costs of consumption but firms can afford to pay those higher wages of consumption but firms can afford to pay those higher wages only if marginal products rise as a result of their using less only if marginal products rise as a result of their using less labor labor

bull The rise in wage rates is not enough to compensate workers The rise in wage rates is not enough to compensate workers fully so the consumption-real wage in equilibrium is (wpfully so the consumption-real wage in equilibrium is (wpCPI CPI ) )

atat point E We can think of import prices as a tax levied on point E We can think of import prices as a tax levied on consumers and of an increase in import prices as widening the consumers and of an increase in import prices as widening the tax wedge Unless the issue that we want to analyze depends on tax wedge Unless the issue that we want to analyze depends on the difference between product- and consumption-real wages the difference between product- and consumption-real wages we will treat the real wage as the same for both labor supply we will treat the real wage as the same for both labor supply and labor demandand labor demand

An Increase in the Price of Consumption GoodsAn Increase in the Price of Consumption GoodsRelative to the Price of OutputRelative to the Price of Output

ANALYZING IDEAL LABOR MARKETSANALYZING IDEAL LABOR MARKETS

bull The aggregate labor-supplylabor-demand diagram provides us The aggregate labor-supplylabor-demand diagram provides us with a powerful tool We now analyze three important with a powerful tool We now analyze three important macroeconomic issues macroeconomic issues

(1) the effect of tax cuts on employment (1) the effect of tax cuts on employment

(2) the effect of technological progress on the well-being of (2) the effect of technological progress on the well-being of workers and workers and

(3) the effect of immigration on existing workers (3) the effect of immigration on existing workers

bull Issue 1 Tax Cuts Issue 1 Tax Cuts What are the effects of a cut in marginal What are the effects of a cut in marginal income-tax rates on employment and the level of GDP in the income-tax rates on employment and the level of GDP in the economyeconomy Recall from section that a lower marginal income-Recall from section that a lower marginal income-tax rate increases labor supply at each real wage (a rightward tax rate increases labor supply at each real wage (a rightward shift of the labor-supply) shift of the labor-supply)

bull Labor-market equilibrium moves from point A to point B in Labor-market equilibrium moves from point A to point B in the lower panel of the following Notice that the amount of the lower panel of the following Notice that the amount of labor available to firms increases so that firms move labor available to firms increases so that firms move production from Arsquo to Brsquo on the labor production function in production from Arsquo to Brsquo on the labor production function in the upper panel Also notice that the real wage falls from (the upper panel Also notice that the real wage falls from (wp)1 wp)1 to (wp)2 Since the cut in taxes increases the number of to (wp)2 Since the cut in taxes increases the number of workers workers willing to work at each wage Workers care about their take-willing to work at each wage Workers care about their take-home pay ndash that is about their home pay ndash that is about their after-tax real wage after-tax real wage This is This is perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 can be greater than the old after-tax real wage (1ndashcan be greater than the old after-tax real wage (1ndashτ1τ1)(wp)1 so )(wp)1 so long as the rise in the take-home share (1 ndash τ) is long as the rise in the take-home share (1 ndash τ) is proportionately greater than the fall in the before-tax real proportionately greater than the fall in the before-tax real wage (wp)wage (wp)

bull The analysis depends on substitution effects dominating The analysis depends on substitution effects dominating income effects which they probably do in aggregate if not for income effects which they probably do in aggregate if not for every worker So the supply-siders of the Reagan years are every worker So the supply-siders of the Reagan years are correct in principle How much output will increase depends on correct in principle How much output will increase depends on how large the substitution effect is If most people work a how large the substitution effect is If most people work a standard 40-hour week the effect could be quite small and the standard 40-hour week the effect could be quite small and the increase in output might also be very small in practiceincrease in output might also be very small in practice

Issue 1 The Effect of a Cut in Marginal Tax RatesIssue 1 The Effect of a Cut in Marginal Tax Rates

Issue 2 Technological Progress and Worker WelfareIssue 2 Technological Progress and Worker Welfare

bull Is technological progress and increasing use of machinery and Is technological progress and increasing use of machinery and other capital beneficial for workersother capital beneficial for workers

bull Technological change or capital accumulation have been Technological change or capital accumulation have been known as ldquoLudditesrdquo (known as ldquoLudditesrdquo (it negatively affects the demand for it negatively affects the demand for laborlabor) To see why the Luddites are wrong ndash at least for ) To see why the Luddites are wrong ndash at least for clearing labor markets ndash recall that technological progress or clearing labor markets ndash recall that technological progress or increased capital both increased capital both shift the labor-demand curve upwardshift the labor-demand curve upward The lower panel of the following figure shows that the effect of The lower panel of the following figure shows that the effect of the increased demand for labor is to increase total employment the increased demand for labor is to increase total employment and the real wage Firms and the real wage Firms can pay a higher real wage can pay a higher real wage because because the additional capital or technological progress the additional capital or technological progress increases the increases the marginal product of labormarginal product of labor

bull The The Ludditesrsquo mistake Ludditesrsquo mistake is most easily seen in the upper panel is most easily seen in the upper panel The Luddite argument assumes that fewer workers will The Luddite argument assumes that fewer workers will produce the same total output Production starts at Arsquo using produce the same total output Production starts at Arsquo using L1 L1 workers to produce Y1 After the upward shift in the production workers to produce Y1 After the upward shift in the production function the same output could be produced using less labor function the same output could be produced using less labor ((L3) at point Arsquorsquo The L3) at point Arsquorsquo The problem is that Arsquorsquo is not an equilibrium problem is that Arsquorsquo is not an equilibrium At that point the marginal product of labor is higher than the At that point the marginal product of labor is higher than the original real wage so a profit-maximizing firm would want to original real wage so a profit-maximizing firm would want to expand production To do this they must hire more labor than expand production To do this they must hire more labor than L3 and indeed they L3 and indeed they find it find it profitable profitable to hire more labor than to hire more labor than the original the original L1 The only way actually to increase labor L1 The only way actually to increase labor is to is to raise the real-wage raise the real-wage rate above its original level Technological rate above its original level Technological progress therefore favors progress therefore favors workers by increasing employment workers by increasing employment and wagesand wages

bull Early in the 19th century hand-woven cloth was very Early in the 19th century hand-woven cloth was very expensive and a worker was lucky to own the clothes on his expensive and a worker was lucky to own the clothes on his back and a spare set for church on Sunday Textiles were one of back and a spare set for church on Sunday Textiles were one of the first industries to benefit from the Industrial Revolution so the first industries to benefit from the Industrial Revolution so that by the end of the 19th century machine-made fabrics and that by the end of the 19th century machine-made fabrics and mass-production made decent clothing in larger quantities mass-production made decent clothing in larger quantities accessible to most of the population of the more developed accessible to most of the population of the more developed countries Similar progress has been made in most forms of countries Similar progress has been made in most forms of production Agricultural production which at the turn of the production Agricultural production which at the turn of the 20th century absorbed half the labor force now absorbs less 20th century absorbed half the labor force now absorbs less than 3 percent while producing more food more cheaply than than 3 percent while producing more food more cheaply than ever ever

bull We must be careful not to dismiss the Luddites as altogether We must be careful not to dismiss the Luddites as altogether foolish While new technology especially over decades has foolish While new technology especially over decades has proved to be a net gain for workers in general the Luddites proved to be a net gain for workers in general the Luddites were in fact correct that their way of life was threatened were in fact correct that their way of life was threatened Independent weavers became factory hands unskilled Independent weavers became factory hands unskilled workers increasingly women and often children replaced workers increasingly women and often children replaced skilled craftsmen and factory work often involved long hours skilled craftsmen and factory work often involved long hours in brutal conditions The wider society reaps the benefits of in brutal conditions The wider society reaps the benefits of technological change while a narrow group sometimes technological change while a narrow group sometimes disproportionately bears its costs Our analysis also assumes disproportionately bears its costs Our analysis also assumes that markets generally clear The implicit assumption is that that markets generally clear The implicit assumption is that displaced workers move on to new jobs possibly in other forms displaced workers move on to new jobs possibly in other forms of production Markets may have a tendency to clear in the of production Markets may have a tendency to clear in the long run yet workers may find themselves displaced in the long run yet workers may find themselves displaced in the short run say over the course of a business cycleshort run say over the course of a business cycle

Issue 3 Immigration Jobs and Real WagesIssue 3 Immigration Jobs and Real Wages

bull How does an increase in the labor force through immigration or How does an increase in the labor force through immigration or natural population growth affect labor and GDP natural population growth affect labor and GDP

bull One of the emotional issues associated with US immigration One of the emotional issues associated with US immigration policy ndash particularly towards low-wage workers from Mexico ndash policy ndash particularly towards low-wage workers from Mexico ndash is the idea that is the idea that immigrants take jobs away from native immigrants take jobs away from native workers workers We might be tempted to dismiss this fear as another We might be tempted to dismiss this fear as another example of the lump-of-labor fallacy Yet there is a sensible example of the lump-of-labor fallacy Yet there is a sensible intuition behind the argument An increase in the labor force ndash intuition behind the argument An increase in the labor force ndash due either to immigration or to higher population growth rates due either to immigration or to higher population growth rates ndash can be represented as an outward shift of the aggregate labor ndash can be represented as an outward shift of the aggregate labor supply curve as shown in the following Figure Employment supply curve as shown in the following Figure Employment increases but real wages fall It is not then that immigrants increases but real wages fall It is not then that immigrants take jobs away from natives take jobs away from natives Rather they compete for jobsRather they compete for jobs putting downward pressure on real wagesputting downward pressure on real wages

bull Again we must exercise care in interpreting the analysis Again we must exercise care in interpreting the analysis Remember that aggregate labor and average wage rates hide Remember that aggregate labor and average wage rates hide many details of the labor process The incomes of the new many details of the labor process The incomes of the new immigrants immigrants creates demand creates demand for the new production that they for the new production that they make possible Immigrant workers (at least those ndash whether make possible Immigrant workers (at least those ndash whether legal or illegal ndash who have become the focus of the most intense legal or illegal ndash who have become the focus of the most intense political debate) political debate) are likely to possess fewer skills than nativesare likely to possess fewer skills than natives The net effect is that the increased demand for goods and The net effect is that the increased demand for goods and services generated by immigrants is likely to increase the services generated by immigrants is likely to increase the demand for skilled (demand for skilled (and largely nativeand largely native) workers relative to ) workers relative to their supply and so to increase real wages of skilled workers their supply and so to increase real wages of skilled workers Low-skilled immigration may lower the real wage for farm Low-skilled immigration may lower the real wage for farm workers but if anything it would raise the real wage for workers but if anything it would raise the real wage for computer programmerscomputer programmers

Next Task Labor Market in Kuwait

Appendix Is Labor Supply Stable Over Time

bull Statistics on participation rates or average hours for a Statistics on participation rates or average hours for a particular month or year are snapshot of the labor market particular month or year are snapshot of the labor market Can we analyze the effects of that increase on the labor market Can we analyze the effects of that increase on the labor market under the assumption that the labor-supply curves of workers under the assumption that the labor-supply curves of workers remain essentially stableremain essentially stable

bull Data on participation rates in the United States appear to Data on participation rates in the United States appear to support this conjecture (see Figure 811) which shows the support this conjecture (see Figure 811) which shows the overall civilian participation rate trending upward ndash at least overall civilian participation rate trending upward ndash at least from the middle of the 1960sfrom the middle of the 1960s

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

Labor Market EquilibriumLabor Market Equilibrium

bull MARKET CLEARINGMARKET CLEARING

bull When both demand and supply curves are plotted on the same When both demand and supply curves are plotted on the same diagram the crossing point defines the diagram the crossing point defines the equilibrium real-wage equilibrium real-wage rate and the rate and the equilibrium level of labor employedequilibrium level of labor employed

bull The real wage The real wage looks different looks different from the point of view of the firm from the point of view of the firm and the worker For the and the worker For the firmfirm the relevant real wage is the the relevant real wage is the product-real wage product-real wage defined as defined as the number of units of the good the number of units of the good the firm produces that the wage will purchase the firm produces that the wage will purchase ((price of price of productproduct = = w) w) For the For the workerworker the relevant real wage is the the relevant real wage is the consumption-consumption-real real wagewage defined as defined as the number of typical consumption baskets the number of typical consumption baskets that the wage will purchase that the wage will purchase ((price of price of consumption basket consumption basket = = w)w)

bull For aggregate analysis we might use the For aggregate analysis we might use the Producer Price IndexProducer Price Index or the GDP deflator to approximate the or the GDP deflator to approximate the product priceproduct price and the and the CPICPI to approximate the to approximate the consumption price consumption price

bull Suppose that the product-real wage and the consumption-real Suppose that the product-real wage and the consumption-real wage in the following figure start out with the identical value wage in the following figure start out with the identical value ((wp) at the market-clearing point Awp) at the market-clearing point A Now suppose that Now suppose that imported Japanese cars are a large portion of the typical imported Japanese cars are a large portion of the typical workerrsquos consumption basket workerrsquos consumption basket and that and that ceteris paribus ceteris paribus the price the price of Japanese cars rises sharply This means that the of Japanese cars rises sharply This means that the real wage real wage from the point of view of the from the point of view of the consumer falls to (consumer falls to (wpwpCPICPI ) )11 at point at point

B B on the labor-supply curve (LS) so that the worker would on the labor-supply curve (LS) so that the worker would want to supply less labor (want to supply less labor (LL11))

bull The rise in the price of Japanese cars has no effect on the price The rise in the price of Japanese cars has no effect on the price of their products Nevertheless they see a reduction of labor of their products Nevertheless they see a reduction of labor supply at the original market clearing wage It is as if the supply at the original market clearing wage It is as if the labor-supply curve labor-supply curve has shifted to the left to has shifted to the left to LSLSrsquo which passes rsquo which passes through ((through ((wp) L1) at point C wp) L1) at point C At the original wage rate labor At the original wage rate labor demand exceeds labor supply so firms raise wages in an effort demand exceeds labor supply so firms raise wages in an effort to attract workers until they reach the new market-clearing to attract workers until they reach the new market-clearing wage at point D where they pay (wage at point D where they pay (wpwpPPIPPI ) for labor of L ) for labor of L The The

rise in the price of Japanese cars has the effect of raising the rise in the price of Japanese cars has the effect of raising the wages that firms must pay and reducing labor employedwages that firms must pay and reducing labor employed Higher wages partly compensate workers for the higher costs Higher wages partly compensate workers for the higher costs of consumption but firms can afford to pay those higher wages of consumption but firms can afford to pay those higher wages only if marginal products rise as a result of their using less only if marginal products rise as a result of their using less labor labor

bull The rise in wage rates is not enough to compensate workers The rise in wage rates is not enough to compensate workers fully so the consumption-real wage in equilibrium is (wpfully so the consumption-real wage in equilibrium is (wpCPI CPI ) )

atat point E We can think of import prices as a tax levied on point E We can think of import prices as a tax levied on consumers and of an increase in import prices as widening the consumers and of an increase in import prices as widening the tax wedge Unless the issue that we want to analyze depends on tax wedge Unless the issue that we want to analyze depends on the difference between product- and consumption-real wages the difference between product- and consumption-real wages we will treat the real wage as the same for both labor supply we will treat the real wage as the same for both labor supply and labor demandand labor demand

An Increase in the Price of Consumption GoodsAn Increase in the Price of Consumption GoodsRelative to the Price of OutputRelative to the Price of Output

ANALYZING IDEAL LABOR MARKETSANALYZING IDEAL LABOR MARKETS

bull The aggregate labor-supplylabor-demand diagram provides us The aggregate labor-supplylabor-demand diagram provides us with a powerful tool We now analyze three important with a powerful tool We now analyze three important macroeconomic issues macroeconomic issues

(1) the effect of tax cuts on employment (1) the effect of tax cuts on employment

(2) the effect of technological progress on the well-being of (2) the effect of technological progress on the well-being of workers and workers and

(3) the effect of immigration on existing workers (3) the effect of immigration on existing workers

bull Issue 1 Tax Cuts Issue 1 Tax Cuts What are the effects of a cut in marginal What are the effects of a cut in marginal income-tax rates on employment and the level of GDP in the income-tax rates on employment and the level of GDP in the economyeconomy Recall from section that a lower marginal income-Recall from section that a lower marginal income-tax rate increases labor supply at each real wage (a rightward tax rate increases labor supply at each real wage (a rightward shift of the labor-supply) shift of the labor-supply)

bull Labor-market equilibrium moves from point A to point B in Labor-market equilibrium moves from point A to point B in the lower panel of the following Notice that the amount of the lower panel of the following Notice that the amount of labor available to firms increases so that firms move labor available to firms increases so that firms move production from Arsquo to Brsquo on the labor production function in production from Arsquo to Brsquo on the labor production function in the upper panel Also notice that the real wage falls from (the upper panel Also notice that the real wage falls from (wp)1 wp)1 to (wp)2 Since the cut in taxes increases the number of to (wp)2 Since the cut in taxes increases the number of workers workers willing to work at each wage Workers care about their take-willing to work at each wage Workers care about their take-home pay ndash that is about their home pay ndash that is about their after-tax real wage after-tax real wage This is This is perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 can be greater than the old after-tax real wage (1ndashcan be greater than the old after-tax real wage (1ndashτ1τ1)(wp)1 so )(wp)1 so long as the rise in the take-home share (1 ndash τ) is long as the rise in the take-home share (1 ndash τ) is proportionately greater than the fall in the before-tax real proportionately greater than the fall in the before-tax real wage (wp)wage (wp)

bull The analysis depends on substitution effects dominating The analysis depends on substitution effects dominating income effects which they probably do in aggregate if not for income effects which they probably do in aggregate if not for every worker So the supply-siders of the Reagan years are every worker So the supply-siders of the Reagan years are correct in principle How much output will increase depends on correct in principle How much output will increase depends on how large the substitution effect is If most people work a how large the substitution effect is If most people work a standard 40-hour week the effect could be quite small and the standard 40-hour week the effect could be quite small and the increase in output might also be very small in practiceincrease in output might also be very small in practice

Issue 1 The Effect of a Cut in Marginal Tax RatesIssue 1 The Effect of a Cut in Marginal Tax Rates

