LABOUR ECONOMICS AND INDUSTRIAL RELATIONS Lecturer/tutor PROFESSOR CHEW SOONSOON-BENG

Lecture 1: Labour Economics and Labour-Leisure Model

Why study Labor Economics? Human resources allocate substantial time and energy to labor markets Labor economics studies how labor markets work Labor economics helps us understand and address many social and economic problems facing modern societies A major part of our GDP comes from labor income Labor service ser ice a primary primar so source rce of ho household sehold income Unique and complex characteristics of the labor market
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Unique and complex characteristics of the labor market k t

Labour L b d demand di is a d derived i dd demand. d Labour demand is linked to product demand. Labour services have to be delivered personally and hence working conditions are important and personal in many cases. Labour services cannot be hoarded. Unemployment p y is increasingly g y not tolerated in modern society. y Jobless growth is increasingly not acceptable to the electorate. When labour markets are molded by popular politics, the country will incur persistent budget deficits. Government borrowing will increase. Eg, the PIGS in the Euro Zone.

Basics of the labor market

Three actors/participants, who are assigned motives; (conflicting interests) Workers look for the best job
The most important actor: without workers, there is no labor Desire to optimize (to select the best option from available choices) to maximize well-being Will want to supply more time and effort for higher payoffs, causing an upward-sloping labor supply curve (up to a point)
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Basics of the labor market-three actors

Firms look for profits Decide who to hire and fire ~ Derived from consumers demand Motivated to maximize profits Relationship between price of labor and no of workers a firm is willing to hire no. generates the labor demand curve Principle-Agent Principle Agent problem; Management takes a short term view; Take more risk for personal g gains and the firm and therefore the workforce and the 5 economy suffer in the long run

Basics of the labor market-three actors

The government wants to be elected or reelected Hard Option: Grow the economy and increase employment Soft Option: Buy votes via excessive public spending p p g

What can the government do?

Government Invest in infrastructure and human capital Imposes taxes, regulations Provides ground rules that guide exchanges made in labor markets Uses regulation to achieve goals of public policy p p y ~ Minimum wages ~ Unemployment benefits ~ Occupational safety

C fli ti Interests Conflicting I t t of f Workers W k and d Firms Fi

Many workers seeking work when wages are high, but few firms want to pay more than necessary Few workers want to work when wages are low, but y firms want to employ p y workers at such low wages g many As workers look for jobs and firms look for workers, the conflicting interests produce different labour market equilibriums depending on circumstances which are influenced by government regulations; Possible outcomes Full employment and competitive wages High labour turnover and no training Min wage law and some degree of unemployment
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Inherent conflicts in the labour , all agents g adopt p short term markets, perspective
Three Actors in the Labor Market Labor Market

Workers S Supply l labor l b for f payoff

Firms D Demand d labor l b given i price of labor and desire for profit Principal-agent problem

Government T Taxes Regulations Rules of exchange Government on short term horizon

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More pay and less work

Government debts mounting Spender p and Lender of Last Resort

2014: A or B
A = low growth B= World recession

A is likely; public debt ratio will increase Modified from Prof Lims slide

LABOUR MARKET DEFINITIONS

People who are active in the labour force (anyone over 16 years of age) Employed holding a job (part-time, fulltime, , temporary) p y) Not employed no job, but actively looking for work Labour force = employed + unemployed Labour force p participation p - determined by y the number of employed and unemployed (LFPR) )= Labour force participation rate ( labour force/population aged 16 and older
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Employment Rate

Employment rate = employed/population ER is a measure of aggregate economic activity ER may overestimate or underestimate the employment activities: 1. Employment does not indicate intensity of work (no indication of hours worked per week; treat involuntary part time as full time), making ER higher 2. Some segments of the population have no intention to work kb but ti included l d d in i the th population, l ti making ki ER lower l The hidden unemployed Discouraged workers who quit the labour force Those with little or no intention of working - retired, teenagers, women with small children, students in schools h l
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Employment Rate
3. ER does not reveal the extent of sub-employment p y Workers forced by economic circumstances to accept jobs that pay lower wages than what they qualify for during full employment periods 4. ER decreases could be due to rise in school enrolment rates, , fertility y rates of women, , which may be good for the country

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Unemployment Rate

Unemployment rate = unemployed / labour force Problems with this measure: 1. Underestimate unemployment due to: i. Hidden unemployment:
~ ~ ~ Discouraged Di d unemployed l d who h drop d out t of f the th labour l b force after unsuccessfully searching for a job Logically should be added to the labour force, but are not t On average, hidden unemployed would increase the unemployment rate by about 0.6%

ii. Sub-employed; some of them should be counted as

unemployed because of lack of choice and earnings may be little
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Unemployment Rate

