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Economics 371

Economics 371. discrimination. monopsony. Labor Economics. unemployment. minimum wages. occupational licensing. education. labor unions. welfare programs. income taxes. job search. diminishing returns. Course Essentials. Course Web Page www.marietta.edu/~delemeeg/econ371 Grades

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Economics 371

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  1. Economics 371 discrimination monopsony Labor Economics unemployment minimum wages occupational licensing education labor unions welfare programs income taxes job search diminishing returns

  2. Course Essentials • Course Web Page • www.marietta.edu/~delemeeg/econ371 • Grades • Exams (60%) • Homework (20%) • Policy/Market Brief (20%)

  3. Economic Models Objectives  Constraints  Behavior Economic Way of Thinking • Rationality • Marginal analysis • Scarcity • Positive vs. normative analysis

  4. Labor Market Model S wages w* D L* Labor

  5. Labor Supply: Labor-Leisure Model • Time Allocation Decision: • Leisure • Work • Market work • Household production • Human Capital Investment • Formal education • On-the-job training Total weekly hours = 168 = H + L

  6. Objective: Utility maximization maximize U = U( Y, L ) Income Preference Rankings: B A B D D C B C Possible that A D » » A B » » C D ≡ I Leisure

  7. Results of Survey $6.96 $7.25 $18. 46 $11.30 4% Yes: 9% No: 91% Yes: 52% No: 48% Yes: 22% No: 78% c or d: 65%

  8. ≡ measures willingness to sacrifice income for leisure Indifference Curves Income • Locus of all bundles of (Y, L) that give the same utility • Higher utility to the NE • Negative slope • Convex: diminishing MRS • Can’t intersect I3 I2 I1 Leisure

  9. Indifference Curves Income Income • Which indifference curve represents a workaholic? ΔL ΔL ΔY ΔY I2 I1 Leisure Leisure MRS1 > MRS2

  10. Budget Constraint Define: 168 = L + H Y = wH + N or Y = w(168-L) + N Where: w = wage rate L = leisure H = hours of work N = non-labor income Y = total income Income $1680 Slope = - w Example: w = $10 N = 0 ΔY ΔL 168 Leisure

  11. Consumer Optimum Maximize U(Y,L) s.t. Y = wH + N Income At point E: MRS = w E Slope of indifference curve Y* Slope of budget constraint I1 Leisure L* 168

  12. Corner Solutions Income Reservation Wage: lowest wage at which one chooses to work I1 I4 At point A: MRS > w A  Choose more leisure Leisure 168

  13. Fred Glick Income 112 105 100 I1 166 167 168 Leisure

  14. Impact of a Change in Non-Labor Income What happens to labor supply if you win the lottery? • Assume leisure is a normal good • As N ↑  H ↓ Assume: w = $10 N = $200 Income $400 I2 I1 Leisure 128 168

  15. Labor Supply and the Lottery Source: Kimball, Miles S. and Matthew D. Shapiro. “Labor Supply: Are the Income and Substitution Effects Both Large or Both Small?” Working Paper, May 16, 2003. Accessed online at www-personal.umich.edu/~mkimball/pdf/labor-16may2003.pdf.

  16. Impact of a Change in Wages What happens to labor supply if your wages rise? • Two possibilities: • As w ↑  H ↑ • As w ↑  H↓ Income I2 < 0 I2 > I1 Leisure 128 168

  17. Wage Change Decomposition • Change in wage has two opposing effects on labor supply: • Substitution effect • Income effect “incentive effect” “lottery effect” Total Effect Substitution Effect Income Effect = + (+) (?) (-)

  18. Observed Change Wage Change Decomposition Example: Wage increase when SE > IE Income IE: H1 to H2 TE: H1 to H3 SE: H2 to H3 I2 Trick: create hypothetical budget line that is parallel to original budget line but tangent to new indifference curve I1 Leisure H3 H1 H2 168

  19. Backward Bending Labor Supply Curve • Elasticity of Supply: Supply wage IE > SE w* SE > IE H* Labor (hours) • Males: E ≈ - 0.10 to - 0.20 • Females: E ≈ +1.0 Why the gender difference?

  20. Premium Pay vs. Straight Pay • FLSA (1938): “time-and-a-half” for hours beyond 40 per week Income Problem Set 1: #10 E2 w =$10: worker chooses E1 and works H = 40 w =$15: worker relocates to E2 and works more than 40 hours E1 I2 I1 128 168 Leisure Suppose initial hours of work was H = 20. Would premium pay encourage more work effort?

  21. Income Tax • Flat tax • Progressive tax • Lump sum tax Income No tax: slope = -w Flat tax: slope = -(1-t)w w1 = $10 t = 20% w2 = (1- 0.2)10 = $8 168 Leisure What happens to labor supply under the flat tax compared to no tax?

  22. TANF Block grant Must work after 2 yrs 5 yr limit SSI Medicaid Food Stamps EITC 3 Basic Features Basic Benefit: B Benefit-Reduction Rate: t Break-even level of income: Yb Income Maintenance Programs Varies from $164 to $923 a month S = B - tY Example: B = $3000 t = 0.50 Y = $5000 S = 3000 – (0.50)(5000) = $500 What is break-even level of income?