Issue 2 Technological Progress and Worker WelfareIssue 2 Technological Progress and Worker Welfare

bull Is technological progress and increasing use of machinery and Is technological progress and increasing use of machinery and other capital beneficial for workersother capital beneficial for workers

bull Technological change or capital accumulation have been Technological change or capital accumulation have been known as ldquoLudditesrdquo (known as ldquoLudditesrdquo (it negatively affects the demand for it negatively affects the demand for laborlabor) To see why the Luddites are wrong ndash at least for ) To see why the Luddites are wrong ndash at least for clearing labor markets ndash recall that technological progress or clearing labor markets ndash recall that technological progress or increased capital both increased capital both shift the labor-demand curve upwardshift the labor-demand curve upward The lower panel of the following figure shows that the effect of The lower panel of the following figure shows that the effect of the increased demand for labor is to increase total employment the increased demand for labor is to increase total employment and the real wage Firms and the real wage Firms can pay a higher real wage can pay a higher real wage because because the additional capital or technological progress the additional capital or technological progress increases the increases the marginal product of labormarginal product of labor

bull The The Ludditesrsquo mistake Ludditesrsquo mistake is most easily seen in the upper panel is most easily seen in the upper panel The Luddite argument assumes that fewer workers will The Luddite argument assumes that fewer workers will produce the same total output Production starts at Arsquo using produce the same total output Production starts at Arsquo using L1 L1 workers to produce Y1 After the upward shift in the production workers to produce Y1 After the upward shift in the production function the same output could be produced using less labor function the same output could be produced using less labor ((L3) at point Arsquorsquo The L3) at point Arsquorsquo The problem is that Arsquorsquo is not an equilibrium problem is that Arsquorsquo is not an equilibrium At that point the marginal product of labor is higher than the At that point the marginal product of labor is higher than the original real wage so a profit-maximizing firm would want to original real wage so a profit-maximizing firm would want to expand production To do this they must hire more labor than expand production To do this they must hire more labor than L3 and indeed they L3 and indeed they find it find it profitable profitable to hire more labor than to hire more labor than the original the original L1 The only way actually to increase labor L1 The only way actually to increase labor is to is to raise the real-wage raise the real-wage rate above its original level Technological rate above its original level Technological progress therefore favors progress therefore favors workers by increasing employment workers by increasing employment and wagesand wages

bull Early in the 19th century hand-woven cloth was very Early in the 19th century hand-woven cloth was very expensive and a worker was lucky to own the clothes on his expensive and a worker was lucky to own the clothes on his back and a spare set for church on Sunday Textiles were one of back and a spare set for church on Sunday Textiles were one of the first industries to benefit from the Industrial Revolution so the first industries to benefit from the Industrial Revolution so that by the end of the 19th century machine-made fabrics and that by the end of the 19th century machine-made fabrics and mass-production made decent clothing in larger quantities mass-production made decent clothing in larger quantities accessible to most of the population of the more developed accessible to most of the population of the more developed countries Similar progress has been made in most forms of countries Similar progress has been made in most forms of production Agricultural production which at the turn of the production Agricultural production which at the turn of the 20th century absorbed half the labor force now absorbs less 20th century absorbed half the labor force now absorbs less than 3 percent while producing more food more cheaply than than 3 percent while producing more food more cheaply than ever ever

bull We must be careful not to dismiss the Luddites as altogether We must be careful not to dismiss the Luddites as altogether foolish While new technology especially over decades has foolish While new technology especially over decades has proved to be a net gain for workers in general the Luddites proved to be a net gain for workers in general the Luddites were in fact correct that their way of life was threatened were in fact correct that their way of life was threatened Independent weavers became factory hands unskilled Independent weavers became factory hands unskilled workers increasingly women and often children replaced workers increasingly women and often children replaced skilled craftsmen and factory work often involved long hours skilled craftsmen and factory work often involved long hours in brutal conditions The wider society reaps the benefits of in brutal conditions The wider society reaps the benefits of technological change while a narrow group sometimes technological change while a narrow group sometimes disproportionately bears its costs Our analysis also assumes disproportionately bears its costs Our analysis also assumes that markets generally clear The implicit assumption is that that markets generally clear The implicit assumption is that displaced workers move on to new jobs possibly in other forms displaced workers move on to new jobs possibly in other forms of production Markets may have a tendency to clear in the of production Markets may have a tendency to clear in the long run yet workers may find themselves displaced in the long run yet workers may find themselves displaced in the short run say over the course of a business cycleshort run say over the course of a business cycle

Issue 3 Immigration Jobs and Real WagesIssue 3 Immigration Jobs and Real Wages

bull How does an increase in the labor force through immigration or How does an increase in the labor force through immigration or natural population growth affect labor and GDP natural population growth affect labor and GDP

bull One of the emotional issues associated with US immigration One of the emotional issues associated with US immigration policy ndash particularly towards low-wage workers from Mexico ndash policy ndash particularly towards low-wage workers from Mexico ndash is the idea that is the idea that immigrants take jobs away from native immigrants take jobs away from native workers workers We might be tempted to dismiss this fear as another We might be tempted to dismiss this fear as another example of the lump-of-labor fallacy Yet there is a sensible example of the lump-of-labor fallacy Yet there is a sensible intuition behind the argument An increase in the labor force ndash intuition behind the argument An increase in the labor force ndash due either to immigration or to higher population growth rates due either to immigration or to higher population growth rates ndash can be represented as an outward shift of the aggregate labor ndash can be represented as an outward shift of the aggregate labor supply curve as shown in the following Figure Employment supply curve as shown in the following Figure Employment increases but real wages fall It is not then that immigrants increases but real wages fall It is not then that immigrants take jobs away from natives take jobs away from natives Rather they compete for jobsRather they compete for jobs putting downward pressure on real wagesputting downward pressure on real wages

bull Again we must exercise care in interpreting the analysis Again we must exercise care in interpreting the analysis Remember that aggregate labor and average wage rates hide Remember that aggregate labor and average wage rates hide many details of the labor process The incomes of the new many details of the labor process The incomes of the new immigrants immigrants creates demand creates demand for the new production that they for the new production that they make possible Immigrant workers (at least those ndash whether make possible Immigrant workers (at least those ndash whether legal or illegal ndash who have become the focus of the most intense legal or illegal ndash who have become the focus of the most intense political debate) political debate) are likely to possess fewer skills than nativesare likely to possess fewer skills than natives The net effect is that the increased demand for goods and The net effect is that the increased demand for goods and services generated by immigrants is likely to increase the services generated by immigrants is likely to increase the demand for skilled (demand for skilled (and largely nativeand largely native) workers relative to ) workers relative to their supply and so to increase real wages of skilled workers their supply and so to increase real wages of skilled workers Low-skilled immigration may lower the real wage for farm Low-skilled immigration may lower the real wage for farm workers but if anything it would raise the real wage for workers but if anything it would raise the real wage for computer programmerscomputer programmers

Next Task Labor Market in Kuwait

Appendix Is Labor Supply Stable Over Time

bull Statistics on participation rates or average hours for a Statistics on participation rates or average hours for a particular month or year are snapshot of the labor market particular month or year are snapshot of the labor market Can we analyze the effects of that increase on the labor market Can we analyze the effects of that increase on the labor market under the assumption that the labor-supply curves of workers under the assumption that the labor-supply curves of workers remain essentially stableremain essentially stable

bull Data on participation rates in the United States appear to Data on participation rates in the United States appear to support this conjecture (see Figure 811) which shows the support this conjecture (see Figure 811) which shows the overall civilian participation rate trending upward ndash at least overall civilian participation rate trending upward ndash at least from the middle of the 1960sfrom the middle of the 1960s

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

bull For aggregate analysis we might use the For aggregate analysis we might use the Producer Price IndexProducer Price Index or the GDP deflator to approximate the or the GDP deflator to approximate the product priceproduct price and the and the CPICPI to approximate the to approximate the consumption price consumption price

bull Suppose that the product-real wage and the consumption-real Suppose that the product-real wage and the consumption-real wage in the following figure start out with the identical value wage in the following figure start out with the identical value ((wp) at the market-clearing point Awp) at the market-clearing point A Now suppose that Now suppose that imported Japanese cars are a large portion of the typical imported Japanese cars are a large portion of the typical workerrsquos consumption basket workerrsquos consumption basket and that and that ceteris paribus ceteris paribus the price the price of Japanese cars rises sharply This means that the of Japanese cars rises sharply This means that the real wage real wage from the point of view of the from the point of view of the consumer falls to (consumer falls to (wpwpCPICPI ) )11 at point at point

B B on the labor-supply curve (LS) so that the worker would on the labor-supply curve (LS) so that the worker would want to supply less labor (want to supply less labor (LL11))

bull The rise in the price of Japanese cars has no effect on the price The rise in the price of Japanese cars has no effect on the price of their products Nevertheless they see a reduction of labor of their products Nevertheless they see a reduction of labor supply at the original market clearing wage It is as if the supply at the original market clearing wage It is as if the labor-supply curve labor-supply curve has shifted to the left to has shifted to the left to LSLSrsquo which passes rsquo which passes through ((through ((wp) L1) at point C wp) L1) at point C At the original wage rate labor At the original wage rate labor demand exceeds labor supply so firms raise wages in an effort demand exceeds labor supply so firms raise wages in an effort to attract workers until they reach the new market-clearing to attract workers until they reach the new market-clearing wage at point D where they pay (wage at point D where they pay (wpwpPPIPPI ) for labor of L ) for labor of L The The

rise in the price of Japanese cars has the effect of raising the rise in the price of Japanese cars has the effect of raising the wages that firms must pay and reducing labor employedwages that firms must pay and reducing labor employed Higher wages partly compensate workers for the higher costs Higher wages partly compensate workers for the higher costs of consumption but firms can afford to pay those higher wages of consumption but firms can afford to pay those higher wages only if marginal products rise as a result of their using less only if marginal products rise as a result of their using less labor labor

bull The rise in wage rates is not enough to compensate workers The rise in wage rates is not enough to compensate workers fully so the consumption-real wage in equilibrium is (wpfully so the consumption-real wage in equilibrium is (wpCPI CPI ) )

atat point E We can think of import prices as a tax levied on point E We can think of import prices as a tax levied on consumers and of an increase in import prices as widening the consumers and of an increase in import prices as widening the tax wedge Unless the issue that we want to analyze depends on tax wedge Unless the issue that we want to analyze depends on the difference between product- and consumption-real wages the difference between product- and consumption-real wages we will treat the real wage as the same for both labor supply we will treat the real wage as the same for both labor supply and labor demandand labor demand

An Increase in the Price of Consumption GoodsAn Increase in the Price of Consumption GoodsRelative to the Price of OutputRelative to the Price of Output

ANALYZING IDEAL LABOR MARKETSANALYZING IDEAL LABOR MARKETS

bull The aggregate labor-supplylabor-demand diagram provides us The aggregate labor-supplylabor-demand diagram provides us with a powerful tool We now analyze three important with a powerful tool We now analyze three important macroeconomic issues macroeconomic issues

(1) the effect of tax cuts on employment (1) the effect of tax cuts on employment

(2) the effect of technological progress on the well-being of (2) the effect of technological progress on the well-being of workers and workers and

(3) the effect of immigration on existing workers (3) the effect of immigration on existing workers

bull Issue 1 Tax Cuts Issue 1 Tax Cuts What are the effects of a cut in marginal What are the effects of a cut in marginal income-tax rates on employment and the level of GDP in the income-tax rates on employment and the level of GDP in the economyeconomy Recall from section that a lower marginal income-Recall from section that a lower marginal income-tax rate increases labor supply at each real wage (a rightward tax rate increases labor supply at each real wage (a rightward shift of the labor-supply) shift of the labor-supply)

bull Labor-market equilibrium moves from point A to point B in Labor-market equilibrium moves from point A to point B in the lower panel of the following Notice that the amount of the lower panel of the following Notice that the amount of labor available to firms increases so that firms move labor available to firms increases so that firms move production from Arsquo to Brsquo on the labor production function in production from Arsquo to Brsquo on the labor production function in the upper panel Also notice that the real wage falls from (the upper panel Also notice that the real wage falls from (wp)1 wp)1 to (wp)2 Since the cut in taxes increases the number of to (wp)2 Since the cut in taxes increases the number of workers workers willing to work at each wage Workers care about their take-willing to work at each wage Workers care about their take-home pay ndash that is about their home pay ndash that is about their after-tax real wage after-tax real wage This is This is perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 can be greater than the old after-tax real wage (1ndashcan be greater than the old after-tax real wage (1ndashτ1τ1)(wp)1 so )(wp)1 so long as the rise in the take-home share (1 ndash τ) is long as the rise in the take-home share (1 ndash τ) is proportionately greater than the fall in the before-tax real proportionately greater than the fall in the before-tax real wage (wp)wage (wp)

bull The analysis depends on substitution effects dominating The analysis depends on substitution effects dominating income effects which they probably do in aggregate if not for income effects which they probably do in aggregate if not for every worker So the supply-siders of the Reagan years are every worker So the supply-siders of the Reagan years are correct in principle How much output will increase depends on correct in principle How much output will increase depends on how large the substitution effect is If most people work a how large the substitution effect is If most people work a standard 40-hour week the effect could be quite small and the standard 40-hour week the effect could be quite small and the increase in output might also be very small in practiceincrease in output might also be very small in practice

Issue 1 The Effect of a Cut in Marginal Tax RatesIssue 1 The Effect of a Cut in Marginal Tax Rates

Issue 2 Technological Progress and Worker WelfareIssue 2 Technological Progress and Worker Welfare

bull Is technological progress and increasing use of machinery and Is technological progress and increasing use of machinery and other capital beneficial for workersother capital beneficial for workers

bull Technological change or capital accumulation have been Technological change or capital accumulation have been known as ldquoLudditesrdquo (known as ldquoLudditesrdquo (it negatively affects the demand for it negatively affects the demand for laborlabor) To see why the Luddites are wrong ndash at least for ) To see why the Luddites are wrong ndash at least for clearing labor markets ndash recall that technological progress or clearing labor markets ndash recall that technological progress or increased capital both increased capital both shift the labor-demand curve upwardshift the labor-demand curve upward The lower panel of the following figure shows that the effect of The lower panel of the following figure shows that the effect of the increased demand for labor is to increase total employment the increased demand for labor is to increase total employment and the real wage Firms and the real wage Firms can pay a higher real wage can pay a higher real wage because because the additional capital or technological progress the additional capital or technological progress increases the increases the marginal product of labormarginal product of labor

bull The The Ludditesrsquo mistake Ludditesrsquo mistake is most easily seen in the upper panel is most easily seen in the upper panel The Luddite argument assumes that fewer workers will The Luddite argument assumes that fewer workers will produce the same total output Production starts at Arsquo using produce the same total output Production starts at Arsquo using L1 L1 workers to produce Y1 After the upward shift in the production workers to produce Y1 After the upward shift in the production function the same output could be produced using less labor function the same output could be produced using less labor ((L3) at point Arsquorsquo The L3) at point Arsquorsquo The problem is that Arsquorsquo is not an equilibrium problem is that Arsquorsquo is not an equilibrium At that point the marginal product of labor is higher than the At that point the marginal product of labor is higher than the original real wage so a profit-maximizing firm would want to original real wage so a profit-maximizing firm would want to expand production To do this they must hire more labor than expand production To do this they must hire more labor than L3 and indeed they L3 and indeed they find it find it profitable profitable to hire more labor than to hire more labor than the original the original L1 The only way actually to increase labor L1 The only way actually to increase labor is to is to raise the real-wage raise the real-wage rate above its original level Technological rate above its original level Technological progress therefore favors progress therefore favors workers by increasing employment workers by increasing employment and wagesand wages

bull Early in the 19th century hand-woven cloth was very Early in the 19th century hand-woven cloth was very expensive and a worker was lucky to own the clothes on his expensive and a worker was lucky to own the clothes on his back and a spare set for church on Sunday Textiles were one of back and a spare set for church on Sunday Textiles were one of the first industries to benefit from the Industrial Revolution so the first industries to benefit from the Industrial Revolution so that by the end of the 19th century machine-made fabrics and that by the end of the 19th century machine-made fabrics and mass-production made decent clothing in larger quantities mass-production made decent clothing in larger quantities accessible to most of the population of the more developed accessible to most of the population of the more developed countries Similar progress has been made in most forms of countries Similar progress has been made in most forms of production Agricultural production which at the turn of the production Agricultural production which at the turn of the 20th century absorbed half the labor force now absorbs less 20th century absorbed half the labor force now absorbs less than 3 percent while producing more food more cheaply than than 3 percent while producing more food more cheaply than ever ever

bull We must be careful not to dismiss the Luddites as altogether We must be careful not to dismiss the Luddites as altogether foolish While new technology especially over decades has foolish While new technology especially over decades has proved to be a net gain for workers in general the Luddites proved to be a net gain for workers in general the Luddites were in fact correct that their way of life was threatened were in fact correct that their way of life was threatened Independent weavers became factory hands unskilled Independent weavers became factory hands unskilled workers increasingly women and often children replaced workers increasingly women and often children replaced skilled craftsmen and factory work often involved long hours skilled craftsmen and factory work often involved long hours in brutal conditions The wider society reaps the benefits of in brutal conditions The wider society reaps the benefits of technological change while a narrow group sometimes technological change while a narrow group sometimes disproportionately bears its costs Our analysis also assumes disproportionately bears its costs Our analysis also assumes that markets generally clear The implicit assumption is that that markets generally clear The implicit assumption is that displaced workers move on to new jobs possibly in other forms displaced workers move on to new jobs possibly in other forms of production Markets may have a tendency to clear in the of production Markets may have a tendency to clear in the long run yet workers may find themselves displaced in the long run yet workers may find themselves displaced in the short run say over the course of a business cycleshort run say over the course of a business cycle