Problems with this measure: 2 Overestimate 2. O ti t unemployment l t due d to: t i. Respondents who falsely declare that they are actively y seeking g work when they y are not in the labor force ii. Inclusion of semi-retired who wish to work part-time, part time, teenagers looking for after-school after school job iii. Workers who remain unemployed because they cannot accept the reality that they can no longer command their initial reservation wages i Workers iv. W k remain i unemployed l d till unemployment benefits run out 16

Source; Robin Chan, S.T. 5/1/2013, page D4

Source; Robin Chan, S.T. 5/1/2013, page D3

Government Revenue (operating revenue) contains mainly taxes and fees & charges Source; Robin Chan, S.T. 5/1/2013, page D4

Source; Robin Chan, S.T. 5/1/2013, page D2

Introduction to labor supply

Some facts Singapore: Working men: labor force participation has been stable around 76% in the 2000s Working women: rise in labor force participation from 50% to 56% from 2000 to 2010 Work hours in Europe and US fell from 40 to 35 per week during 1947-1990 and to less than 34 per week by 2000 Singapore: 44 per week; beyond which employees are entitled to over time 25 payments

Labour Supply - data

Data on labour force participation rates are a good measure of labour supply because they include the employed, employed the unemployed and the hidden unemployed Data on hours worked reflect more closely the demand for labour by employers

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Labour Supply pp y

People allocate their time each day between work and leisure Labour supply theory states that decision on desired hours of work depends on: 1. Wealth the more wealthy workers are, the less ess willing ga are et they ey to supp supply y labour abou negative income effect: increase in income reduces the supply pp y of labour at any y given wage 2. Wage rate the higher the wage rate, the more labour are they willing to supply.
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A model of Labour Supply Labour-Leisure Labour Leisure Model;

Three conceptual building blocks Introducing I t d i the th preference f of f job j b seeker k Incorporating his skills in terms of market k t wages He is rational in terms of maximizing his utility

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Labour-Leisure Model

Introducing the preferences Utility Utilit function f ti measures satisfaction ti f ti that individuals receive from consumption of goods and leisure U = f(C, L), where U is an index Higher U means happier person

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Indifference curves
Consumption ($)

500 450 400

y z x 40,000 Utils 25,000 Utils 100 125 150 Hours of Leisure

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Indifference Curves

Downward sloping (indicates the trade off between consumption and leisure) Higher curves = higher utility Do not intersect Convex to the origin g (indicating ( g that opportunity costs increase)

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Different Preferences
Vertical and horizon indifference curves Consumption ($) Consumption ($) U1 U0 U0 U1 Hours of Leisure ( ) A leisure-lover: (a) Income/consumption is not a substitute for leisure Hours of Leisure ( ) A workaholic: Ieisure is (b) not a substitute for consumption 32

Different Preferences
Steep and flat indifference curves Consumption ($) Consumption ($)

U1 U0 U1 U0 Hours of Leisure ( ) A workaholic, (b) , or someone who has heavy financial commitments 33

Hours of Leisure ( ) A leisure-lover, (a) , or someone who has important activities aside from work

Different Preferences
Consumption ($)

150

60 50 UJack 70 UJill

80 Hours of Leisure

Market Wages and The Budget Constraint

Consumption = labor earning (wages x hours) plus nonlabor income (V) C = wh + V Note: assumption of zero saving Because of the time constraint (T=24 hours a day), reexpress p the equation q as: C = w(T L) + V, where h = T L C=(wT + V) wL a straight-line t i ht li function, f ti slope l =w Budget constraint sets the boundary on the workers opportunity set of all the consumption baskets the worker can afford
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Depicting the budget constraint

Consumption ($) wT+V Budget Li Line Consumption ($) wT Budget Li Line

T Hours of Leisure B dget constraint with Budget ith positive non-labor income

T Hours of Leisure Budget constraint with zero non-labor income 36

An increase in non-labor income

Consumption ($) wT+2V wT+V Budget Line Li

T Hours of Leisure B dget constraint shifts Budget up if non-labor income increases 0

Utility Maximization
Individual will choose consumption p and leisure to maximize utility Optimal consumption at the tangency between b d t line budget li and d indifference i diff curve ~ Slope of indifference curve = slope of budget line Marginal Rate of Substitution between consumption and leisure = wage rate ~ MUL/ MUC = w ~ MUL/w = MUC Any other bundle of consumption and leisure given the budget g constraint gives g individual less utility y
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Optimal consumption and leisure

Consumption ($) $1200 $1100 A She would prefer to be on U1, but given the market wage and her nonlabour income, she cannot reach it.

