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Chapter 5

Chapter 5. Quasi-Fixed Labor Costs and Their Effects on Demand. Nonwage Labor Costs. hiring and training costs employee benefits These costs make up 20 to 30% of payroll. (See Table 5.2 on page 135).

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Chapter 5

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  1. Chapter 5 Quasi-Fixed Labor Costs and Their Effects on Demand

  2. Nonwage Labor Costs • hiring and training costs • employee benefits • These costs make up 20 to 30% of payroll. (See Table 5.2 on page 135)

  3. These nonwage labor costs are important in determining the number of employees hired and the number of hours they work. WHY?

  4. Hiring costs include: • advertising positions • screening potential employees • processing successful applicants To fill a vacancy, Employers spend 15 – 22 hours screening and interviewing less-skilled workers (“1982 survey” cited in Bishop (1993)

  5. Training can be formal or informal

  6. Three types of training costs: • Explicit monetary costs - labor costs of individuals used as trainers and materials used in training process • Implicit opportunity costs of trainee’s time - lost production while a worker is being trained • Implicit and opportunity costs of capital and experienced employees used in training - lost production while a worker is being trained

  7. These costs are incurred in early years of employment and yield returns throughout the term of employment.

  8. One important aspect of training is who bears the cost of the training - - the firm or the worker?

  9. Employee Benefits • legally required social insurance contributions • unemployment insurance, workers’ compensation, Social Security, Medicare • privately provided benefits • holiday pay, vacation and sick leave, pensions, health and life insurance

  10. Because many of these nonwage costs are costs per worker instead of costs per hour worked, they are considered to be quasi-fixed costs. Once an employee is hired, these quasi-fixed costs don't change, regardless of hours worked.

  11. Hiring and training costs are quasi-fixed because they are associated with each new employee hired and not with the number of hours he or she works.

  12. Insurance premiums are also quasi-fixed.

  13. How do quasi fixed costs affect these decisions: • How many workers should the firm hire? • How many hours should each employee work? • If the firm needs to increase output, should it hire more workers or increase the number of hours worked by each employee?

  14. Let's look at the firm's decision of how many workers to hire (M) and the average number of hours worked each week per employee (H).

  15. Q = f (M,H) • Assume MPM > 0 and MPH > 0 but both are diminishing.

  16. Let’s call the marginal expense an employer faces when employing an additional worker MEM. MEM will be a function of both the quasi-fixed labor costs plus the worker’s wage and variable employee benefit costs

  17. Let’s call the marginal expense an employer faces when it decides to increase the average workweek of its employees by one hour MEH. MEH will be equal to the hourly wage and variable employee benefits costs multiplied by the number of workers

  18. To minimize costs, the firm should follow the equi-marginal principle: MPM/MEM = MPH/MEH

  19. Much overtime worked is due to rush orders, deadlines, seasonal demand, etc. However, some of it is regularly scheduled overtime

  20. Why does an employer regularly schedule overtime?

  21. Suppose that a firm is currently maximizing profit and then quasi- fixed costs increase: • MPM/MEM < MPH/MEH because MEM increased • to restore the equi-marginal principle, the firm must either increase the left-hand side or decrease the right-hand side (or both) • because of diminishing marginal product, the left hand side will increase if M is lowered and the right hand side will decrease if H is increased

  22. Suppose government wishes to encourage employers to increase employment and stop using regular overtime. How can it do this? • Increase the overtime premium • this will increase MEH so that MPM/MEM > MPH/MEH • employers will need to either decrease H or increase M (or both)

  23. But, there may be reasons why this does not lead to an increase in employment: • Employers may substitute capital for labor • scale effects may occur as the price of output increases • total labor hours may fall limiting the employment gain for any decline in overtime hours

  24. Hiring And Training Costs • Firms worry about not only current MRPL but also future MRPL • Contracts with workers are usually long term

  25. We’re going to assume a two-period time horizon • firms incur hiring and training costs in the first period which cost Z per worker in real terms (dollar costs/product price) • without training the worker's MPL is MP* • during training he's not as productive so his MPL is MP0 (which < MP*) • after training, MPL is higher than without training (i.e., MP1 > MP*) • the wage the firm must pay is w0 in the first period and w1 in the second period

  26. Figure 5.2 Effects of Training on Marginal Product Schedules

  27. MP*- MP0 is the implicit cost of the trainee’s time in training

  28. Since a dollar in the future is worth less than a dollar today we must discount the future costs and productivity.

  29. Present value of marginal productivity

  30. Present value of the marginal expense of labor

  31. The profit-maximizing condition is therefore: PVP = PVE

  32. If Z=0 (no hiring and training costs), profit maximization requires that: • this implies that the firm can maximize profit by setting MP0 = w0 and MP1= w1 • in this case, the end result of the two-period model is exactly the same as the one-period model (workers are paid their MPL)

  33. However, Z > 0 implies that the firm has made some sort of initial investment in terms of hiring or training costs. Thus, the firm will want to recoup these costs in the future.

  34. The Net Expense of Hiring a Worker in the Initial Period: • this is likely to be positive because the amount that the firm spends on the worker in the initial period (w0 + Z) is likely to be greater than the worker’s productivity in the initial period (MP0)

  35. In order to recoup the net expense, the firm must run a net surplus in the next period Note that the net surplus must be discounted because it occurs in the second period.

  36. The Net Surplus Is Defined As:

  37. To maximize profits, net expense in the initial period must equal the surplus from the subsequent period:

  38. Note that wages may not always be equal to MP • If net expense > 0 then net surplus > 0 • this implies W1 < MP1 • if the firm's labor costs in the first period exceed MP then wages in the second period will be less than MP

  39. What determines who pays for the costs of training? • It depends on what type of training is received • there are two types of training: general training and specific training

  40. General training increases a worker's productivity to many employers equally.

  41. Specific training increases the worker's productivity only at the specific firm.

  42. Suppose the firm offers general training and incurs net costs NE0: • the training increases productivity to MP1 in the second period • but, to maximize profit, the firm must keep w1< MP1 to get a net surplus • the worker’s MP=MP1 to other firms so they would be willing to pay him a wage= MP1 • so the worker can earn w1< MP1 if he stays with the firm or he can earn w1= MP1 at other firms • what will the worker likely do?

  43. Will a firm offer general training?Who will have to pay?

  44. Specific training: • increases the worker's productivity only at the specific firm to MP1 • at all other firms, the worker is only worth MP* • the firm has an incentive to pay the worker at least MP* (what other firms are willing to pay) but less than MP1 (to recoup some of the costs of training)

  45. Let’s do an example: Assume: • the worker has a MP = MP* without training • the worker can obtain w= w* = MP* at all firms without training • during specific training the worker’s MP falls to MP0 and then after training MP rises to MP1 > MP*

  46. Graphically: MP1 w* = MP* MP0 Period 0 Period 1

  47. How will the firm set wages? It must meet three conditions: • to maximize profit, the firm must not incur wage and training expenses that exceed the value of the worker’s productivity • to attract workers, the firm must offer a wage stream whose present value is at least as large as alternative firms • to keep workers after training, the firm must pay a wage greater than w*

  48. What will the wage structure look like? Employees and firms share the costs of specific training MP1 w1 w* = MP* w0 MP0 Period 0 Period 1

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