Issue 3 Immigration Jobs and Real WagesIssue 3 Immigration Jobs and Real Wages

bull How does an increase in the labor force through immigration or How does an increase in the labor force through immigration or natural population growth affect labor and GDP natural population growth affect labor and GDP

bull One of the emotional issues associated with US immigration One of the emotional issues associated with US immigration policy ndash particularly towards low-wage workers from Mexico ndash policy ndash particularly towards low-wage workers from Mexico ndash is the idea that is the idea that immigrants take jobs away from native immigrants take jobs away from native workers workers We might be tempted to dismiss this fear as another We might be tempted to dismiss this fear as another example of the lump-of-labor fallacy Yet there is a sensible example of the lump-of-labor fallacy Yet there is a sensible intuition behind the argument An increase in the labor force ndash intuition behind the argument An increase in the labor force ndash due either to immigration or to higher population growth rates due either to immigration or to higher population growth rates ndash can be represented as an outward shift of the aggregate labor ndash can be represented as an outward shift of the aggregate labor supply curve as shown in the following Figure Employment supply curve as shown in the following Figure Employment increases but real wages fall It is not then that immigrants increases but real wages fall It is not then that immigrants take jobs away from natives take jobs away from natives Rather they compete for jobsRather they compete for jobs putting downward pressure on real wagesputting downward pressure on real wages

bull Again we must exercise care in interpreting the analysis Again we must exercise care in interpreting the analysis Remember that aggregate labor and average wage rates hide Remember that aggregate labor and average wage rates hide many details of the labor process The incomes of the new many details of the labor process The incomes of the new immigrants immigrants creates demand creates demand for the new production that they for the new production that they make possible Immigrant workers (at least those ndash whether make possible Immigrant workers (at least those ndash whether legal or illegal ndash who have become the focus of the most intense legal or illegal ndash who have become the focus of the most intense political debate) political debate) are likely to possess fewer skills than nativesare likely to possess fewer skills than natives The net effect is that the increased demand for goods and The net effect is that the increased demand for goods and services generated by immigrants is likely to increase the services generated by immigrants is likely to increase the demand for skilled (demand for skilled (and largely nativeand largely native) workers relative to ) workers relative to their supply and so to increase real wages of skilled workers their supply and so to increase real wages of skilled workers Low-skilled immigration may lower the real wage for farm Low-skilled immigration may lower the real wage for farm workers but if anything it would raise the real wage for workers but if anything it would raise the real wage for computer programmerscomputer programmers

Next Task Labor Market in Kuwait

Appendix Is Labor Supply Stable Over Time

bull Statistics on participation rates or average hours for a Statistics on participation rates or average hours for a particular month or year are snapshot of the labor market particular month or year are snapshot of the labor market Can we analyze the effects of that increase on the labor market Can we analyze the effects of that increase on the labor market under the assumption that the labor-supply curves of workers under the assumption that the labor-supply curves of workers remain essentially stableremain essentially stable

bull Data on participation rates in the United States appear to Data on participation rates in the United States appear to support this conjecture (see Figure 811) which shows the support this conjecture (see Figure 811) which shows the overall civilian participation rate trending upward ndash at least overall civilian participation rate trending upward ndash at least from the middle of the 1960sfrom the middle of the 1960s

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

bull The rise in the price of Japanese cars has no effect on the price The rise in the price of Japanese cars has no effect on the price of their products Nevertheless they see a reduction of labor of their products Nevertheless they see a reduction of labor supply at the original market clearing wage It is as if the supply at the original market clearing wage It is as if the labor-supply curve labor-supply curve has shifted to the left to has shifted to the left to LSLSrsquo which passes rsquo which passes through ((through ((wp) L1) at point C wp) L1) at point C At the original wage rate labor At the original wage rate labor demand exceeds labor supply so firms raise wages in an effort demand exceeds labor supply so firms raise wages in an effort to attract workers until they reach the new market-clearing to attract workers until they reach the new market-clearing wage at point D where they pay (wage at point D where they pay (wpwpPPIPPI ) for labor of L ) for labor of L The The

rise in the price of Japanese cars has the effect of raising the rise in the price of Japanese cars has the effect of raising the wages that firms must pay and reducing labor employedwages that firms must pay and reducing labor employed Higher wages partly compensate workers for the higher costs Higher wages partly compensate workers for the higher costs of consumption but firms can afford to pay those higher wages of consumption but firms can afford to pay those higher wages only if marginal products rise as a result of their using less only if marginal products rise as a result of their using less labor labor

bull The rise in wage rates is not enough to compensate workers The rise in wage rates is not enough to compensate workers fully so the consumption-real wage in equilibrium is (wpfully so the consumption-real wage in equilibrium is (wpCPI CPI ) )

atat point E We can think of import prices as a tax levied on point E We can think of import prices as a tax levied on consumers and of an increase in import prices as widening the consumers and of an increase in import prices as widening the tax wedge Unless the issue that we want to analyze depends on tax wedge Unless the issue that we want to analyze depends on the difference between product- and consumption-real wages the difference between product- and consumption-real wages we will treat the real wage as the same for both labor supply we will treat the real wage as the same for both labor supply and labor demandand labor demand

An Increase in the Price of Consumption GoodsAn Increase in the Price of Consumption GoodsRelative to the Price of OutputRelative to the Price of Output

ANALYZING IDEAL LABOR MARKETSANALYZING IDEAL LABOR MARKETS

bull The aggregate labor-supplylabor-demand diagram provides us The aggregate labor-supplylabor-demand diagram provides us with a powerful tool We now analyze three important with a powerful tool We now analyze three important macroeconomic issues macroeconomic issues

(1) the effect of tax cuts on employment (1) the effect of tax cuts on employment

(2) the effect of technological progress on the well-being of (2) the effect of technological progress on the well-being of workers and workers and

(3) the effect of immigration on existing workers (3) the effect of immigration on existing workers

bull Issue 1 Tax Cuts Issue 1 Tax Cuts What are the effects of a cut in marginal What are the effects of a cut in marginal income-tax rates on employment and the level of GDP in the income-tax rates on employment and the level of GDP in the economyeconomy Recall from section that a lower marginal income-Recall from section that a lower marginal income-tax rate increases labor supply at each real wage (a rightward tax rate increases labor supply at each real wage (a rightward shift of the labor-supply) shift of the labor-supply)

bull Labor-market equilibrium moves from point A to point B in Labor-market equilibrium moves from point A to point B in the lower panel of the following Notice that the amount of the lower panel of the following Notice that the amount of labor available to firms increases so that firms move labor available to firms increases so that firms move production from Arsquo to Brsquo on the labor production function in production from Arsquo to Brsquo on the labor production function in the upper panel Also notice that the real wage falls from (the upper panel Also notice that the real wage falls from (wp)1 wp)1 to (wp)2 Since the cut in taxes increases the number of to (wp)2 Since the cut in taxes increases the number of workers workers willing to work at each wage Workers care about their take-willing to work at each wage Workers care about their take-home pay ndash that is about their home pay ndash that is about their after-tax real wage after-tax real wage This is This is perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 can be greater than the old after-tax real wage (1ndashcan be greater than the old after-tax real wage (1ndashτ1τ1)(wp)1 so )(wp)1 so long as the rise in the take-home share (1 ndash τ) is long as the rise in the take-home share (1 ndash τ) is proportionately greater than the fall in the before-tax real proportionately greater than the fall in the before-tax real wage (wp)wage (wp)

bull The analysis depends on substitution effects dominating The analysis depends on substitution effects dominating income effects which they probably do in aggregate if not for income effects which they probably do in aggregate if not for every worker So the supply-siders of the Reagan years are every worker So the supply-siders of the Reagan years are correct in principle How much output will increase depends on correct in principle How much output will increase depends on how large the substitution effect is If most people work a how large the substitution effect is If most people work a standard 40-hour week the effect could be quite small and the standard 40-hour week the effect could be quite small and the increase in output might also be very small in practiceincrease in output might also be very small in practice

Issue 1 The Effect of a Cut in Marginal Tax RatesIssue 1 The Effect of a Cut in Marginal Tax Rates

Issue 2 Technological Progress and Worker WelfareIssue 2 Technological Progress and Worker Welfare

bull Is technological progress and increasing use of machinery and Is technological progress and increasing use of machinery and other capital beneficial for workersother capital beneficial for workers

bull Technological change or capital accumulation have been Technological change or capital accumulation have been known as ldquoLudditesrdquo (known as ldquoLudditesrdquo (it negatively affects the demand for it negatively affects the demand for laborlabor) To see why the Luddites are wrong ndash at least for ) To see why the Luddites are wrong ndash at least for clearing labor markets ndash recall that technological progress or clearing labor markets ndash recall that technological progress or increased capital both increased capital both shift the labor-demand curve upwardshift the labor-demand curve upward The lower panel of the following figure shows that the effect of The lower panel of the following figure shows that the effect of the increased demand for labor is to increase total employment the increased demand for labor is to increase total employment and the real wage Firms and the real wage Firms can pay a higher real wage can pay a higher real wage because because the additional capital or technological progress the additional capital or technological progress increases the increases the marginal product of labormarginal product of labor

bull The The Ludditesrsquo mistake Ludditesrsquo mistake is most easily seen in the upper panel is most easily seen in the upper panel The Luddite argument assumes that fewer workers will The Luddite argument assumes that fewer workers will produce the same total output Production starts at Arsquo using produce the same total output Production starts at Arsquo using L1 L1 workers to produce Y1 After the upward shift in the production workers to produce Y1 After the upward shift in the production function the same output could be produced using less labor function the same output could be produced using less labor ((L3) at point Arsquorsquo The L3) at point Arsquorsquo The problem is that Arsquorsquo is not an equilibrium problem is that Arsquorsquo is not an equilibrium At that point the marginal product of labor is higher than the At that point the marginal product of labor is higher than the original real wage so a profit-maximizing firm would want to original real wage so a profit-maximizing firm would want to expand production To do this they must hire more labor than expand production To do this they must hire more labor than L3 and indeed they L3 and indeed they find it find it profitable profitable to hire more labor than to hire more labor than the original the original L1 The only way actually to increase labor L1 The only way actually to increase labor is to is to raise the real-wage raise the real-wage rate above its original level Technological rate above its original level Technological progress therefore favors progress therefore favors workers by increasing employment workers by increasing employment and wagesand wages

bull Early in the 19th century hand-woven cloth was very Early in the 19th century hand-woven cloth was very expensive and a worker was lucky to own the clothes on his expensive and a worker was lucky to own the clothes on his back and a spare set for church on Sunday Textiles were one of back and a spare set for church on Sunday Textiles were one of the first industries to benefit from the Industrial Revolution so the first industries to benefit from the Industrial Revolution so that by the end of the 19th century machine-made fabrics and that by the end of the 19th century machine-made fabrics and mass-production made decent clothing in larger quantities mass-production made decent clothing in larger quantities accessible to most of the population of the more developed accessible to most of the population of the more developed countries Similar progress has been made in most forms of countries Similar progress has been made in most forms of production Agricultural production which at the turn of the production Agricultural production which at the turn of the 20th century absorbed half the labor force now absorbs less 20th century absorbed half the labor force now absorbs less than 3 percent while producing more food more cheaply than than 3 percent while producing more food more cheaply than ever ever

bull We must be careful not to dismiss the Luddites as altogether We must be careful not to dismiss the Luddites as altogether foolish While new technology especially over decades has foolish While new technology especially over decades has proved to be a net gain for workers in general the Luddites proved to be a net gain for workers in general the Luddites were in fact correct that their way of life was threatened were in fact correct that their way of life was threatened Independent weavers became factory hands unskilled Independent weavers became factory hands unskilled workers increasingly women and often children replaced workers increasingly women and often children replaced skilled craftsmen and factory work often involved long hours skilled craftsmen and factory work often involved long hours in brutal conditions The wider society reaps the benefits of in brutal conditions The wider society reaps the benefits of technological change while a narrow group sometimes technological change while a narrow group sometimes disproportionately bears its costs Our analysis also assumes disproportionately bears its costs Our analysis also assumes that markets generally clear The implicit assumption is that that markets generally clear The implicit assumption is that displaced workers move on to new jobs possibly in other forms displaced workers move on to new jobs possibly in other forms of production Markets may have a tendency to clear in the of production Markets may have a tendency to clear in the long run yet workers may find themselves displaced in the long run yet workers may find themselves displaced in the short run say over the course of a business cycleshort run say over the course of a business cycle

Issue 3 Immigration Jobs and Real WagesIssue 3 Immigration Jobs and Real Wages

bull How does an increase in the labor force through immigration or How does an increase in the labor force through immigration or natural population growth affect labor and GDP natural population growth affect labor and GDP

bull One of the emotional issues associated with US immigration One of the emotional issues associated with US immigration policy ndash particularly towards low-wage workers from Mexico ndash policy ndash particularly towards low-wage workers from Mexico ndash is the idea that is the idea that immigrants take jobs away from native immigrants take jobs away from native workers workers We might be tempted to dismiss this fear as another We might be tempted to dismiss this fear as another example of the lump-of-labor fallacy Yet there is a sensible example of the lump-of-labor fallacy Yet there is a sensible intuition behind the argument An increase in the labor force ndash intuition behind the argument An increase in the labor force ndash due either to immigration or to higher population growth rates due either to immigration or to higher population growth rates ndash can be represented as an outward shift of the aggregate labor ndash can be represented as an outward shift of the aggregate labor supply curve as shown in the following Figure Employment supply curve as shown in the following Figure Employment increases but real wages fall It is not then that immigrants increases but real wages fall It is not then that immigrants take jobs away from natives take jobs away from natives Rather they compete for jobsRather they compete for jobs putting downward pressure on real wagesputting downward pressure on real wages

bull Again we must exercise care in interpreting the analysis Again we must exercise care in interpreting the analysis Remember that aggregate labor and average wage rates hide Remember that aggregate labor and average wage rates hide many details of the labor process The incomes of the new many details of the labor process The incomes of the new immigrants immigrants creates demand creates demand for the new production that they for the new production that they make possible Immigrant workers (at least those ndash whether make possible Immigrant workers (at least those ndash whether legal or illegal ndash who have become the focus of the most intense legal or illegal ndash who have become the focus of the most intense political debate) political debate) are likely to possess fewer skills than nativesare likely to possess fewer skills than natives The net effect is that the increased demand for goods and The net effect is that the increased demand for goods and services generated by immigrants is likely to increase the services generated by immigrants is likely to increase the demand for skilled (demand for skilled (and largely nativeand largely native) workers relative to ) workers relative to their supply and so to increase real wages of skilled workers their supply and so to increase real wages of skilled workers Low-skilled immigration may lower the real wage for farm Low-skilled immigration may lower the real wage for farm workers but if anything it would raise the real wage for workers but if anything it would raise the real wage for computer programmerscomputer programmers

Next Task Labor Market in Kuwait

Appendix Is Labor Supply Stable Over Time

bull Statistics on participation rates or average hours for a Statistics on participation rates or average hours for a particular month or year are snapshot of the labor market particular month or year are snapshot of the labor market Can we analyze the effects of that increase on the labor market Can we analyze the effects of that increase on the labor market under the assumption that the labor-supply curves of workers under the assumption that the labor-supply curves of workers remain essentially stableremain essentially stable

bull Data on participation rates in the United States appear to Data on participation rates in the United States appear to support this conjecture (see Figure 811) which shows the support this conjecture (see Figure 811) which shows the overall civilian participation rate trending upward ndash at least overall civilian participation rate trending upward ndash at least from the middle of the 1960sfrom the middle of the 1960s

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

bull The rise in wage rates is not enough to compensate workers The rise in wage rates is not enough to compensate workers fully so the consumption-real wage in equilibrium is (wpfully so the consumption-real wage in equilibrium is (wpCPI CPI ) )

atat point E We can think of import prices as a tax levied on point E We can think of import prices as a tax levied on consumers and of an increase in import prices as widening the consumers and of an increase in import prices as widening the tax wedge Unless the issue that we want to analyze depends on tax wedge Unless the issue that we want to analyze depends on the difference between product- and consumption-real wages the difference between product- and consumption-real wages we will treat the real wage as the same for both labor supply we will treat the real wage as the same for both labor supply and labor demandand labor demand

An Increase in the Price of Consumption GoodsAn Increase in the Price of Consumption GoodsRelative to the Price of OutputRelative to the Price of Output

ANALYZING IDEAL LABOR MARKETSANALYZING IDEAL LABOR MARKETS

bull The aggregate labor-supplylabor-demand diagram provides us The aggregate labor-supplylabor-demand diagram provides us with a powerful tool We now analyze three important with a powerful tool We now analyze three important macroeconomic issues macroeconomic issues

(1) the effect of tax cuts on employment (1) the effect of tax cuts on employment

(2) the effect of technological progress on the well-being of (2) the effect of technological progress on the well-being of workers and workers and

(3) the effect of immigration on existing workers (3) the effect of immigration on existing workers

bull Issue 1 Tax Cuts Issue 1 Tax Cuts What are the effects of a cut in marginal What are the effects of a cut in marginal income-tax rates on employment and the level of GDP in the income-tax rates on employment and the level of GDP in the economyeconomy Recall from section that a lower marginal income-Recall from section that a lower marginal income-tax rate increases labor supply at each real wage (a rightward tax rate increases labor supply at each real wage (a rightward shift of the labor-supply) shift of the labor-supply)

bull Labor-market equilibrium moves from point A to point B in Labor-market equilibrium moves from point A to point B in the lower panel of the following Notice that the amount of the lower panel of the following Notice that the amount of labor available to firms increases so that firms move labor available to firms increases so that firms move production from Arsquo to Brsquo on the labor production function in production from Arsquo to Brsquo on the labor production function in the upper panel Also notice that the real wage falls from (the upper panel Also notice that the real wage falls from (wp)1 wp)1 to (wp)2 Since the cut in taxes increases the number of to (wp)2 Since the cut in taxes increases the number of workers workers willing to work at each wage Workers care about their take-willing to work at each wage Workers care about their take-home pay ndash that is about their home pay ndash that is about their after-tax real wage after-tax real wage This is This is perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 can be greater than the old after-tax real wage (1ndashcan be greater than the old after-tax real wage (1ndashτ1τ1)(wp)1 so )(wp)1 so long as the rise in the take-home share (1 ndash τ) is long as the rise in the take-home share (1 ndash τ) is proportionately greater than the fall in the before-tax real proportionately greater than the fall in the before-tax real wage (wp)wage (wp)

bull The analysis depends on substitution effects dominating The analysis depends on substitution effects dominating income effects which they probably do in aggregate if not for income effects which they probably do in aggregate if not for every worker So the supply-siders of the Reagan years are every worker So the supply-siders of the Reagan years are correct in principle How much output will increase depends on correct in principle How much output will increase depends on how large the substitution effect is If most people work a how large the substitution effect is If most people work a standard 40-hour week the effect could be quite small and the standard 40-hour week the effect could be quite small and the increase in output might also be very small in practiceincrease in output might also be very small in practice

Issue 1 The Effect of a Cut in Marginal Tax RatesIssue 1 The Effect of a Cut in Marginal Tax Rates