$500

P U1 E U U0 70 40 110 0 Hours of Leisure Hours of Work

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$100 $ 0 110

A typical diagram for equilibrium in labour-leisure choice

Consumption ($) A Equilibrium point is P Hours of work is FT Hours of leisure is 0F C is consumption Utility level is U T is i the th endowment d t point i t as there th is no non-labour income P U 0 Hours of Leisure F T

At P, , we have a point p of tangency g y which means MUL/ MUC = w

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Rise in W: new budget line = AT

Consumption ($)A A

New equilibrium point point, P P Outcome: more work Labour supply curve is U Upward-sloping d l i

P U

FF

Hours of Leisure
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Rise in W: new budget line = AT

A

A P

New equilibrium point, P Outcome: less work Labour supply curve is Backward-bending

U U

Hours of Leisure
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Change in W produces two conflicting effects

A rise in W will make the worker richer. richer As he is richer, he wants to consume more leisure (normal good) and therefore , given T, work less; This is known as income effect ( how about fall in W?) A rise in W means the cost of enjoying leisure is higher and the worker therefore consumes less leisure (as leisure is more expensive) and work more longer. This is known as substitution effect How to isolate substitution effect when analysing income effect and vice versa???
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Draw imaginary budget line BB

A B A K P K:point of tangency between BB and U curve P to K: on same indifference curve-curve pure substitution effect with BB steeper than AT indicating an increase in the price of leisure (wage rate is higher) P to K: more work

B T

Hours of Leisure
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Suppose P is new equilibrium point

A B A K P P K to P: pure income effect (higher indifference curve) and no substitution effect BB and AT reflect the same wage rate K to P reflects an increase in income, leading to less work

B T

Hours of Leisure
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Case 1: PK > KP (horizontally)

A B A K P P PK (substitution effect) leads to more work, and KP (income effect) leads to less work; but PK > KP KP increase in W more work Labour supply curve is upward-sloping

B T

Hours of Leisure
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Case 2: PK < KP (horizontally)

A B A K P P PK (substitution effect) leads to more work, and KP (income effect) leads to less work; but PK < KP KP increase in W less work Labour supply curve is backward-bending

B T

Hours of Leisure
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Conclusions
1.

2.

When the income effect on work effort is less than the substitution effect effect, the labour supply curve is upward-sloping When the income effect on work effort is stronger than the substitution effect, the labour supply curve is backward-bending Wage rate
LS

Hours worked

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Policy Implications
Singapore experienced steady increase in wage rate and hence we confronted the danger of a backwardbending labour supply curve The backward bending labour supply curve was averted due to the absence of a pension system and rising prices of housing housing. There is low income effect with higher wages. The labour supply curve is LS*
Wage rate LS S* LS*

Hours worked

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Increase in non-labour income

1.

Increase in non-labor income allows worker to jump to higher indifference curve, curve indicating jump the Income Effect Leisure is a normal g good in this course

2.

There is no Substitution Effect as the wage rate remains the same

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Initial equilibrium
Consumption ($)

With original i i l nonlabor income 0V, , worker chooses P on U1

A U1

V 0 F

E1 Hours of Leisure
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The income effect only

Consumption ($)

Increase in I i nonlabor income allows worker to jump jump to higher indifference curve, indicating the Income Effect
R

Note: in this diagram assume diagram, leisure is a normal good

0

E3 E2 U2 E1

U3

U1

F1 F2 F3

Hours of Leisure
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To work or not to work?

Are the terms of trade sufficiently attractive to bribe a worker to enter the labor market? Workers only willing to work for wages above the reservation wage g Reservation wage: wage at which a person is indifferent between working and not working Rule 1: if the market wage is less than the reservation wage, then the person will not work k Rule 2: the reservation wage increases as nonlabor income increases
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The reservation wage, w*

Consumption ($) A Slope = -w2 UG UH

A*

X Slope = -w1 0

Slope = -w*

E T

U0 Hours of Leisure
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The labour market supply curve - a horizontal summation of individual labour supply pp y curves
w SJ w SM w S

w0 a

w0 b

w0 a +b

John

Mary

The Market

H/LS
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Introduce income tax , t %

A New budget line is AT: the worker is worse off, less work in this diagram (it can be more work) Depending on income and substitution Effect Tax amount is JP

P J P

Hours of Leisure
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Raising income tax , t %

A New budget line is AT: the worker s new equilibrium point can be anywhere on A AT; T; P P* or P P P J P P* P

Hours of Leisure
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The Laffer Curve

Increase in income tax rate initially increases tax revenue Beyond tax rate rate, t* t , an increase in tax rate shackles creativity and productivity of the labour force and reduces tax revenue