  23. Policy Proposals: Raise B: _________ labor supply ________ program costs Lower t: _________ labor supply ________ program costs Policy Objectives __________________ __________________ __________________ Income Maintenance Programs Income S = B - tY Yb I2 I1 H1 168 Leisure

  24. Welfare Case Loads • 1990s economic boom • Expansion of EITC • Welfare reform • Expansion of child care and training programs Families (millions) What caused the drop in caseloads?

  25. Labor Force Participation Rates LFPR = LF / Pop u = U / LF

  26. Male and Female LF Participation Rates: 1950-2008 Male All Percent Female Source: http://www.bls.gov/cps/tables.htm

  27. Male LFPR by Age Percent

  28. Female LFPR by Age Percent

  29. Male LFPR by Race Percent

  30. Male LFPR by Race Percent

  31. Female LFPR by Race Percent

  32. Secular Trends in LFPR • Falling male LFPR • _____________________________ • _____________________________ • _____________________________ • _____________________________ • Rising female LFPR • _____________________________ • _____________________________ • _____________________________ • _____________________________ • _____________________________ • _____________________________

  33. Cyclical Trends in LFPR • Added worker effect • Discouraged worker effect LFPR LFPR is _____________ GDP time

  34. Human Capital • Formal Education • ___________? • ___________? • ___________? • On-the-job Training In 1970, 36% of the labor force was a high school dropout. In 2002, it was 13%.

  35. 17 + years 16 years 12 years < 12 years Based on Figure 4.1 in McConnell, Brue, and Macpherson (2006)

  36. Human Capital Investment • Initial cost to be recouped over time $ College _________________ HS ________________ 18 ______________ age

  37. Net Present Value: Go to college if __________ HK Decision Rules Where: Ei = incremental earnings in year i i = interest rate n = expected working life

  38. PV of $8,000 Investment in Webmaster Training Program(Interest Rate = 10 Percent) Incremental Earnings (2) Discounted Value(10 Percent Rate)(3) Present Valueof Earnings(4) Year(1) • Suppose Melinda is considering taking a webmaster training program that involves direct costs of $3,000 and forgone earnings $5,000. The training program will increase Melinda’s earnings by $3,000, $4,000, and $5,000 for the 3 years she plans on working. • Because she can borrow the funds at an interest rate of 10%, we will discount the future expected income at an 10% rate. • What is the present value (PV)of this training program? • The PV of the training program is positive, Melinda should take the training program. 0 -$ 8,000 1.000 $ -8,000 1 $ 3,000 0.909 $ 2,727 2 $ 4,000 0.826 $ 3,305 3 $ 5,000 0.751 $ 3,755 $ 1,787

  39. Net Present Value: Go to college if NPV > 0 HK Decision Rules Where: Ei = incremental earnings in year i i = interest rate n = expected working life • Internal Rate of Return: Go to college if _______ Example: r = 12% i = 8%

  40. Human Capital Model • Implications: • Time horizon • Costs • Earnings differential • Discount rate • Empirical Evidence • Rate-of-return studies: r ≈ _______________ • College wage premiums

  41. Based on Example 4.2 in McConnell, Brue, and Macpherson (2006)

  42. Female Male Based on Figure 4.3 in McConnell, Brue, and Macpherson (2006)

  43. Social Rate of Return to HK • External benefits • ______________________ • ______________________ • ______________________ • ______________________ • ______________________ • Biases: • ______________________ • ______________________ Neglecting ability _________ gains due to education Neglecting fringes/psychic benefits may _________ gains due to education

  44. George Psacharaopoulos and Harry Patrinos, “Returns to Investment in Education: A Further Update,” World Bank Policy Research Working Paper 2881, September 2002.

  45. Distribution of Earnings: HK explanation Source: Mayer, Gerald. “The Distribution of Earnings of Wage and Salary Workers in the United States, 1994-2003.” December 2004. Available at http://digitalcommons.ilr.cornell.edu/key_workplace/194

  46. Distribution of Earnings: HK explanation Demand: diminishing returns to education Supply: perfectly elastic • Differences in HK investment • __________________ • __________________ • __________________ • Capital market imperfections • __________________ • __________________ r(%) r1 r2 DB DA e1 e2 education

  47. Screening Hypothesis • College degree as sorting device • Low-cost _________ device • College ________ add to HK • Evidence • “___________ effect”: rate of return on 12th and 16th year of schooling are much higher than 11th and 15th years • _____________ vs. salaried workers: SE have slightly less E than salaried • Wise (1975): GPAs and earnings of Ford workers are ____________ correlated • Suggests that social rate of return is __________

  48. On-the-Job Training • General training • Raises productivity to _______ employers • Specific training • Raises productivity to ________ employer Who pays for OTJ?

  49. MRPu = productivity without training MRPt = productivity during training MRPp = productivity after training On-the-Job Training $ MRPp wp wu MRPU MRPt time t1 Specific Training: MRPu< wp < MRPp wt = MRPu Employer pays for training; employee is exploited after training General Training: wp = MRPp wt = MRPt Employee pays thru low training wage

  50. Source: http://www.advicenow.org.uk/go/feature/feature_357.html?pkgid=35

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