Issue 2 Technological Progress and Worker WelfareIssue 2 Technological Progress and Worker Welfare

bull Is technological progress and increasing use of machinery and Is technological progress and increasing use of machinery and other capital beneficial for workersother capital beneficial for workers

bull Technological change or capital accumulation have been Technological change or capital accumulation have been known as ldquoLudditesrdquo (known as ldquoLudditesrdquo (it negatively affects the demand for it negatively affects the demand for laborlabor) To see why the Luddites are wrong ndash at least for ) To see why the Luddites are wrong ndash at least for clearing labor markets ndash recall that technological progress or clearing labor markets ndash recall that technological progress or increased capital both increased capital both shift the labor-demand curve upwardshift the labor-demand curve upward The lower panel of the following figure shows that the effect of The lower panel of the following figure shows that the effect of the increased demand for labor is to increase total employment the increased demand for labor is to increase total employment and the real wage Firms and the real wage Firms can pay a higher real wage can pay a higher real wage because because the additional capital or technological progress the additional capital or technological progress increases the increases the marginal product of labormarginal product of labor

bull The The Ludditesrsquo mistake Ludditesrsquo mistake is most easily seen in the upper panel is most easily seen in the upper panel The Luddite argument assumes that fewer workers will The Luddite argument assumes that fewer workers will produce the same total output Production starts at Arsquo using produce the same total output Production starts at Arsquo using L1 L1 workers to produce Y1 After the upward shift in the production workers to produce Y1 After the upward shift in the production function the same output could be produced using less labor function the same output could be produced using less labor ((L3) at point Arsquorsquo The L3) at point Arsquorsquo The problem is that Arsquorsquo is not an equilibrium problem is that Arsquorsquo is not an equilibrium At that point the marginal product of labor is higher than the At that point the marginal product of labor is higher than the original real wage so a profit-maximizing firm would want to original real wage so a profit-maximizing firm would want to expand production To do this they must hire more labor than expand production To do this they must hire more labor than L3 and indeed they L3 and indeed they find it find it profitable profitable to hire more labor than to hire more labor than the original the original L1 The only way actually to increase labor L1 The only way actually to increase labor is to is to raise the real-wage raise the real-wage rate above its original level Technological rate above its original level Technological progress therefore favors progress therefore favors workers by increasing employment workers by increasing employment and wagesand wages

bull Early in the 19th century hand-woven cloth was very Early in the 19th century hand-woven cloth was very expensive and a worker was lucky to own the clothes on his expensive and a worker was lucky to own the clothes on his back and a spare set for church on Sunday Textiles were one of back and a spare set for church on Sunday Textiles were one of the first industries to benefit from the Industrial Revolution so the first industries to benefit from the Industrial Revolution so that by the end of the 19th century machine-made fabrics and that by the end of the 19th century machine-made fabrics and mass-production made decent clothing in larger quantities mass-production made decent clothing in larger quantities accessible to most of the population of the more developed accessible to most of the population of the more developed countries Similar progress has been made in most forms of countries Similar progress has been made in most forms of production Agricultural production which at the turn of the production Agricultural production which at the turn of the 20th century absorbed half the labor force now absorbs less 20th century absorbed half the labor force now absorbs less than 3 percent while producing more food more cheaply than than 3 percent while producing more food more cheaply than ever ever

bull We must be careful not to dismiss the Luddites as altogether We must be careful not to dismiss the Luddites as altogether foolish While new technology especially over decades has foolish While new technology especially over decades has proved to be a net gain for workers in general the Luddites proved to be a net gain for workers in general the Luddites were in fact correct that their way of life was threatened were in fact correct that their way of life was threatened Independent weavers became factory hands unskilled Independent weavers became factory hands unskilled workers increasingly women and often children replaced workers increasingly women and often children replaced skilled craftsmen and factory work often involved long hours skilled craftsmen and factory work often involved long hours in brutal conditions The wider society reaps the benefits of in brutal conditions The wider society reaps the benefits of technological change while a narrow group sometimes technological change while a narrow group sometimes disproportionately bears its costs Our analysis also assumes disproportionately bears its costs Our analysis also assumes that markets generally clear The implicit assumption is that that markets generally clear The implicit assumption is that displaced workers move on to new jobs possibly in other forms displaced workers move on to new jobs possibly in other forms of production Markets may have a tendency to clear in the of production Markets may have a tendency to clear in the long run yet workers may find themselves displaced in the long run yet workers may find themselves displaced in the short run say over the course of a business cycleshort run say over the course of a business cycle

Issue 3 Immigration Jobs and Real WagesIssue 3 Immigration Jobs and Real Wages

bull How does an increase in the labor force through immigration or How does an increase in the labor force through immigration or natural population growth affect labor and GDP natural population growth affect labor and GDP

bull One of the emotional issues associated with US immigration One of the emotional issues associated with US immigration policy ndash particularly towards low-wage workers from Mexico ndash policy ndash particularly towards low-wage workers from Mexico ndash is the idea that is the idea that immigrants take jobs away from native immigrants take jobs away from native workers workers We might be tempted to dismiss this fear as another We might be tempted to dismiss this fear as another example of the lump-of-labor fallacy Yet there is a sensible example of the lump-of-labor fallacy Yet there is a sensible intuition behind the argument An increase in the labor force ndash intuition behind the argument An increase in the labor force ndash due either to immigration or to higher population growth rates due either to immigration or to higher population growth rates ndash can be represented as an outward shift of the aggregate labor ndash can be represented as an outward shift of the aggregate labor supply curve as shown in the following Figure Employment supply curve as shown in the following Figure Employment increases but real wages fall It is not then that immigrants increases but real wages fall It is not then that immigrants take jobs away from natives take jobs away from natives Rather they compete for jobsRather they compete for jobs putting downward pressure on real wagesputting downward pressure on real wages

bull Again we must exercise care in interpreting the analysis Again we must exercise care in interpreting the analysis Remember that aggregate labor and average wage rates hide Remember that aggregate labor and average wage rates hide many details of the labor process The incomes of the new many details of the labor process The incomes of the new immigrants immigrants creates demand creates demand for the new production that they for the new production that they make possible Immigrant workers (at least those ndash whether make possible Immigrant workers (at least those ndash whether legal or illegal ndash who have become the focus of the most intense legal or illegal ndash who have become the focus of the most intense political debate) political debate) are likely to possess fewer skills than nativesare likely to possess fewer skills than natives The net effect is that the increased demand for goods and The net effect is that the increased demand for goods and services generated by immigrants is likely to increase the services generated by immigrants is likely to increase the demand for skilled (demand for skilled (and largely nativeand largely native) workers relative to ) workers relative to their supply and so to increase real wages of skilled workers their supply and so to increase real wages of skilled workers Low-skilled immigration may lower the real wage for farm Low-skilled immigration may lower the real wage for farm workers but if anything it would raise the real wage for workers but if anything it would raise the real wage for computer programmerscomputer programmers

Next Task Labor Market in Kuwait

Appendix Is Labor Supply Stable Over Time

bull Statistics on participation rates or average hours for a Statistics on participation rates or average hours for a particular month or year are snapshot of the labor market particular month or year are snapshot of the labor market Can we analyze the effects of that increase on the labor market Can we analyze the effects of that increase on the labor market under the assumption that the labor-supply curves of workers under the assumption that the labor-supply curves of workers remain essentially stableremain essentially stable

bull Data on participation rates in the United States appear to Data on participation rates in the United States appear to support this conjecture (see Figure 811) which shows the support this conjecture (see Figure 811) which shows the overall civilian participation rate trending upward ndash at least overall civilian participation rate trending upward ndash at least from the middle of the 1960sfrom the middle of the 1960s

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

An Increase in the Price of Consumption GoodsAn Increase in the Price of Consumption GoodsRelative to the Price of OutputRelative to the Price of Output

ANALYZING IDEAL LABOR MARKETSANALYZING IDEAL LABOR MARKETS

bull The aggregate labor-supplylabor-demand diagram provides us The aggregate labor-supplylabor-demand diagram provides us with a powerful tool We now analyze three important with a powerful tool We now analyze three important macroeconomic issues macroeconomic issues

(1) the effect of tax cuts on employment (1) the effect of tax cuts on employment

(2) the effect of technological progress on the well-being of (2) the effect of technological progress on the well-being of workers and workers and

(3) the effect of immigration on existing workers (3) the effect of immigration on existing workers

bull Issue 1 Tax Cuts Issue 1 Tax Cuts What are the effects of a cut in marginal What are the effects of a cut in marginal income-tax rates on employment and the level of GDP in the income-tax rates on employment and the level of GDP in the economyeconomy Recall from section that a lower marginal income-Recall from section that a lower marginal income-tax rate increases labor supply at each real wage (a rightward tax rate increases labor supply at each real wage (a rightward shift of the labor-supply) shift of the labor-supply)

bull Labor-market equilibrium moves from point A to point B in Labor-market equilibrium moves from point A to point B in the lower panel of the following Notice that the amount of the lower panel of the following Notice that the amount of labor available to firms increases so that firms move labor available to firms increases so that firms move production from Arsquo to Brsquo on the labor production function in production from Arsquo to Brsquo on the labor production function in the upper panel Also notice that the real wage falls from (the upper panel Also notice that the real wage falls from (wp)1 wp)1 to (wp)2 Since the cut in taxes increases the number of to (wp)2 Since the cut in taxes increases the number of workers workers willing to work at each wage Workers care about their take-willing to work at each wage Workers care about their take-home pay ndash that is about their home pay ndash that is about their after-tax real wage after-tax real wage This is This is perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 can be greater than the old after-tax real wage (1ndashcan be greater than the old after-tax real wage (1ndashτ1τ1)(wp)1 so )(wp)1 so long as the rise in the take-home share (1 ndash τ) is long as the rise in the take-home share (1 ndash τ) is proportionately greater than the fall in the before-tax real proportionately greater than the fall in the before-tax real wage (wp)wage (wp)

bull The analysis depends on substitution effects dominating The analysis depends on substitution effects dominating income effects which they probably do in aggregate if not for income effects which they probably do in aggregate if not for every worker So the supply-siders of the Reagan years are every worker So the supply-siders of the Reagan years are correct in principle How much output will increase depends on correct in principle How much output will increase depends on how large the substitution effect is If most people work a how large the substitution effect is If most people work a standard 40-hour week the effect could be quite small and the standard 40-hour week the effect could be quite small and the increase in output might also be very small in practiceincrease in output might also be very small in practice

Issue 1 The Effect of a Cut in Marginal Tax RatesIssue 1 The Effect of a Cut in Marginal Tax Rates

Issue 2 Technological Progress and Worker WelfareIssue 2 Technological Progress and Worker Welfare

bull Is technological progress and increasing use of machinery and Is technological progress and increasing use of machinery and other capital beneficial for workersother capital beneficial for workers

bull Technological change or capital accumulation have been Technological change or capital accumulation have been known as ldquoLudditesrdquo (known as ldquoLudditesrdquo (it negatively affects the demand for it negatively affects the demand for laborlabor) To see why the Luddites are wrong ndash at least for ) To see why the Luddites are wrong ndash at least for clearing labor markets ndash recall that technological progress or clearing labor markets ndash recall that technological progress or increased capital both increased capital both shift the labor-demand curve upwardshift the labor-demand curve upward The lower panel of the following figure shows that the effect of The lower panel of the following figure shows that the effect of the increased demand for labor is to increase total employment the increased demand for labor is to increase total employment and the real wage Firms and the real wage Firms can pay a higher real wage can pay a higher real wage because because the additional capital or technological progress the additional capital or technological progress increases the increases the marginal product of labormarginal product of labor

bull The The Ludditesrsquo mistake Ludditesrsquo mistake is most easily seen in the upper panel is most easily seen in the upper panel The Luddite argument assumes that fewer workers will The Luddite argument assumes that fewer workers will produce the same total output Production starts at Arsquo using produce the same total output Production starts at Arsquo using L1 L1 workers to produce Y1 After the upward shift in the production workers to produce Y1 After the upward shift in the production function the same output could be produced using less labor function the same output could be produced using less labor ((L3) at point Arsquorsquo The L3) at point Arsquorsquo The problem is that Arsquorsquo is not an equilibrium problem is that Arsquorsquo is not an equilibrium At that point the marginal product of labor is higher than the At that point the marginal product of labor is higher than the original real wage so a profit-maximizing firm would want to original real wage so a profit-maximizing firm would want to expand production To do this they must hire more labor than expand production To do this they must hire more labor than L3 and indeed they L3 and indeed they find it find it profitable profitable to hire more labor than to hire more labor than the original the original L1 The only way actually to increase labor L1 The only way actually to increase labor is to is to raise the real-wage raise the real-wage rate above its original level Technological rate above its original level Technological progress therefore favors progress therefore favors workers by increasing employment workers by increasing employment and wagesand wages

bull Early in the 19th century hand-woven cloth was very Early in the 19th century hand-woven cloth was very expensive and a worker was lucky to own the clothes on his expensive and a worker was lucky to own the clothes on his back and a spare set for church on Sunday Textiles were one of back and a spare set for church on Sunday Textiles were one of the first industries to benefit from the Industrial Revolution so the first industries to benefit from the Industrial Revolution so that by the end of the 19th century machine-made fabrics and that by the end of the 19th century machine-made fabrics and mass-production made decent clothing in larger quantities mass-production made decent clothing in larger quantities accessible to most of the population of the more developed accessible to most of the population of the more developed countries Similar progress has been made in most forms of countries Similar progress has been made in most forms of production Agricultural production which at the turn of the production Agricultural production which at the turn of the 20th century absorbed half the labor force now absorbs less 20th century absorbed half the labor force now absorbs less than 3 percent while producing more food more cheaply than than 3 percent while producing more food more cheaply than ever ever

bull We must be careful not to dismiss the Luddites as altogether We must be careful not to dismiss the Luddites as altogether foolish While new technology especially over decades has foolish While new technology especially over decades has proved to be a net gain for workers in general the Luddites proved to be a net gain for workers in general the Luddites were in fact correct that their way of life was threatened were in fact correct that their way of life was threatened Independent weavers became factory hands unskilled Independent weavers became factory hands unskilled workers increasingly women and often children replaced workers increasingly women and often children replaced skilled craftsmen and factory work often involved long hours skilled craftsmen and factory work often involved long hours in brutal conditions The wider society reaps the benefits of in brutal conditions The wider society reaps the benefits of technological change while a narrow group sometimes technological change while a narrow group sometimes disproportionately bears its costs Our analysis also assumes disproportionately bears its costs Our analysis also assumes that markets generally clear The implicit assumption is that that markets generally clear The implicit assumption is that displaced workers move on to new jobs possibly in other forms displaced workers move on to new jobs possibly in other forms of production Markets may have a tendency to clear in the of production Markets may have a tendency to clear in the long run yet workers may find themselves displaced in the long run yet workers may find themselves displaced in the short run say over the course of a business cycleshort run say over the course of a business cycle

Issue 3 Immigration Jobs and Real WagesIssue 3 Immigration Jobs and Real Wages

bull How does an increase in the labor force through immigration or How does an increase in the labor force through immigration or natural population growth affect labor and GDP natural population growth affect labor and GDP

bull One of the emotional issues associated with US immigration One of the emotional issues associated with US immigration policy ndash particularly towards low-wage workers from Mexico ndash policy ndash particularly towards low-wage workers from Mexico ndash is the idea that is the idea that immigrants take jobs away from native immigrants take jobs away from native workers workers We might be tempted to dismiss this fear as another We might be tempted to dismiss this fear as another example of the lump-of-labor fallacy Yet there is a sensible example of the lump-of-labor fallacy Yet there is a sensible intuition behind the argument An increase in the labor force ndash intuition behind the argument An increase in the labor force ndash due either to immigration or to higher population growth rates due either to immigration or to higher population growth rates ndash can be represented as an outward shift of the aggregate labor ndash can be represented as an outward shift of the aggregate labor supply curve as shown in the following Figure Employment supply curve as shown in the following Figure Employment increases but real wages fall It is not then that immigrants increases but real wages fall It is not then that immigrants take jobs away from natives take jobs away from natives Rather they compete for jobsRather they compete for jobs putting downward pressure on real wagesputting downward pressure on real wages

bull Again we must exercise care in interpreting the analysis Again we must exercise care in interpreting the analysis Remember that aggregate labor and average wage rates hide Remember that aggregate labor and average wage rates hide many details of the labor process The incomes of the new many details of the labor process The incomes of the new immigrants immigrants creates demand creates demand for the new production that they for the new production that they make possible Immigrant workers (at least those ndash whether make possible Immigrant workers (at least those ndash whether legal or illegal ndash who have become the focus of the most intense legal or illegal ndash who have become the focus of the most intense political debate) political debate) are likely to possess fewer skills than nativesare likely to possess fewer skills than natives The net effect is that the increased demand for goods and The net effect is that the increased demand for goods and services generated by immigrants is likely to increase the services generated by immigrants is likely to increase the demand for skilled (demand for skilled (and largely nativeand largely native) workers relative to ) workers relative to their supply and so to increase real wages of skilled workers their supply and so to increase real wages of skilled workers Low-skilled immigration may lower the real wage for farm Low-skilled immigration may lower the real wage for farm workers but if anything it would raise the real wage for workers but if anything it would raise the real wage for computer programmerscomputer programmers

Next Task Labor Market in Kuwait

Appendix Is Labor Supply Stable Over Time

bull Statistics on participation rates or average hours for a Statistics on participation rates or average hours for a particular month or year are snapshot of the labor market particular month or year are snapshot of the labor market Can we analyze the effects of that increase on the labor market Can we analyze the effects of that increase on the labor market under the assumption that the labor-supply curves of workers under the assumption that the labor-supply curves of workers remain essentially stableremain essentially stable

bull Data on participation rates in the United States appear to Data on participation rates in the United States appear to support this conjecture (see Figure 811) which shows the support this conjecture (see Figure 811) which shows the overall civilian participation rate trending upward ndash at least overall civilian participation rate trending upward ndash at least from the middle of the 1960sfrom the middle of the 1960s

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

ANALYZING IDEAL LABOR MARKETSANALYZING IDEAL LABOR MARKETS

bull The aggregate labor-supplylabor-demand diagram provides us The aggregate labor-supplylabor-demand diagram provides us with a powerful tool We now analyze three important with a powerful tool We now analyze three important macroeconomic issues macroeconomic issues

(1) the effect of tax cuts on employment (1) the effect of tax cuts on employment

(2) the effect of technological progress on the well-being of (2) the effect of technological progress on the well-being of workers and workers and

