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CHAPTER 1

CHAPTER 1. “Observations always involve theory.” -Edwin Hubble. Why Study Labor Economics?. Individuals, organizations, and governments allocate substantial resources to labor markets Labor economics studies how these agents interact in labor markets

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CHAPTER 1

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  1. CHAPTER 1 “Observations always involve theory.” -Edwin Hubble

  2. Why Study Labor Economics? • Individuals, organizations, and governments allocate substantial resources to labor markets • Labor economics studies how these agents interact in labor markets • Labor economics provides a logically coherent framework for understanding many social and economic problems facing modern societies

  3. Basics of the Labor Market Participants (“agents”) have motives: Individuals maximize their well-being or “utility” Organizations maximize profits and/or minimize costs Governments use taxes, subsidies, and regulation to try to achieve goals of public policy: Minimum wage Occupational safety • Payroll taxes

  4. Three “Agents” • Individuals • Decide whether or not to work and, if so, how many hours to work, how much effort to provide, and for whom • Maximize utility subject to constraint(s); i.e., optimize by selecting the best (highest utility) option from available choices • Supply more time and effort in response to higher payoffs, implying an upward-sloping labor supply curve

  5. Three “Agents” • Organizations • Decide whom, and how many, to hire and fire • Maximize profits and/or minimize costs • Equate the price of labor with the (diminishing) marginal productivity of increasing numbers of workers, implying a downward-sloping labor-demand curve

  6. Three “Agents” • Governments • Impose taxes and regulations • Provide subsidies and public goods • Establish ground rules that provide a framework for legal exchanges between individuals and organizations in labor markets

  7. Why Do We Need a Theory? • To help us organize observations (“facts”) about the labor market in a logically coherent way • To force us to focus on the most important factors determining the behavior of individuals and organizations (operating within a framework of government taxes, subsidies, and regulations) while leaving out the less important factors • To help us understand and generalize about how individuals, organizations, and governments interact in the labor market

  8. Positive vs. Normative Economics Positive economics Concerned with the facts Focuses on “what is” Analyses the consequences of changes in constraints on the optimal choices of individuals and organizations Normative economics Embodies ethical judgments or “values” Focuses on “what should be”

  9. The Alaskan Labor Market and Construction of the Oil Pipeline Earnings ($) S0 w1 w0 D1 D0 Employment E1 E0

  10. Wages and Employment in the Alaskan Labor Market, 1968-1984

  11. Summary • Labor economics studies how individuals and organizations engage in mutually beneficial exchange in markets that are affected by government rules • Models in labor economics typically contain three actors: people, organizations, and governments • A “scientific” theory or hypothesis is derived from a set of assumptions and can, in principle, be “falsified” with real-world data • The tools of economics and statistics are used to conduct positive analyses of labor-market issues

  12. Regression Analysis Log Wage Change in log wage Slope = b Years of Schooling Change in schooling a

  13. Wages and Schooling by Occupation

  14. Choosing Among Lines Summarizing Trends in the Data

  15. The Best-Fit Regression Line

  16. Multiple RegressionModel • Extends the simple regression model to the more realistic case of additional explanatory variables • y =  + x + z +  • Example: Earnings across occupations, again • Include p = proportion of women in an occupation • logw=  + s + p +  • log w = 0.924 + 0.150s – 0.003p (0.154) (0.011) (0.001) R2 = 0.816

  17. Simple Regression Model • y =  + x +  • The slope  gives the marginal effect of a one-unit change in the explanatory variable x on the dependent variable, y • The intercept  gives the expected value of y when x = 0 • The error term  is a random variable that captures the effects of specification error, measurement error in x or y, and “luck”

  18. Example: Schooling and Earnings • loge(Wage) =  + (Years of Schooling) +  • log w =  + s +  • log w = 0.869 + 0.143s (0.172) (0.012) R2= 0.762

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