Tax revenue T

100%
Reduction in work effort is small

t* Reduction in work
effort is significant

Ta rate Tax
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Raising income tax , t %

A New budget line is AT If the worker chooses to work much less, eg around P, P , tax revenue will fall If there is little change in work effort, tax revenue will increase

P J P P*

P 0 T Hours of Leisure
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References

GB, chs 1 & 2

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Course Assessment

70% based on final exam 20% based on 2 MCQs: 1st MCQ covers Lectures 1-6 Held during g week of Lecture 6 2nd MCQ covers Lectures 7-12 Held during week of Lecture 12 10% based on participation during tutorials Exam Format: 4 questions each has a few parts, parts no choice choice. Format shorts questions/problems, as in tutorials

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Questions for Tutorial 1

1. Derive the individual labour supply curves ( against rising wage rate) 2 Cindy gains utility from consumption C and 2. leisure L. The most leisure she can consume in any given week is 168 hours. Her utility function is U(C,L) (C ) = C L. This functional f f form implies that Cindys marginal rate of substitution is C / L. Cindy y receives $ $630 each week from her great-grandmother, regardless of how much Cindy works. What is Cindys reservation wage? (From the text; 2-4)

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Questions for Tutorial 1 (cont)

3 Shelly 3. Shellys s preferences for consumption and leisure can be expressed as: U(C,L) = ( C 200 ) ( L 80 ). This utility function implies that Shellys marginal utility of leisure is C 200 and her marginal utility of consumption is L 80. There are 168 hours in the week available to split between work and leisure. Shelly earns $5 per hour after taxes. She also receives $320 worth of welfare benefits each week regardless of how much she works. (From the text 2-6) (a) Graph Shelly Shellys s budget line. (b) What is Shellys marginal rate of substitution when L = 100 and she is on her budget line? (c) What is Shelly Shellys s reservation wage? (d) Find Shellys optimal amount of consumption and leisure.

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Question 4

You can either take a bus or drive your car to work. A bus pass costs $5 per week, whereas driving your car to work costs $60 weekly y (p (parking, g, tolls, ,g gas, , etc.). ) You spend half-an-hour less on a one-way trip in your car than on a bus. How would you prefer to travel to work if your wage rate is $10 per hour? Will you change your preferred mode of transportation if your wage rate rises to $20 per hour? Assume you work five days a week k and d time i spent riding idi on a bus b or d driving i i a car does not directly enter your utility.

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MCQs for Lecture 1 1 The sum of the employment rate and the 1. unemployment rate is equal to

(a) 100% (b) 80% (c) 60% (d) i is meaningless i l

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2 Hidden unemployment is the result of 2.

(a) those unemployed who borrow money from the banks but cannot afford to pay back (b) those unemployed who get discouraged after unsuccessfully searching for a job, and hence drop out of the labour force. (c) those unemployed who are working illegally (d) all of the above (e) none of the above

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3. Which of f the f following g is not a property p p y of f standard indifference curves in a leisure-consumption model?

(a) Indifference curves tend to be downward sloping. (b) Higher indifference curves (to the northeast) indicate higher levels of utility. (c) ( ) Indifference curves tend to be convex to the origin. g (d) There is an indifference curve passing through every leisure-consumption bundle. (e) Indifference curves intersect one another.

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4. The objective of a job seeker in the Labour-Leisure Model is to maximize (a) number of leisure hours (b) consumption level (c) his utility (d) all of the above (e) none of the above

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5. Suppose pp labor supply pp y can be described as ES = 0.1w 1,000 where w is yearly salary. How many workers are willing to work when the yearly salary is $20,000?

(a) 100 (b) 200 (c) 500 (d) 1,000 (e) 5,000

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6. An upward-sloping labor supply curve implies that

(a) a firm can always hire more workers, workers even without increasing the wage. (b) ( ) more workers are willing g to work when wages g are low. (c) more workers are willing to work as the market wage increases. i (d) labor supplied is fixed. (e) there is a continuously increasing demand for labor labor.

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7. Assuming g consumption p and leisure are normal goods, g hours worked will fall when the wage increases if

(a) the income effect dominates the substitution effect. (b) the substitution effect dominates the income effect. effect (c) the income and substitution effect move in the same direction ( (i.e., , if they y are of the same sign). g ) (d) the income and substitution effect move in the opposite direction (i.e., if they are of the opposite sign). (e) the wage increase is accompanied by an increase in prices.

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8 Introduction of an income tax will encourage 8.

(a) workers to work longer hours (b) workers to work fewer hours (c) will not affect hours of work (d) all of the above (e) none of the above

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