(3) the effect of immigration on existing workers (3) the effect of immigration on existing workers

bull Issue 1 Tax Cuts Issue 1 Tax Cuts What are the effects of a cut in marginal What are the effects of a cut in marginal income-tax rates on employment and the level of GDP in the income-tax rates on employment and the level of GDP in the economyeconomy Recall from section that a lower marginal income-Recall from section that a lower marginal income-tax rate increases labor supply at each real wage (a rightward tax rate increases labor supply at each real wage (a rightward shift of the labor-supply) shift of the labor-supply)

bull Labor-market equilibrium moves from point A to point B in Labor-market equilibrium moves from point A to point B in the lower panel of the following Notice that the amount of the lower panel of the following Notice that the amount of labor available to firms increases so that firms move labor available to firms increases so that firms move production from Arsquo to Brsquo on the labor production function in production from Arsquo to Brsquo on the labor production function in the upper panel Also notice that the real wage falls from (the upper panel Also notice that the real wage falls from (wp)1 wp)1 to (wp)2 Since the cut in taxes increases the number of to (wp)2 Since the cut in taxes increases the number of workers workers willing to work at each wage Workers care about their take-willing to work at each wage Workers care about their take-home pay ndash that is about their home pay ndash that is about their after-tax real wage after-tax real wage This is This is perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 can be greater than the old after-tax real wage (1ndashcan be greater than the old after-tax real wage (1ndashτ1τ1)(wp)1 so )(wp)1 so long as the rise in the take-home share (1 ndash τ) is long as the rise in the take-home share (1 ndash τ) is proportionately greater than the fall in the before-tax real proportionately greater than the fall in the before-tax real wage (wp)wage (wp)

bull The analysis depends on substitution effects dominating The analysis depends on substitution effects dominating income effects which they probably do in aggregate if not for income effects which they probably do in aggregate if not for every worker So the supply-siders of the Reagan years are every worker So the supply-siders of the Reagan years are correct in principle How much output will increase depends on correct in principle How much output will increase depends on how large the substitution effect is If most people work a how large the substitution effect is If most people work a standard 40-hour week the effect could be quite small and the standard 40-hour week the effect could be quite small and the increase in output might also be very small in practiceincrease in output might also be very small in practice

Issue 1 The Effect of a Cut in Marginal Tax RatesIssue 1 The Effect of a Cut in Marginal Tax Rates

Issue 2 Technological Progress and Worker WelfareIssue 2 Technological Progress and Worker Welfare

bull Is technological progress and increasing use of machinery and Is technological progress and increasing use of machinery and other capital beneficial for workersother capital beneficial for workers

bull Technological change or capital accumulation have been Technological change or capital accumulation have been known as ldquoLudditesrdquo (known as ldquoLudditesrdquo (it negatively affects the demand for it negatively affects the demand for laborlabor) To see why the Luddites are wrong ndash at least for ) To see why the Luddites are wrong ndash at least for clearing labor markets ndash recall that technological progress or clearing labor markets ndash recall that technological progress or increased capital both increased capital both shift the labor-demand curve upwardshift the labor-demand curve upward The lower panel of the following figure shows that the effect of The lower panel of the following figure shows that the effect of the increased demand for labor is to increase total employment the increased demand for labor is to increase total employment and the real wage Firms and the real wage Firms can pay a higher real wage can pay a higher real wage because because the additional capital or technological progress the additional capital or technological progress increases the increases the marginal product of labormarginal product of labor

bull The The Ludditesrsquo mistake Ludditesrsquo mistake is most easily seen in the upper panel is most easily seen in the upper panel The Luddite argument assumes that fewer workers will The Luddite argument assumes that fewer workers will produce the same total output Production starts at Arsquo using produce the same total output Production starts at Arsquo using L1 L1 workers to produce Y1 After the upward shift in the production workers to produce Y1 After the upward shift in the production function the same output could be produced using less labor function the same output could be produced using less labor ((L3) at point Arsquorsquo The L3) at point Arsquorsquo The problem is that Arsquorsquo is not an equilibrium problem is that Arsquorsquo is not an equilibrium At that point the marginal product of labor is higher than the At that point the marginal product of labor is higher than the original real wage so a profit-maximizing firm would want to original real wage so a profit-maximizing firm would want to expand production To do this they must hire more labor than expand production To do this they must hire more labor than L3 and indeed they L3 and indeed they find it find it profitable profitable to hire more labor than to hire more labor than the original the original L1 The only way actually to increase labor L1 The only way actually to increase labor is to is to raise the real-wage raise the real-wage rate above its original level Technological rate above its original level Technological progress therefore favors progress therefore favors workers by increasing employment workers by increasing employment and wagesand wages

bull Early in the 19th century hand-woven cloth was very Early in the 19th century hand-woven cloth was very expensive and a worker was lucky to own the clothes on his expensive and a worker was lucky to own the clothes on his back and a spare set for church on Sunday Textiles were one of back and a spare set for church on Sunday Textiles were one of the first industries to benefit from the Industrial Revolution so the first industries to benefit from the Industrial Revolution so that by the end of the 19th century machine-made fabrics and that by the end of the 19th century machine-made fabrics and mass-production made decent clothing in larger quantities mass-production made decent clothing in larger quantities accessible to most of the population of the more developed accessible to most of the population of the more developed countries Similar progress has been made in most forms of countries Similar progress has been made in most forms of production Agricultural production which at the turn of the production Agricultural production which at the turn of the 20th century absorbed half the labor force now absorbs less 20th century absorbed half the labor force now absorbs less than 3 percent while producing more food more cheaply than than 3 percent while producing more food more cheaply than ever ever

bull We must be careful not to dismiss the Luddites as altogether We must be careful not to dismiss the Luddites as altogether foolish While new technology especially over decades has foolish While new technology especially over decades has proved to be a net gain for workers in general the Luddites proved to be a net gain for workers in general the Luddites were in fact correct that their way of life was threatened were in fact correct that their way of life was threatened Independent weavers became factory hands unskilled Independent weavers became factory hands unskilled workers increasingly women and often children replaced workers increasingly women and often children replaced skilled craftsmen and factory work often involved long hours skilled craftsmen and factory work often involved long hours in brutal conditions The wider society reaps the benefits of in brutal conditions The wider society reaps the benefits of technological change while a narrow group sometimes technological change while a narrow group sometimes disproportionately bears its costs Our analysis also assumes disproportionately bears its costs Our analysis also assumes that markets generally clear The implicit assumption is that that markets generally clear The implicit assumption is that displaced workers move on to new jobs possibly in other forms displaced workers move on to new jobs possibly in other forms of production Markets may have a tendency to clear in the of production Markets may have a tendency to clear in the long run yet workers may find themselves displaced in the long run yet workers may find themselves displaced in the short run say over the course of a business cycleshort run say over the course of a business cycle

Issue 3 Immigration Jobs and Real WagesIssue 3 Immigration Jobs and Real Wages

bull How does an increase in the labor force through immigration or How does an increase in the labor force through immigration or natural population growth affect labor and GDP natural population growth affect labor and GDP

bull One of the emotional issues associated with US immigration One of the emotional issues associated with US immigration policy ndash particularly towards low-wage workers from Mexico ndash policy ndash particularly towards low-wage workers from Mexico ndash is the idea that is the idea that immigrants take jobs away from native immigrants take jobs away from native workers workers We might be tempted to dismiss this fear as another We might be tempted to dismiss this fear as another example of the lump-of-labor fallacy Yet there is a sensible example of the lump-of-labor fallacy Yet there is a sensible intuition behind the argument An increase in the labor force ndash intuition behind the argument An increase in the labor force ndash due either to immigration or to higher population growth rates due either to immigration or to higher population growth rates ndash can be represented as an outward shift of the aggregate labor ndash can be represented as an outward shift of the aggregate labor supply curve as shown in the following Figure Employment supply curve as shown in the following Figure Employment increases but real wages fall It is not then that immigrants increases but real wages fall It is not then that immigrants take jobs away from natives take jobs away from natives Rather they compete for jobsRather they compete for jobs putting downward pressure on real wagesputting downward pressure on real wages

bull Again we must exercise care in interpreting the analysis Again we must exercise care in interpreting the analysis Remember that aggregate labor and average wage rates hide Remember that aggregate labor and average wage rates hide many details of the labor process The incomes of the new many details of the labor process The incomes of the new immigrants immigrants creates demand creates demand for the new production that they for the new production that they make possible Immigrant workers (at least those ndash whether make possible Immigrant workers (at least those ndash whether legal or illegal ndash who have become the focus of the most intense legal or illegal ndash who have become the focus of the most intense political debate) political debate) are likely to possess fewer skills than nativesare likely to possess fewer skills than natives The net effect is that the increased demand for goods and The net effect is that the increased demand for goods and services generated by immigrants is likely to increase the services generated by immigrants is likely to increase the demand for skilled (demand for skilled (and largely nativeand largely native) workers relative to ) workers relative to their supply and so to increase real wages of skilled workers their supply and so to increase real wages of skilled workers Low-skilled immigration may lower the real wage for farm Low-skilled immigration may lower the real wage for farm workers but if anything it would raise the real wage for workers but if anything it would raise the real wage for computer programmerscomputer programmers

Next Task Labor Market in Kuwait

Appendix Is Labor Supply Stable Over Time

bull Statistics on participation rates or average hours for a Statistics on participation rates or average hours for a particular month or year are snapshot of the labor market particular month or year are snapshot of the labor market Can we analyze the effects of that increase on the labor market Can we analyze the effects of that increase on the labor market under the assumption that the labor-supply curves of workers under the assumption that the labor-supply curves of workers remain essentially stableremain essentially stable

bull Data on participation rates in the United States appear to Data on participation rates in the United States appear to support this conjecture (see Figure 811) which shows the support this conjecture (see Figure 811) which shows the overall civilian participation rate trending upward ndash at least overall civilian participation rate trending upward ndash at least from the middle of the 1960sfrom the middle of the 1960s

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

bull Labor-market equilibrium moves from point A to point B in Labor-market equilibrium moves from point A to point B in the lower panel of the following Notice that the amount of the lower panel of the following Notice that the amount of labor available to firms increases so that firms move labor available to firms increases so that firms move production from Arsquo to Brsquo on the labor production function in production from Arsquo to Brsquo on the labor production function in the upper panel Also notice that the real wage falls from (the upper panel Also notice that the real wage falls from (wp)1 wp)1 to (wp)2 Since the cut in taxes increases the number of to (wp)2 Since the cut in taxes increases the number of workers workers willing to work at each wage Workers care about their take-willing to work at each wage Workers care about their take-home pay ndash that is about their home pay ndash that is about their after-tax real wage after-tax real wage This is This is perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 perfectly consistent the new after-tax real wage (1ndashτ2)(wp)2 can be greater than the old after-tax real wage (1ndashcan be greater than the old after-tax real wage (1ndashτ1τ1)(wp)1 so )(wp)1 so long as the rise in the take-home share (1 ndash τ) is long as the rise in the take-home share (1 ndash τ) is proportionately greater than the fall in the before-tax real proportionately greater than the fall in the before-tax real wage (wp)wage (wp)

bull The analysis depends on substitution effects dominating The analysis depends on substitution effects dominating income effects which they probably do in aggregate if not for income effects which they probably do in aggregate if not for every worker So the supply-siders of the Reagan years are every worker So the supply-siders of the Reagan years are correct in principle How much output will increase depends on correct in principle How much output will increase depends on how large the substitution effect is If most people work a how large the substitution effect is If most people work a standard 40-hour week the effect could be quite small and the standard 40-hour week the effect could be quite small and the increase in output might also be very small in practiceincrease in output might also be very small in practice

Issue 1 The Effect of a Cut in Marginal Tax RatesIssue 1 The Effect of a Cut in Marginal Tax Rates

Issue 2 Technological Progress and Worker WelfareIssue 2 Technological Progress and Worker Welfare

bull Is technological progress and increasing use of machinery and Is technological progress and increasing use of machinery and other capital beneficial for workersother capital beneficial for workers

bull Technological change or capital accumulation have been Technological change or capital accumulation have been known as ldquoLudditesrdquo (known as ldquoLudditesrdquo (it negatively affects the demand for it negatively affects the demand for laborlabor) To see why the Luddites are wrong ndash at least for ) To see why the Luddites are wrong ndash at least for clearing labor markets ndash recall that technological progress or clearing labor markets ndash recall that technological progress or increased capital both increased capital both shift the labor-demand curve upwardshift the labor-demand curve upward The lower panel of the following figure shows that the effect of The lower panel of the following figure shows that the effect of the increased demand for labor is to increase total employment the increased demand for labor is to increase total employment and the real wage Firms and the real wage Firms can pay a higher real wage can pay a higher real wage because because the additional capital or technological progress the additional capital or technological progress increases the increases the marginal product of labormarginal product of labor

bull The The Ludditesrsquo mistake Ludditesrsquo mistake is most easily seen in the upper panel is most easily seen in the upper panel The Luddite argument assumes that fewer workers will The Luddite argument assumes that fewer workers will produce the same total output Production starts at Arsquo using produce the same total output Production starts at Arsquo using L1 L1 workers to produce Y1 After the upward shift in the production workers to produce Y1 After the upward shift in the production function the same output could be produced using less labor function the same output could be produced using less labor ((L3) at point Arsquorsquo The L3) at point Arsquorsquo The problem is that Arsquorsquo is not an equilibrium problem is that Arsquorsquo is not an equilibrium At that point the marginal product of labor is higher than the At that point the marginal product of labor is higher than the original real wage so a profit-maximizing firm would want to original real wage so a profit-maximizing firm would want to expand production To do this they must hire more labor than expand production To do this they must hire more labor than L3 and indeed they L3 and indeed they find it find it profitable profitable to hire more labor than to hire more labor than the original the original L1 The only way actually to increase labor L1 The only way actually to increase labor is to is to raise the real-wage raise the real-wage rate above its original level Technological rate above its original level Technological progress therefore favors progress therefore favors workers by increasing employment workers by increasing employment and wagesand wages

bull Early in the 19th century hand-woven cloth was very Early in the 19th century hand-woven cloth was very expensive and a worker was lucky to own the clothes on his expensive and a worker was lucky to own the clothes on his back and a spare set for church on Sunday Textiles were one of back and a spare set for church on Sunday Textiles were one of the first industries to benefit from the Industrial Revolution so the first industries to benefit from the Industrial Revolution so that by the end of the 19th century machine-made fabrics and that by the end of the 19th century machine-made fabrics and mass-production made decent clothing in larger quantities mass-production made decent clothing in larger quantities accessible to most of the population of the more developed accessible to most of the population of the more developed countries Similar progress has been made in most forms of countries Similar progress has been made in most forms of production Agricultural production which at the turn of the production Agricultural production which at the turn of the 20th century absorbed half the labor force now absorbs less 20th century absorbed half the labor force now absorbs less than 3 percent while producing more food more cheaply than than 3 percent while producing more food more cheaply than ever ever

bull We must be careful not to dismiss the Luddites as altogether We must be careful not to dismiss the Luddites as altogether foolish While new technology especially over decades has foolish While new technology especially over decades has proved to be a net gain for workers in general the Luddites proved to be a net gain for workers in general the Luddites were in fact correct that their way of life was threatened were in fact correct that their way of life was threatened Independent weavers became factory hands unskilled Independent weavers became factory hands unskilled workers increasingly women and often children replaced workers increasingly women and often children replaced skilled craftsmen and factory work often involved long hours skilled craftsmen and factory work often involved long hours in brutal conditions The wider society reaps the benefits of in brutal conditions The wider society reaps the benefits of technological change while a narrow group sometimes technological change while a narrow group sometimes disproportionately bears its costs Our analysis also assumes disproportionately bears its costs Our analysis also assumes that markets generally clear The implicit assumption is that that markets generally clear The implicit assumption is that displaced workers move on to new jobs possibly in other forms displaced workers move on to new jobs possibly in other forms of production Markets may have a tendency to clear in the of production Markets may have a tendency to clear in the long run yet workers may find themselves displaced in the long run yet workers may find themselves displaced in the short run say over the course of a business cycleshort run say over the course of a business cycle

Issue 3 Immigration Jobs and Real WagesIssue 3 Immigration Jobs and Real Wages

bull How does an increase in the labor force through immigration or How does an increase in the labor force through immigration or natural population growth affect labor and GDP natural population growth affect labor and GDP

bull One of the emotional issues associated with US immigration One of the emotional issues associated with US immigration policy ndash particularly towards low-wage workers from Mexico ndash policy ndash particularly towards low-wage workers from Mexico ndash is the idea that is the idea that immigrants take jobs away from native immigrants take jobs away from native workers workers We might be tempted to dismiss this fear as another We might be tempted to dismiss this fear as another example of the lump-of-labor fallacy Yet there is a sensible example of the lump-of-labor fallacy Yet there is a sensible intuition behind the argument An increase in the labor force ndash intuition behind the argument An increase in the labor force ndash due either to immigration or to higher population growth rates due either to immigration or to higher population growth rates ndash can be represented as an outward shift of the aggregate labor ndash can be represented as an outward shift of the aggregate labor supply curve as shown in the following Figure Employment supply curve as shown in the following Figure Employment increases but real wages fall It is not then that immigrants increases but real wages fall It is not then that immigrants take jobs away from natives take jobs away from natives Rather they compete for jobsRather they compete for jobs putting downward pressure on real wagesputting downward pressure on real wages

bull Again we must exercise care in interpreting the analysis Again we must exercise care in interpreting the analysis Remember that aggregate labor and average wage rates hide Remember that aggregate labor and average wage rates hide many details of the labor process The incomes of the new many details of the labor process The incomes of the new immigrants immigrants creates demand creates demand for the new production that they for the new production that they make possible Immigrant workers (at least those ndash whether make possible Immigrant workers (at least those ndash whether legal or illegal ndash who have become the focus of the most intense legal or illegal ndash who have become the focus of the most intense political debate) political debate) are likely to possess fewer skills than nativesare likely to possess fewer skills than natives The net effect is that the increased demand for goods and The net effect is that the increased demand for goods and services generated by immigrants is likely to increase the services generated by immigrants is likely to increase the demand for skilled (demand for skilled (and largely nativeand largely native) workers relative to ) workers relative to their supply and so to increase real wages of skilled workers their supply and so to increase real wages of skilled workers Low-skilled immigration may lower the real wage for farm Low-skilled immigration may lower the real wage for farm workers but if anything it would raise the real wage for workers but if anything it would raise the real wage for computer programmerscomputer programmers

Next Task Labor Market in Kuwait

Appendix Is Labor Supply Stable Over Time

bull Statistics on participation rates or average hours for a Statistics on participation rates or average hours for a particular month or year are snapshot of the labor market particular month or year are snapshot of the labor market Can we analyze the effects of that increase on the labor market Can we analyze the effects of that increase on the labor market under the assumption that the labor-supply curves of workers under the assumption that the labor-supply curves of workers remain essentially stableremain essentially stable

bull Data on participation rates in the United States appear to Data on participation rates in the United States appear to support this conjecture (see Figure 811) which shows the support this conjecture (see Figure 811) which shows the overall civilian participation rate trending upward ndash at least overall civilian participation rate trending upward ndash at least from the middle of the 1960sfrom the middle of the 1960s

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

bull The analysis depends on substitution effects dominating The analysis depends on substitution effects dominating income effects which they probably do in aggregate if not for income effects which they probably do in aggregate if not for every worker So the supply-siders of the Reagan years are every worker So the supply-siders of the Reagan years are correct in principle How much output will increase depends on correct in principle How much output will increase depends on how large the substitution effect is If most people work a how large the substitution effect is If most people work a standard 40-hour week the effect could be quite small and the standard 40-hour week the effect could be quite small and the increase in output might also be very small in practiceincrease in output might also be very small in practice

Issue 1 The Effect of a Cut in Marginal Tax RatesIssue 1 The Effect of a Cut in Marginal Tax Rates

Issue 2 Technological Progress and Worker WelfareIssue 2 Technological Progress and Worker Welfare

bull Is technological progress and increasing use of machinery and Is technological progress and increasing use of machinery and other capital beneficial for workersother capital beneficial for workers

bull Technological change or capital accumulation have been Technological change or capital accumulation have been known as ldquoLudditesrdquo (known as ldquoLudditesrdquo (it negatively affects the demand for it negatively affects the demand for laborlabor) To see why the Luddites are wrong ndash at least for ) To see why the Luddites are wrong ndash at least for clearing labor markets ndash recall that technological progress or clearing labor markets ndash recall that technological progress or increased capital both increased capital both shift the labor-demand curve upwardshift the labor-demand curve upward The lower panel of the following figure shows that the effect of The lower panel of the following figure shows that the effect of the increased demand for labor is to increase total employment the increased demand for labor is to increase total employment and the real wage Firms and the real wage Firms can pay a higher real wage can pay a higher real wage because because the additional capital or technological progress the additional capital or technological progress increases the increases the marginal product of labormarginal product of labor

bull The The Ludditesrsquo mistake Ludditesrsquo mistake is most easily seen in the upper panel is most easily seen in the upper panel The Luddite argument assumes that fewer workers will The Luddite argument assumes that fewer workers will produce the same total output Production starts at Arsquo using produce the same total output Production starts at Arsquo using L1 L1 workers to produce Y1 After the upward shift in the production workers to produce Y1 After the upward shift in the production function the same output could be produced using less labor function the same output could be produced using less labor ((L3) at point Arsquorsquo The L3) at point Arsquorsquo The problem is that Arsquorsquo is not an equilibrium problem is that Arsquorsquo is not an equilibrium At that point the marginal product of labor is higher than the At that point the marginal product of labor is higher than the original real wage so a profit-maximizing firm would want to original real wage so a profit-maximizing firm would want to expand production To do this they must hire more labor than expand production To do this they must hire more labor than L3 and indeed they L3 and indeed they find it find it profitable profitable to hire more labor than to hire more labor than the original the original L1 The only way actually to increase labor L1 The only way actually to increase labor is to is to raise the real-wage raise the real-wage rate above its original level Technological rate above its original level Technological progress therefore favors progress therefore favors workers by increasing employment workers by increasing employment and wagesand wages

bull Early in the 19th century hand-woven cloth was very Early in the 19th century hand-woven cloth was very expensive and a worker was lucky to own the clothes on his expensive and a worker was lucky to own the clothes on his back and a spare set for church on Sunday Textiles were one of back and a spare set for church on Sunday Textiles were one of the first industries to benefit from the Industrial Revolution so the first industries to benefit from the Industrial Revolution so that by the end of the 19th century machine-made fabrics and that by the end of the 19th century machine-made fabrics and mass-production made decent clothing in larger quantities mass-production made decent clothing in larger quantities accessible to most of the population of the more developed accessible to most of the population of the more developed countries Similar progress has been made in most forms of countries Similar progress has been made in most forms of production Agricultural production which at the turn of the production Agricultural production which at the turn of the 20th century absorbed half the labor force now absorbs less 20th century absorbed half the labor force now absorbs less than 3 percent while producing more food more cheaply than than 3 percent while producing more food more cheaply than ever ever

bull We must be careful not to dismiss the Luddites as altogether We must be careful not to dismiss the Luddites as altogether foolish While new technology especially over decades has foolish While new technology especially over decades has proved to be a net gain for workers in general the Luddites proved to be a net gain for workers in general the Luddites were in fact correct that their way of life was threatened were in fact correct that their way of life was threatened Independent weavers became factory hands unskilled Independent weavers became factory hands unskilled workers increasingly women and often children replaced workers increasingly women and often children replaced skilled craftsmen and factory work often involved long hours skilled craftsmen and factory work often involved long hours in brutal conditions The wider society reaps the benefits of in brutal conditions The wider society reaps the benefits of technological change while a narrow group sometimes technological change while a narrow group sometimes disproportionately bears its costs Our analysis also assumes disproportionately bears its costs Our analysis also assumes that markets generally clear The implicit assumption is that that markets generally clear The implicit assumption is that displaced workers move on to new jobs possibly in other forms displaced workers move on to new jobs possibly in other forms of production Markets may have a tendency to clear in the of production Markets may have a tendency to clear in the long run yet workers may find themselves displaced in the long run yet workers may find themselves displaced in the short run say over the course of a business cycleshort run say over the course of a business cycle

Issue 3 Immigration Jobs and Real WagesIssue 3 Immigration Jobs and Real Wages

bull How does an increase in the labor force through immigration or How does an increase in the labor force through immigration or natural population growth affect labor and GDP natural population growth affect labor and GDP

bull One of the emotional issues associated with US immigration One of the emotional issues associated with US immigration policy ndash particularly towards low-wage workers from Mexico ndash policy ndash particularly towards low-wage workers from Mexico ndash is the idea that is the idea that immigrants take jobs away from native immigrants take jobs away from native workers workers We might be tempted to dismiss this fear as another We might be tempted to dismiss this fear as another example of the lump-of-labor fallacy Yet there is a sensible example of the lump-of-labor fallacy Yet there is a sensible intuition behind the argument An increase in the labor force ndash intuition behind the argument An increase in the labor force ndash due either to immigration or to higher population growth rates due either to immigration or to higher population growth rates ndash can be represented as an outward shift of the aggregate labor ndash can be represented as an outward shift of the aggregate labor supply curve as shown in the following Figure Employment supply curve as shown in the following Figure Employment increases but real wages fall It is not then that immigrants increases but real wages fall It is not then that immigrants take jobs away from natives take jobs away from natives Rather they compete for jobsRather they compete for jobs putting downward pressure on real wagesputting downward pressure on real wages

bull Again we must exercise care in interpreting the analysis Again we must exercise care in interpreting the analysis Remember that aggregate labor and average wage rates hide Remember that aggregate labor and average wage rates hide many details of the labor process The incomes of the new many details of the labor process The incomes of the new immigrants immigrants creates demand creates demand for the new production that they for the new production that they make possible Immigrant workers (at least those ndash whether make possible Immigrant workers (at least those ndash whether legal or illegal ndash who have become the focus of the most intense legal or illegal ndash who have become the focus of the most intense political debate) political debate) are likely to possess fewer skills than nativesare likely to possess fewer skills than natives The net effect is that the increased demand for goods and The net effect is that the increased demand for goods and services generated by immigrants is likely to increase the services generated by immigrants is likely to increase the demand for skilled (demand for skilled (and largely nativeand largely native) workers relative to ) workers relative to their supply and so to increase real wages of skilled workers their supply and so to increase real wages of skilled workers Low-skilled immigration may lower the real wage for farm Low-skilled immigration may lower the real wage for farm workers but if anything it would raise the real wage for workers but if anything it would raise the real wage for computer programmerscomputer programmers

Next Task Labor Market in Kuwait

Appendix Is Labor Supply Stable Over Time

bull Statistics on participation rates or average hours for a Statistics on participation rates or average hours for a particular month or year are snapshot of the labor market particular month or year are snapshot of the labor market Can we analyze the effects of that increase on the labor market Can we analyze the effects of that increase on the labor market under the assumption that the labor-supply curves of workers under the assumption that the labor-supply curves of workers remain essentially stableremain essentially stable

bull Data on participation rates in the United States appear to Data on participation rates in the United States appear to support this conjecture (see Figure 811) which shows the support this conjecture (see Figure 811) which shows the overall civilian participation rate trending upward ndash at least overall civilian participation rate trending upward ndash at least from the middle of the 1960sfrom the middle of the 1960s

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

Issue 1 The Effect of a Cut in Marginal Tax RatesIssue 1 The Effect of a Cut in Marginal Tax Rates

Issue 2 Technological Progress and Worker WelfareIssue 2 Technological Progress and Worker Welfare

bull Is technological progress and increasing use of machinery and Is technological progress and increasing use of machinery and other capital beneficial for workersother capital beneficial for workers

bull Technological change or capital accumulation have been Technological change or capital accumulation have been known as ldquoLudditesrdquo (known as ldquoLudditesrdquo (it negatively affects the demand for it negatively affects the demand for laborlabor) To see why the Luddites are wrong ndash at least for ) To see why the Luddites are wrong ndash at least for clearing labor markets ndash recall that technological progress or clearing labor markets ndash recall that technological progress or increased capital both increased capital both shift the labor-demand curve upwardshift the labor-demand curve upward The lower panel of the following figure shows that the effect of The lower panel of the following figure shows that the effect of the increased demand for labor is to increase total employment the increased demand for labor is to increase total employment and the real wage Firms and the real wage Firms can pay a higher real wage can pay a higher real wage because because the additional capital or technological progress the additional capital or technological progress increases the increases the marginal product of labormarginal product of labor

bull The The Ludditesrsquo mistake Ludditesrsquo mistake is most easily seen in the upper panel is most easily seen in the upper panel The Luddite argument assumes that fewer workers will The Luddite argument assumes that fewer workers will produce the same total output Production starts at Arsquo using produce the same total output Production starts at Arsquo using L1 L1 workers to produce Y1 After the upward shift in the production workers to produce Y1 After the upward shift in the production function the same output could be produced using less labor function the same output could be produced using less labor ((L3) at point Arsquorsquo The L3) at point Arsquorsquo The problem is that Arsquorsquo is not an equilibrium problem is that Arsquorsquo is not an equilibrium At that point the marginal product of labor is higher than the At that point the marginal product of labor is higher than the original real wage so a profit-maximizing firm would want to original real wage so a profit-maximizing firm would want to expand production To do this they must hire more labor than expand production To do this they must hire more labor than L3 and indeed they L3 and indeed they find it find it profitable profitable to hire more labor than to hire more labor than the original the original L1 The only way actually to increase labor L1 The only way actually to increase labor is to is to raise the real-wage raise the real-wage rate above its original level Technological rate above its original level Technological progress therefore favors progress therefore favors workers by increasing employment workers by increasing employment and wagesand wages

bull Early in the 19th century hand-woven cloth was very Early in the 19th century hand-woven cloth was very expensive and a worker was lucky to own the clothes on his expensive and a worker was lucky to own the clothes on his back and a spare set for church on Sunday Textiles were one of back and a spare set for church on Sunday Textiles were one of the first industries to benefit from the Industrial Revolution so the first industries to benefit from the Industrial Revolution so that by the end of the 19th century machine-made fabrics and that by the end of the 19th century machine-made fabrics and mass-production made decent clothing in larger quantities mass-production made decent clothing in larger quantities accessible to most of the population of the more developed accessible to most of the population of the more developed countries Similar progress has been made in most forms of countries Similar progress has been made in most forms of production Agricultural production which at the turn of the production Agricultural production which at the turn of the 20th century absorbed half the labor force now absorbs less 20th century absorbed half the labor force now absorbs less than 3 percent while producing more food more cheaply than than 3 percent while producing more food more cheaply than ever ever

bull We must be careful not to dismiss the Luddites as altogether We must be careful not to dismiss the Luddites as altogether foolish While new technology especially over decades has foolish While new technology especially over decades has proved to be a net gain for workers in general the Luddites proved to be a net gain for workers in general the Luddites were in fact correct that their way of life was threatened were in fact correct that their way of life was threatened Independent weavers became factory hands unskilled Independent weavers became factory hands unskilled workers increasingly women and often children replaced workers increasingly women and often children replaced skilled craftsmen and factory work often involved long hours skilled craftsmen and factory work often involved long hours in brutal conditions The wider society reaps the benefits of in brutal conditions The wider society reaps the benefits of technological change while a narrow group sometimes technological change while a narrow group sometimes disproportionately bears its costs Our analysis also assumes disproportionately bears its costs Our analysis also assumes that markets generally clear The implicit assumption is that that markets generally clear The implicit assumption is that displaced workers move on to new jobs possibly in other forms displaced workers move on to new jobs possibly in other forms of production Markets may have a tendency to clear in the of production Markets may have a tendency to clear in the long run yet workers may find themselves displaced in the long run yet workers may find themselves displaced in the short run say over the course of a business cycleshort run say over the course of a business cycle

Issue 3 Immigration Jobs and Real WagesIssue 3 Immigration Jobs and Real Wages

bull How does an increase in the labor force through immigration or How does an increase in the labor force through immigration or natural population growth affect labor and GDP natural population growth affect labor and GDP

bull One of the emotional issues associated with US immigration One of the emotional issues associated with US immigration policy ndash particularly towards low-wage workers from Mexico ndash policy ndash particularly towards low-wage workers from Mexico ndash is the idea that is the idea that immigrants take jobs away from native immigrants take jobs away from native workers workers We might be tempted to dismiss this fear as another We might be tempted to dismiss this fear as another example of the lump-of-labor fallacy Yet there is a sensible example of the lump-of-labor fallacy Yet there is a sensible intuition behind the argument An increase in the labor force ndash intuition behind the argument An increase in the labor force ndash due either to immigration or to higher population growth rates due either to immigration or to higher population growth rates ndash can be represented as an outward shift of the aggregate labor ndash can be represented as an outward shift of the aggregate labor supply curve as shown in the following Figure Employment supply curve as shown in the following Figure Employment increases but real wages fall It is not then that immigrants increases but real wages fall It is not then that immigrants take jobs away from natives take jobs away from natives Rather they compete for jobsRather they compete for jobs putting downward pressure on real wagesputting downward pressure on real wages

bull Again we must exercise care in interpreting the analysis Again we must exercise care in interpreting the analysis Remember that aggregate labor and average wage rates hide Remember that aggregate labor and average wage rates hide many details of the labor process The incomes of the new many details of the labor process The incomes of the new immigrants immigrants creates demand creates demand for the new production that they for the new production that they make possible Immigrant workers (at least those ndash whether make possible Immigrant workers (at least those ndash whether legal or illegal ndash who have become the focus of the most intense legal or illegal ndash who have become the focus of the most intense political debate) political debate) are likely to possess fewer skills than nativesare likely to possess fewer skills than natives The net effect is that the increased demand for goods and The net effect is that the increased demand for goods and services generated by immigrants is likely to increase the services generated by immigrants is likely to increase the demand for skilled (demand for skilled (and largely nativeand largely native) workers relative to ) workers relative to their supply and so to increase real wages of skilled workers their supply and so to increase real wages of skilled workers Low-skilled immigration may lower the real wage for farm Low-skilled immigration may lower the real wage for farm workers but if anything it would raise the real wage for workers but if anything it would raise the real wage for computer programmerscomputer programmers

Next Task Labor Market in Kuwait

Appendix Is Labor Supply Stable Over Time

bull Statistics on participation rates or average hours for a Statistics on participation rates or average hours for a particular month or year are snapshot of the labor market particular month or year are snapshot of the labor market Can we analyze the effects of that increase on the labor market Can we analyze the effects of that increase on the labor market under the assumption that the labor-supply curves of workers under the assumption that the labor-supply curves of workers remain essentially stableremain essentially stable

bull Data on participation rates in the United States appear to Data on participation rates in the United States appear to support this conjecture (see Figure 811) which shows the support this conjecture (see Figure 811) which shows the overall civilian participation rate trending upward ndash at least overall civilian participation rate trending upward ndash at least from the middle of the 1960sfrom the middle of the 1960s

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

Issue 2 Technological Progress and Worker WelfareIssue 2 Technological Progress and Worker Welfare

bull Is technological progress and increasing use of machinery and Is technological progress and increasing use of machinery and other capital beneficial for workersother capital beneficial for workers

bull Technological change or capital accumulation have been Technological change or capital accumulation have been known as ldquoLudditesrdquo (known as ldquoLudditesrdquo (it negatively affects the demand for it negatively affects the demand for laborlabor) To see why the Luddites are wrong ndash at least for ) To see why the Luddites are wrong ndash at least for clearing labor markets ndash recall that technological progress or clearing labor markets ndash recall that technological progress or increased capital both increased capital both shift the labor-demand curve upwardshift the labor-demand curve upward The lower panel of the following figure shows that the effect of The lower panel of the following figure shows that the effect of the increased demand for labor is to increase total employment the increased demand for labor is to increase total employment and the real wage Firms and the real wage Firms can pay a higher real wage can pay a higher real wage because because the additional capital or technological progress the additional capital or technological progress increases the increases the marginal product of labormarginal product of labor

bull The The Ludditesrsquo mistake Ludditesrsquo mistake is most easily seen in the upper panel is most easily seen in the upper panel The Luddite argument assumes that fewer workers will The Luddite argument assumes that fewer workers will produce the same total output Production starts at Arsquo using produce the same total output Production starts at Arsquo using L1 L1 workers to produce Y1 After the upward shift in the production workers to produce Y1 After the upward shift in the production function the same output could be produced using less labor function the same output could be produced using less labor ((L3) at point Arsquorsquo The L3) at point Arsquorsquo The problem is that Arsquorsquo is not an equilibrium problem is that Arsquorsquo is not an equilibrium At that point the marginal product of labor is higher than the At that point the marginal product of labor is higher than the original real wage so a profit-maximizing firm would want to original real wage so a profit-maximizing firm would want to expand production To do this they must hire more labor than expand production To do this they must hire more labor than L3 and indeed they L3 and indeed they find it find it profitable profitable to hire more labor than to hire more labor than the original the original L1 The only way actually to increase labor L1 The only way actually to increase labor is to is to raise the real-wage raise the real-wage rate above its original level Technological rate above its original level Technological progress therefore favors progress therefore favors workers by increasing employment workers by increasing employment and wagesand wages

bull Early in the 19th century hand-woven cloth was very Early in the 19th century hand-woven cloth was very expensive and a worker was lucky to own the clothes on his expensive and a worker was lucky to own the clothes on his back and a spare set for church on Sunday Textiles were one of back and a spare set for church on Sunday Textiles were one of the first industries to benefit from the Industrial Revolution so the first industries to benefit from the Industrial Revolution so that by the end of the 19th century machine-made fabrics and that by the end of the 19th century machine-made fabrics and mass-production made decent clothing in larger quantities mass-production made decent clothing in larger quantities accessible to most of the population of the more developed accessible to most of the population of the more developed countries Similar progress has been made in most forms of countries Similar progress has been made in most forms of production Agricultural production which at the turn of the production Agricultural production which at the turn of the 20th century absorbed half the labor force now absorbs less 20th century absorbed half the labor force now absorbs less than 3 percent while producing more food more cheaply than than 3 percent while producing more food more cheaply than ever ever

bull We must be careful not to dismiss the Luddites as altogether We must be careful not to dismiss the Luddites as altogether foolish While new technology especially over decades has foolish While new technology especially over decades has proved to be a net gain for workers in general the Luddites proved to be a net gain for workers in general the Luddites were in fact correct that their way of life was threatened were in fact correct that their way of life was threatened Independent weavers became factory hands unskilled Independent weavers became factory hands unskilled workers increasingly women and often children replaced workers increasingly women and often children replaced skilled craftsmen and factory work often involved long hours skilled craftsmen and factory work often involved long hours in brutal conditions The wider society reaps the benefits of in brutal conditions The wider society reaps the benefits of technological change while a narrow group sometimes technological change while a narrow group sometimes disproportionately bears its costs Our analysis also assumes disproportionately bears its costs Our analysis also assumes that markets generally clear The implicit assumption is that that markets generally clear The implicit assumption is that displaced workers move on to new jobs possibly in other forms displaced workers move on to new jobs possibly in other forms of production Markets may have a tendency to clear in the of production Markets may have a tendency to clear in the long run yet workers may find themselves displaced in the long run yet workers may find themselves displaced in the short run say over the course of a business cycleshort run say over the course of a business cycle

Issue 3 Immigration Jobs and Real WagesIssue 3 Immigration Jobs and Real Wages

bull How does an increase in the labor force through immigration or How does an increase in the labor force through immigration or natural population growth affect labor and GDP natural population growth affect labor and GDP

bull One of the emotional issues associated with US immigration One of the emotional issues associated with US immigration policy ndash particularly towards low-wage workers from Mexico ndash policy ndash particularly towards low-wage workers from Mexico ndash is the idea that is the idea that immigrants take jobs away from native immigrants take jobs away from native workers workers We might be tempted to dismiss this fear as another We might be tempted to dismiss this fear as another example of the lump-of-labor fallacy Yet there is a sensible example of the lump-of-labor fallacy Yet there is a sensible intuition behind the argument An increase in the labor force ndash intuition behind the argument An increase in the labor force ndash due either to immigration or to higher population growth rates due either to immigration or to higher population growth rates ndash can be represented as an outward shift of the aggregate labor ndash can be represented as an outward shift of the aggregate labor supply curve as shown in the following Figure Employment supply curve as shown in the following Figure Employment increases but real wages fall It is not then that immigrants increases but real wages fall It is not then that immigrants take jobs away from natives take jobs away from natives Rather they compete for jobsRather they compete for jobs putting downward pressure on real wagesputting downward pressure on real wages

bull Again we must exercise care in interpreting the analysis Again we must exercise care in interpreting the analysis Remember that aggregate labor and average wage rates hide Remember that aggregate labor and average wage rates hide many details of the labor process The incomes of the new many details of the labor process The incomes of the new immigrants immigrants creates demand creates demand for the new production that they for the new production that they make possible Immigrant workers (at least those ndash whether make possible Immigrant workers (at least those ndash whether legal or illegal ndash who have become the focus of the most intense legal or illegal ndash who have become the focus of the most intense political debate) political debate) are likely to possess fewer skills than nativesare likely to possess fewer skills than natives The net effect is that the increased demand for goods and The net effect is that the increased demand for goods and services generated by immigrants is likely to increase the services generated by immigrants is likely to increase the demand for skilled (demand for skilled (and largely nativeand largely native) workers relative to ) workers relative to their supply and so to increase real wages of skilled workers their supply and so to increase real wages of skilled workers Low-skilled immigration may lower the real wage for farm Low-skilled immigration may lower the real wage for farm workers but if anything it would raise the real wage for workers but if anything it would raise the real wage for computer programmerscomputer programmers

Next Task Labor Market in Kuwait

Appendix Is Labor Supply Stable Over Time

bull Statistics on participation rates or average hours for a Statistics on participation rates or average hours for a particular month or year are snapshot of the labor market particular month or year are snapshot of the labor market Can we analyze the effects of that increase on the labor market Can we analyze the effects of that increase on the labor market under the assumption that the labor-supply curves of workers under the assumption that the labor-supply curves of workers remain essentially stableremain essentially stable

bull Data on participation rates in the United States appear to Data on participation rates in the United States appear to support this conjecture (see Figure 811) which shows the support this conjecture (see Figure 811) which shows the overall civilian participation rate trending upward ndash at least overall civilian participation rate trending upward ndash at least from the middle of the 1960sfrom the middle of the 1960s

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

bull The The Ludditesrsquo mistake Ludditesrsquo mistake is most easily seen in the upper panel is most easily seen in the upper panel The Luddite argument assumes that fewer workers will The Luddite argument assumes that fewer workers will produce the same total output Production starts at Arsquo using produce the same total output Production starts at Arsquo using L1 L1 workers to produce Y1 After the upward shift in the production workers to produce Y1 After the upward shift in the production function the same output could be produced using less labor function the same output could be produced using less labor ((L3) at point Arsquorsquo The L3) at point Arsquorsquo The problem is that Arsquorsquo is not an equilibrium problem is that Arsquorsquo is not an equilibrium At that point the marginal product of labor is higher than the At that point the marginal product of labor is higher than the original real wage so a profit-maximizing firm would want to original real wage so a profit-maximizing firm would want to expand production To do this they must hire more labor than expand production To do this they must hire more labor than L3 and indeed they L3 and indeed they find it find it profitable profitable to hire more labor than to hire more labor than the original the original L1 The only way actually to increase labor L1 The only way actually to increase labor is to is to raise the real-wage raise the real-wage rate above its original level Technological rate above its original level Technological progress therefore favors progress therefore favors workers by increasing employment workers by increasing employment and wagesand wages

bull Early in the 19th century hand-woven cloth was very Early in the 19th century hand-woven cloth was very expensive and a worker was lucky to own the clothes on his expensive and a worker was lucky to own the clothes on his back and a spare set for church on Sunday Textiles were one of back and a spare set for church on Sunday Textiles were one of the first industries to benefit from the Industrial Revolution so the first industries to benefit from the Industrial Revolution so that by the end of the 19th century machine-made fabrics and that by the end of the 19th century machine-made fabrics and mass-production made decent clothing in larger quantities mass-production made decent clothing in larger quantities accessible to most of the population of the more developed accessible to most of the population of the more developed countries Similar progress has been made in most forms of countries Similar progress has been made in most forms of production Agricultural production which at the turn of the production Agricultural production which at the turn of the 20th century absorbed half the labor force now absorbs less 20th century absorbed half the labor force now absorbs less than 3 percent while producing more food more cheaply than than 3 percent while producing more food more cheaply than ever ever

bull We must be careful not to dismiss the Luddites as altogether We must be careful not to dismiss the Luddites as altogether foolish While new technology especially over decades has foolish While new technology especially over decades has proved to be a net gain for workers in general the Luddites proved to be a net gain for workers in general the Luddites were in fact correct that their way of life was threatened were in fact correct that their way of life was threatened Independent weavers became factory hands unskilled Independent weavers became factory hands unskilled workers increasingly women and often children replaced workers increasingly women and often children replaced skilled craftsmen and factory work often involved long hours skilled craftsmen and factory work often involved long hours in brutal conditions The wider society reaps the benefits of in brutal conditions The wider society reaps the benefits of technological change while a narrow group sometimes technological change while a narrow group sometimes disproportionately bears its costs Our analysis also assumes disproportionately bears its costs Our analysis also assumes that markets generally clear The implicit assumption is that that markets generally clear The implicit assumption is that displaced workers move on to new jobs possibly in other forms displaced workers move on to new jobs possibly in other forms of production Markets may have a tendency to clear in the of production Markets may have a tendency to clear in the long run yet workers may find themselves displaced in the long run yet workers may find themselves displaced in the short run say over the course of a business cycleshort run say over the course of a business cycle

Issue 3 Immigration Jobs and Real WagesIssue 3 Immigration Jobs and Real Wages

bull How does an increase in the labor force through immigration or How does an increase in the labor force through immigration or natural population growth affect labor and GDP natural population growth affect labor and GDP

bull One of the emotional issues associated with US immigration One of the emotional issues associated with US immigration policy ndash particularly towards low-wage workers from Mexico ndash policy ndash particularly towards low-wage workers from Mexico ndash is the idea that is the idea that immigrants take jobs away from native immigrants take jobs away from native workers workers We might be tempted to dismiss this fear as another We might be tempted to dismiss this fear as another example of the lump-of-labor fallacy Yet there is a sensible example of the lump-of-labor fallacy Yet there is a sensible intuition behind the argument An increase in the labor force ndash intuition behind the argument An increase in the labor force ndash due either to immigration or to higher population growth rates due either to immigration or to higher population growth rates ndash can be represented as an outward shift of the aggregate labor ndash can be represented as an outward shift of the aggregate labor supply curve as shown in the following Figure Employment supply curve as shown in the following Figure Employment increases but real wages fall It is not then that immigrants increases but real wages fall It is not then that immigrants take jobs away from natives take jobs away from natives Rather they compete for jobsRather they compete for jobs putting downward pressure on real wagesputting downward pressure on real wages

bull Again we must exercise care in interpreting the analysis Again we must exercise care in interpreting the analysis Remember that aggregate labor and average wage rates hide Remember that aggregate labor and average wage rates hide many details of the labor process The incomes of the new many details of the labor process The incomes of the new immigrants immigrants creates demand creates demand for the new production that they for the new production that they make possible Immigrant workers (at least those ndash whether make possible Immigrant workers (at least those ndash whether legal or illegal ndash who have become the focus of the most intense legal or illegal ndash who have become the focus of the most intense political debate) political debate) are likely to possess fewer skills than nativesare likely to possess fewer skills than natives The net effect is that the increased demand for goods and The net effect is that the increased demand for goods and services generated by immigrants is likely to increase the services generated by immigrants is likely to increase the demand for skilled (demand for skilled (and largely nativeand largely native) workers relative to ) workers relative to their supply and so to increase real wages of skilled workers their supply and so to increase real wages of skilled workers Low-skilled immigration may lower the real wage for farm Low-skilled immigration may lower the real wage for farm workers but if anything it would raise the real wage for workers but if anything it would raise the real wage for computer programmerscomputer programmers

Next Task Labor Market in Kuwait

Appendix Is Labor Supply Stable Over Time

bull Statistics on participation rates or average hours for a Statistics on participation rates or average hours for a particular month or year are snapshot of the labor market particular month or year are snapshot of the labor market Can we analyze the effects of that increase on the labor market Can we analyze the effects of that increase on the labor market under the assumption that the labor-supply curves of workers under the assumption that the labor-supply curves of workers remain essentially stableremain essentially stable

bull Data on participation rates in the United States appear to Data on participation rates in the United States appear to support this conjecture (see Figure 811) which shows the support this conjecture (see Figure 811) which shows the overall civilian participation rate trending upward ndash at least overall civilian participation rate trending upward ndash at least from the middle of the 1960sfrom the middle of the 1960s

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

bull Early in the 19th century hand-woven cloth was very Early in the 19th century hand-woven cloth was very expensive and a worker was lucky to own the clothes on his expensive and a worker was lucky to own the clothes on his back and a spare set for church on Sunday Textiles were one of back and a spare set for church on Sunday Textiles were one of the first industries to benefit from the Industrial Revolution so the first industries to benefit from the Industrial Revolution so that by the end of the 19th century machine-made fabrics and that by the end of the 19th century machine-made fabrics and mass-production made decent clothing in larger quantities mass-production made decent clothing in larger quantities accessible to most of the population of the more developed accessible to most of the population of the more developed countries Similar progress has been made in most forms of countries Similar progress has been made in most forms of production Agricultural production which at the turn of the production Agricultural production which at the turn of the 20th century absorbed half the labor force now absorbs less 20th century absorbed half the labor force now absorbs less than 3 percent while producing more food more cheaply than than 3 percent while producing more food more cheaply than ever ever

bull We must be careful not to dismiss the Luddites as altogether We must be careful not to dismiss the Luddites as altogether foolish While new technology especially over decades has foolish While new technology especially over decades has proved to be a net gain for workers in general the Luddites proved to be a net gain for workers in general the Luddites were in fact correct that their way of life was threatened were in fact correct that their way of life was threatened Independent weavers became factory hands unskilled Independent weavers became factory hands unskilled workers increasingly women and often children replaced workers increasingly women and often children replaced skilled craftsmen and factory work often involved long hours skilled craftsmen and factory work often involved long hours in brutal conditions The wider society reaps the benefits of in brutal conditions The wider society reaps the benefits of technological change while a narrow group sometimes technological change while a narrow group sometimes disproportionately bears its costs Our analysis also assumes disproportionately bears its costs Our analysis also assumes that markets generally clear The implicit assumption is that that markets generally clear The implicit assumption is that displaced workers move on to new jobs possibly in other forms displaced workers move on to new jobs possibly in other forms of production Markets may have a tendency to clear in the of production Markets may have a tendency to clear in the long run yet workers may find themselves displaced in the long run yet workers may find themselves displaced in the short run say over the course of a business cycleshort run say over the course of a business cycle

Issue 3 Immigration Jobs and Real WagesIssue 3 Immigration Jobs and Real Wages

bull How does an increase in the labor force through immigration or How does an increase in the labor force through immigration or natural population growth affect labor and GDP natural population growth affect labor and GDP

bull One of the emotional issues associated with US immigration One of the emotional issues associated with US immigration policy ndash particularly towards low-wage workers from Mexico ndash policy ndash particularly towards low-wage workers from Mexico ndash is the idea that is the idea that immigrants take jobs away from native immigrants take jobs away from native workers workers We might be tempted to dismiss this fear as another We might be tempted to dismiss this fear as another example of the lump-of-labor fallacy Yet there is a sensible example of the lump-of-labor fallacy Yet there is a sensible intuition behind the argument An increase in the labor force ndash intuition behind the argument An increase in the labor force ndash due either to immigration or to higher population growth rates due either to immigration or to higher population growth rates ndash can be represented as an outward shift of the aggregate labor ndash can be represented as an outward shift of the aggregate labor supply curve as shown in the following Figure Employment supply curve as shown in the following Figure Employment increases but real wages fall It is not then that immigrants increases but real wages fall It is not then that immigrants take jobs away from natives take jobs away from natives Rather they compete for jobsRather they compete for jobs putting downward pressure on real wagesputting downward pressure on real wages

bull Again we must exercise care in interpreting the analysis Again we must exercise care in interpreting the analysis Remember that aggregate labor and average wage rates hide Remember that aggregate labor and average wage rates hide many details of the labor process The incomes of the new many details of the labor process The incomes of the new immigrants immigrants creates demand creates demand for the new production that they for the new production that they make possible Immigrant workers (at least those ndash whether make possible Immigrant workers (at least those ndash whether legal or illegal ndash who have become the focus of the most intense legal or illegal ndash who have become the focus of the most intense political debate) political debate) are likely to possess fewer skills than nativesare likely to possess fewer skills than natives The net effect is that the increased demand for goods and The net effect is that the increased demand for goods and services generated by immigrants is likely to increase the services generated by immigrants is likely to increase the demand for skilled (demand for skilled (and largely nativeand largely native) workers relative to ) workers relative to their supply and so to increase real wages of skilled workers their supply and so to increase real wages of skilled workers Low-skilled immigration may lower the real wage for farm Low-skilled immigration may lower the real wage for farm workers but if anything it would raise the real wage for workers but if anything it would raise the real wage for computer programmerscomputer programmers

Next Task Labor Market in Kuwait

Appendix Is Labor Supply Stable Over Time

bull Statistics on participation rates or average hours for a Statistics on participation rates or average hours for a particular month or year are snapshot of the labor market particular month or year are snapshot of the labor market Can we analyze the effects of that increase on the labor market Can we analyze the effects of that increase on the labor market under the assumption that the labor-supply curves of workers under the assumption that the labor-supply curves of workers remain essentially stableremain essentially stable

bull Data on participation rates in the United States appear to Data on participation rates in the United States appear to support this conjecture (see Figure 811) which shows the support this conjecture (see Figure 811) which shows the overall civilian participation rate trending upward ndash at least overall civilian participation rate trending upward ndash at least from the middle of the 1960sfrom the middle of the 1960s

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

bull We must be careful not to dismiss the Luddites as altogether We must be careful not to dismiss the Luddites as altogether foolish While new technology especially over decades has foolish While new technology especially over decades has proved to be a net gain for workers in general the Luddites proved to be a net gain for workers in general the Luddites were in fact correct that their way of life was threatened were in fact correct that their way of life was threatened Independent weavers became factory hands unskilled Independent weavers became factory hands unskilled workers increasingly women and often children replaced workers increasingly women and often children replaced skilled craftsmen and factory work often involved long hours skilled craftsmen and factory work often involved long hours in brutal conditions The wider society reaps the benefits of in brutal conditions The wider society reaps the benefits of technological change while a narrow group sometimes technological change while a narrow group sometimes disproportionately bears its costs Our analysis also assumes disproportionately bears its costs Our analysis also assumes that markets generally clear The implicit assumption is that that markets generally clear The implicit assumption is that displaced workers move on to new jobs possibly in other forms displaced workers move on to new jobs possibly in other forms of production Markets may have a tendency to clear in the of production Markets may have a tendency to clear in the long run yet workers may find themselves displaced in the long run yet workers may find themselves displaced in the short run say over the course of a business cycleshort run say over the course of a business cycle

Issue 3 Immigration Jobs and Real WagesIssue 3 Immigration Jobs and Real Wages

bull How does an increase in the labor force through immigration or How does an increase in the labor force through immigration or natural population growth affect labor and GDP natural population growth affect labor and GDP

bull One of the emotional issues associated with US immigration One of the emotional issues associated with US immigration policy ndash particularly towards low-wage workers from Mexico ndash policy ndash particularly towards low-wage workers from Mexico ndash is the idea that is the idea that immigrants take jobs away from native immigrants take jobs away from native workers workers We might be tempted to dismiss this fear as another We might be tempted to dismiss this fear as another example of the lump-of-labor fallacy Yet there is a sensible example of the lump-of-labor fallacy Yet there is a sensible intuition behind the argument An increase in the labor force ndash intuition behind the argument An increase in the labor force ndash due either to immigration or to higher population growth rates due either to immigration or to higher population growth rates ndash can be represented as an outward shift of the aggregate labor ndash can be represented as an outward shift of the aggregate labor supply curve as shown in the following Figure Employment supply curve as shown in the following Figure Employment increases but real wages fall It is not then that immigrants increases but real wages fall It is not then that immigrants take jobs away from natives take jobs away from natives Rather they compete for jobsRather they compete for jobs putting downward pressure on real wagesputting downward pressure on real wages

bull Again we must exercise care in interpreting the analysis Again we must exercise care in interpreting the analysis Remember that aggregate labor and average wage rates hide Remember that aggregate labor and average wage rates hide many details of the labor process The incomes of the new many details of the labor process The incomes of the new immigrants immigrants creates demand creates demand for the new production that they for the new production that they make possible Immigrant workers (at least those ndash whether make possible Immigrant workers (at least those ndash whether legal or illegal ndash who have become the focus of the most intense legal or illegal ndash who have become the focus of the most intense political debate) political debate) are likely to possess fewer skills than nativesare likely to possess fewer skills than natives The net effect is that the increased demand for goods and The net effect is that the increased demand for goods and services generated by immigrants is likely to increase the services generated by immigrants is likely to increase the demand for skilled (demand for skilled (and largely nativeand largely native) workers relative to ) workers relative to their supply and so to increase real wages of skilled workers their supply and so to increase real wages of skilled workers Low-skilled immigration may lower the real wage for farm Low-skilled immigration may lower the real wage for farm workers but if anything it would raise the real wage for workers but if anything it would raise the real wage for computer programmerscomputer programmers

Next Task Labor Market in Kuwait

Appendix Is Labor Supply Stable Over Time

bull Statistics on participation rates or average hours for a Statistics on participation rates or average hours for a particular month or year are snapshot of the labor market particular month or year are snapshot of the labor market Can we analyze the effects of that increase on the labor market Can we analyze the effects of that increase on the labor market under the assumption that the labor-supply curves of workers under the assumption that the labor-supply curves of workers remain essentially stableremain essentially stable

bull Data on participation rates in the United States appear to Data on participation rates in the United States appear to support this conjecture (see Figure 811) which shows the support this conjecture (see Figure 811) which shows the overall civilian participation rate trending upward ndash at least overall civilian participation rate trending upward ndash at least from the middle of the 1960sfrom the middle of the 1960s

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

Issue 3 Immigration Jobs and Real WagesIssue 3 Immigration Jobs and Real Wages

bull How does an increase in the labor force through immigration or How does an increase in the labor force through immigration or natural population growth affect labor and GDP natural population growth affect labor and GDP

bull One of the emotional issues associated with US immigration One of the emotional issues associated with US immigration policy ndash particularly towards low-wage workers from Mexico ndash policy ndash particularly towards low-wage workers from Mexico ndash is the idea that is the idea that immigrants take jobs away from native immigrants take jobs away from native workers workers We might be tempted to dismiss this fear as another We might be tempted to dismiss this fear as another example of the lump-of-labor fallacy Yet there is a sensible example of the lump-of-labor fallacy Yet there is a sensible intuition behind the argument An increase in the labor force ndash intuition behind the argument An increase in the labor force ndash due either to immigration or to higher population growth rates due either to immigration or to higher population growth rates ndash can be represented as an outward shift of the aggregate labor ndash can be represented as an outward shift of the aggregate labor supply curve as shown in the following Figure Employment supply curve as shown in the following Figure Employment increases but real wages fall It is not then that immigrants increases but real wages fall It is not then that immigrants take jobs away from natives take jobs away from natives Rather they compete for jobsRather they compete for jobs putting downward pressure on real wagesputting downward pressure on real wages

bull Again we must exercise care in interpreting the analysis Again we must exercise care in interpreting the analysis Remember that aggregate labor and average wage rates hide Remember that aggregate labor and average wage rates hide many details of the labor process The incomes of the new many details of the labor process The incomes of the new immigrants immigrants creates demand creates demand for the new production that they for the new production that they make possible Immigrant workers (at least those ndash whether make possible Immigrant workers (at least those ndash whether legal or illegal ndash who have become the focus of the most intense legal or illegal ndash who have become the focus of the most intense political debate) political debate) are likely to possess fewer skills than nativesare likely to possess fewer skills than natives The net effect is that the increased demand for goods and The net effect is that the increased demand for goods and services generated by immigrants is likely to increase the services generated by immigrants is likely to increase the demand for skilled (demand for skilled (and largely nativeand largely native) workers relative to ) workers relative to their supply and so to increase real wages of skilled workers their supply and so to increase real wages of skilled workers Low-skilled immigration may lower the real wage for farm Low-skilled immigration may lower the real wage for farm workers but if anything it would raise the real wage for workers but if anything it would raise the real wage for computer programmerscomputer programmers

Next Task Labor Market in Kuwait

Appendix Is Labor Supply Stable Over Time

bull Statistics on participation rates or average hours for a Statistics on participation rates or average hours for a particular month or year are snapshot of the labor market particular month or year are snapshot of the labor market Can we analyze the effects of that increase on the labor market Can we analyze the effects of that increase on the labor market under the assumption that the labor-supply curves of workers under the assumption that the labor-supply curves of workers remain essentially stableremain essentially stable

bull Data on participation rates in the United States appear to Data on participation rates in the United States appear to support this conjecture (see Figure 811) which shows the support this conjecture (see Figure 811) which shows the overall civilian participation rate trending upward ndash at least overall civilian participation rate trending upward ndash at least from the middle of the 1960sfrom the middle of the 1960s

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

bull Again we must exercise care in interpreting the analysis Again we must exercise care in interpreting the analysis Remember that aggregate labor and average wage rates hide Remember that aggregate labor and average wage rates hide many details of the labor process The incomes of the new many details of the labor process The incomes of the new immigrants immigrants creates demand creates demand for the new production that they for the new production that they make possible Immigrant workers (at least those ndash whether make possible Immigrant workers (at least those ndash whether legal or illegal ndash who have become the focus of the most intense legal or illegal ndash who have become the focus of the most intense political debate) political debate) are likely to possess fewer skills than nativesare likely to possess fewer skills than natives The net effect is that the increased demand for goods and The net effect is that the increased demand for goods and services generated by immigrants is likely to increase the services generated by immigrants is likely to increase the demand for skilled (demand for skilled (and largely nativeand largely native) workers relative to ) workers relative to their supply and so to increase real wages of skilled workers their supply and so to increase real wages of skilled workers Low-skilled immigration may lower the real wage for farm Low-skilled immigration may lower the real wage for farm workers but if anything it would raise the real wage for workers but if anything it would raise the real wage for computer programmerscomputer programmers

Next Task Labor Market in Kuwait

Appendix Is Labor Supply Stable Over Time

bull Statistics on participation rates or average hours for a Statistics on participation rates or average hours for a particular month or year are snapshot of the labor market particular month or year are snapshot of the labor market Can we analyze the effects of that increase on the labor market Can we analyze the effects of that increase on the labor market under the assumption that the labor-supply curves of workers under the assumption that the labor-supply curves of workers remain essentially stableremain essentially stable

bull Data on participation rates in the United States appear to Data on participation rates in the United States appear to support this conjecture (see Figure 811) which shows the support this conjecture (see Figure 811) which shows the overall civilian participation rate trending upward ndash at least overall civilian participation rate trending upward ndash at least from the middle of the 1960sfrom the middle of the 1960s

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

Next Task Labor Market in Kuwait

Appendix Is Labor Supply Stable Over Time

bull Statistics on participation rates or average hours for a Statistics on participation rates or average hours for a particular month or year are snapshot of the labor market particular month or year are snapshot of the labor market Can we analyze the effects of that increase on the labor market Can we analyze the effects of that increase on the labor market under the assumption that the labor-supply curves of workers under the assumption that the labor-supply curves of workers remain essentially stableremain essentially stable

bull Data on participation rates in the United States appear to Data on participation rates in the United States appear to support this conjecture (see Figure 811) which shows the support this conjecture (see Figure 811) which shows the overall civilian participation rate trending upward ndash at least overall civilian participation rate trending upward ndash at least from the middle of the 1960sfrom the middle of the 1960s

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

Appendix Is Labor Supply Stable Over Time

bull Statistics on participation rates or average hours for a Statistics on participation rates or average hours for a particular month or year are snapshot of the labor market particular month or year are snapshot of the labor market Can we analyze the effects of that increase on the labor market Can we analyze the effects of that increase on the labor market under the assumption that the labor-supply curves of workers under the assumption that the labor-supply curves of workers remain essentially stableremain essentially stable

bull Data on participation rates in the United States appear to Data on participation rates in the United States appear to support this conjecture (see Figure 811) which shows the support this conjecture (see Figure 811) which shows the overall civilian participation rate trending upward ndash at least overall civilian participation rate trending upward ndash at least from the middle of the 1960sfrom the middle of the 1960s

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

bull Unfortunately the behavior of participation rates probably Unfortunately the behavior of participation rates probably does not reflect the effect of rising real-wage rates on stable does not reflect the effect of rising real-wage rates on stable labor-supply curves Peoplersquos tastes and reservation wages labor-supply curves Peoplersquos tastes and reservation wages (opportunity costs) are likely to depend on age sex and (opportunity costs) are likely to depend on age sex and possibly other factors The overall participation rate reflects in possibly other factors The overall participation rate reflects in part the average effect of these various factors and in part the part the average effect of these various factors and in part the effect of changing real-wage rates The overall participation effect of changing real-wage rates The overall participation rate may be hard to interpret because it mixes men and rate may be hard to interpret because it mixes men and women young and old skilled and unskilled To isolate the women young and old skilled and unskilled To isolate the effect of real wages it would be better to look at more effect of real wages it would be better to look at more homogeneous groups Figure 811 also shows the participation homogeneous groups Figure 811 also shows the participation rate for one such grouprate for one such group

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

bull prime-age males ndash that is prime-age males ndash that is men in their peak working years 24-men in their peak working years 24-54 Their participation 54 Their participation rate varied from month-to-month rate varied from month-to-month around a fairly steady mean (about 97 percent) until 1970 It around a fairly steady mean (about 97 percent) until 1970 It then fell until the late 1980s and appears to have stabilized then fell until the late 1980s and appears to have stabilized around a mean of 92 percent since then around a mean of 92 percent since then

bull What explains the fall in prime-age male participation rates What explains the fall in prime-age male participation rates For several years economists and politicians have debated For several years economists and politicians have debated whether real wages ndash properly computed ndash rose or fell from the whether real wages ndash properly computed ndash rose or fell from the early 1970s to the mid-1990s The fall in the prime-male early 1970s to the mid-1990s The fall in the prime-male participation rate is consistent with a constant distribution of participation rate is consistent with a constant distribution of reservation wages and a falling real wagereservation wages and a falling real wage

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

bull But the reservation wages were not necessarily constant The But the reservation wages were not necessarily constant The fall in participation rates is also consistent with an increasing fall in participation rates is also consistent with an increasing reservation wage that could have resulted from changing reservation wage that could have resulted from changing demographics and social relations (for example the average demographics and social relations (for example the average numbers of children in families or the proportion of wives in numbers of children in families or the proportion of wives in the labor force) The two relatively stable periods before 1970 the labor force) The two relatively stable periods before 1970 and after 1990 also challenge the idea that labor-supply curves and after 1990 also challenge the idea that labor-supply curves were stable Real wages increased over both periods which were stable Real wages increased over both periods which should imply increased participation rates This may provide should imply increased participation rates This may provide further evidence that reservation wages vary over time further evidence that reservation wages vary over time perhaps because workersrsquo relative taste for leisure over perhaps because workersrsquo relative taste for leisure over consumption adjusts to the levels of consumption to which they consumption adjusts to the levels of consumption to which they become accustomedbecome accustomed

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

bull For example if a real wage of $8 per hour was enough to induce a worker For example if a real wage of $8 per hour was enough to induce a worker to enter the work force in 1970 and by 2006 real wages had risen to say to enter the work force in 1970 and by 2006 real wages had risen to say $24 per hour then that worker who is now used to the higher wage might $24 per hour then that worker who is now used to the higher wage might have stop participating if the real wage falls to$21 per hour A young but have stop participating if the real wage falls to$21 per hour A young but otherwise similar worker might not wish to enter the labor force unless the otherwise similar worker might not wish to enter the labor force unless the real wage were more than $24 per hour Such shifting tastes and real wage were more than $24 per hour Such shifting tastes and relative relative preferences are also consistent with the notion that poverty is a matter of preferences are also consistent with the notion that poverty is a matter of relative rather than absolute material deprivationrelative rather than absolute material deprivation

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

bull Turning to the choice of hours of labor it is harder to draw a definite prediction Turning to the choice of hours of labor it is harder to draw a definite prediction from our analysis If we imagine that Figures 88 and 89 describe typical individual from our analysis If we imagine that Figures 88 and 89 describe typical individual labor-supply curves where any individual worker finds himself on the curve labor-supply curves where any individual worker finds himself on the curve depends on the distribution of wage rates offered by firms If the average real wage depends on the distribution of wage rates offered by firms If the average real wage rises over time we would expect the whole wage structure to shift up Workers on rises over time we would expect the whole wage structure to shift up Workers on the low end of the wage spectrum are likely to supply more hours workers at the low end of the wage spectrum are likely to supply more hours workers at intermediate wage rates would supply the same number of hours (the statutory 40 intermediate wage rates would supply the same number of hours (the statutory 40 per week) and workers at the higher end who find themselves on the backward-per week) and workers at the higher end who find themselves on the backward-bending segment would supply fewer hours But how do these changes affect the bending segment would supply fewer hours But how do these changes affect the aggregate number of hours supplied That depends on how many people are on each aggregate number of hours supplied That depends on how many people are on each segment of the typical labor-supply curve If many people are on the lower upward-segment of the typical labor-supply curve If many people are on the lower upward-sloping segment then the rise in average real-wage rates should increase average sloping segment then the rise in average real-wage rates should increase average hours supplied If as seems likely from the data behind Figure 88 many workers hours supplied If as seems likely from the data behind Figure 88 many workers find themselves constrained to supply 40 hours per week then average hours would find themselves constrained to supply 40 hours per week then average hours would not be too sensitive to changes in wages rates Only if many workers were on the not be too sensitive to changes in wages rates Only if many workers were on the backward-bending segments might we expect average hours to fall What actually backward-bending segments might we expect average hours to fall What actually happenedhappened

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

bull Average weekly hours of work for all persons in private industry fell Average weekly hours of work for all persons in private industry fell steadily between the mid 1960s and the early 1990s (Figure 812) But as steadily between the mid 1960s and the early 1990s (Figure 812) But as with the data on civilian participation rates these data mix a wide diversity with the data on civilian participation rates these data mix a wide diversity of workers Figure 812 also shows the average hours for a single sector in of workers Figure 812 also shows the average hours for a single sector in which workers may be more homogeneous manufacturing These are which workers may be more homogeneous manufacturing These are highly variable around a steady mean of about 40 hours per week up to the highly variable around a steady mean of about 40 hours per week up to the mid 1980s They have since trended up a little to about 42 hours per weekmid 1980s They have since trended up a little to about 42 hours per week

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

bull Steady average hours could have several explanations One possibility is that Steady average hours could have several explanations One possibility is that income effects could exactly offset substitution effects A second is that income effects could exactly offset substitution effects A second is that workers generally wish to work more hours but are constrained to work the workers generally wish to work more hours but are constrained to work the normal 40-hour week by their employers The first explanation seems normal 40-hour week by their employers The first explanation seems unlikely Precisely offsetting income and substitution effects would make the unlikely Precisely offsetting income and substitution effects would make the labor-supply curve in Figure 89 vertical but would not remove the labor-supply curve in Figure 89 vertical but would not remove the discontinuity at the reservation wage So while hours supplied would remain discontinuity at the reservation wage So while hours supplied would remain steady on average rising wages would over time be accompanied by rising steady on average rising wages would over time be accompanied by rising participation rates But as we saw participation rates tend to be constant or participation rates But as we saw participation rates tend to be constant or fallingfalling

bull Given the statutory 40-hour week the rising trend in average hours in Given the statutory 40-hour week the rising trend in average hours in manufacturing since the mid 1980s must be the result of overtime The manufacturing since the mid 1980s must be the result of overtime The explanation for increased overtime is unlikely to be a change in taste on the explanation for increased overtime is unlikely to be a change in taste on the part of workers Surely many of those who work a 40-hour week would work part of workers Surely many of those who work a 40-hour week would work more if the employers would let them But the rule of time-and-a-half for more if the employers would let them But the rule of time-and-a-half for overtime means that there is a large jump in marginal costs at 40 hours per overtime means that there is a large jump in marginal costs at 40 hours per week A firm will only allow overtime on a continuing basis if it is cheaper to week A firm will only allow overtime on a continuing basis if it is cheaper to pay some workers overtime than to hire more workers on straight time The pay some workers overtime than to hire more workers on straight time The explanation for rising overtime surely must be sought in some change in the explanation for rising overtime surely must be sought in some change in the structure of labor costs in firms rather than in changes in the tastes of structure of labor costs in firms rather than in changes in the tastes of workersworkers

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked

bull The interpretation of average hours is complicated To get behind The interpretation of average hours is complicated To get behind the aggregate data the economist needs to pay attention to the aggregate data the economist needs to pay attention to demographics social organization the distribution of worker skills demographics social organization the distribution of worker skills and other factors These are the domain of a specialized field and other factors These are the domain of a specialized field labor labor economics and outside the scope of a macroeconomics course economics and outside the scope of a macroeconomics course Still the Still the evidence points to some general conclusions about evidence points to some general conclusions about aggregate labor supply The fact that many workers are constrained aggregate labor supply The fact that many workers are constrained to work 40-hour weeks plus the empirical observation that to work 40-hour weeks plus the empirical observation that participation rates do not vary much despite massive increases in participation rates do not vary much despite massive increases in real wages (Figure 811) suggests that aggregate labor-supply real wages (Figure 811) suggests that aggregate labor-supply curves are likely to be relatively steep ndash that is large changes in curves are likely to be relatively steep ndash that is large changes in average real-wage rates cause only small changes in participation average real-wage rates cause only small changes in participation rates or average hours workedrates or average hours worked