Labour economics
Labour economics is the subfield of economics concerned with the study of labour as an input to economic production. Broadly, it surveys labor markets and the economic decisions of agents participating in such markets. Topics of study include the labour supply of workers and how it is affected by variables such as age, education, gender and childbearing, as well as the labour demand by firms searching for different forms of labor as an input in the production of goods and services. In addition, labour economics studies, amongst others, phenomena such as schooling, human capital, inequality, unemployment, trade unions, discrimination, technological change, and public policies related to labor markets, such as unemployment benefits, pensions and health care.
Macro and micro analysis of labour markets
Labour economics can generally be seen as the application of microeconomic or macroeconomic techniques to the labour market. A general assumption in the microeconomic study of labor markets is that workers – suppliers of labor – make rational choices based on the information that they know regarding wage, desire to provide labour, and desire for leisure, to maximise utility over their lifetime by consuming economic goods, services and leisure. Conversely, economic firms – demanders of labor – seek to maximise profits by hiring these laborers.The labour force is defined as the number of people of working age, who are either employed or actively looking for work. The labour force participation rate is the number of people in the labour force divided by the size of the adult civilian noninstitutional population, LFPR = LF/Population.
The non-labour force includes those who are not looking for work, those who are institutionalized, stay-at-home spouses, children not of working age, and those serving in the military. The unemployment level is defined as the labour force minus the number of people currently employed. The unemployment rate is defined as the level of unemployment divided by the labour force. The employment rate is defined as the number of people currently employed divided by the adult population. In these statistics, self-employed people are counted as employed.
The labour market has the ability to create a higher derivative efficiency of labour, especially on a national and international level, compared to simpler forms of labour distribution, leading to a higher financial GDP growth and output. An efficient labour market is important for the private sector as it drives up derivative income through the reduction of relative costs of labour. This presupposes that division of labour is used as a method to attain cost efficiency.
Variables like employment level, unemployment level, labour force, and unfilled vacancies are called stock variables because they measure a quantity at a point in time. They can be contrasted with flow variables which measure a quantity over a duration of time. Changes in the labour force are due to flow variables such as natural population growth, net immigration, new entrants, and retirements. Changes in unemployment depend on inflows and outflows. When looking at the overall macroeconomy, several types of unemployment have been identified, which can be separated into two categories of natural and unnatural unemployment.
Natural Unemployment
- Frictional unemployment – This reflects the fact that it takes time for people to find and settle into new jobs that they feel are appropriate for them and their skill set. Technological advancement often reduces frictional unemployment; for example, internet search engines have reduced the cost and time associated with finding work and hiring decisions.
- Structural unemployment – The number of jobs available in an industry are insufficient to provide jobs to all persons who are interested in working or qualified to work in that industry. This can be due to the changes in industries prevalent in a country or because wages for the industry are too high, causing people to want to supply their labour to that industry.
- Seasonal unemployment – Unemployment due to seasonal fluctuations of demand for workers across industries, such as in the retail industry after holidays that involve a lot of shopping are over.
- Natural rate of unemployment – This is the summation of frictional and structural unemployment, that excludes cyclical contributions of unemployment and seasonal unemployment. It is the lowest rate of unemployment that a stable economy can expect to achieve, given that some frictional and structural unemployment is inevitable. Economists do not agree on the level of the natural rate, with estimates ranging from 1% to 5%, or on its meaning – some associate it with "non-accelerating inflation". The estimated rate varies between countries and across time.
- Demand deficient unemployment – Any level of unemployment beyond the natural rate caused by the failure of markets to clear, generally due to insufficient aggregate demand in the economy. During a recession, demand is deficient, causing the underutilisation of inputs.
Neoclassical microeconomics
view the labour market as similar to other markets in that the forces of supply and demand jointly determine the price and quantity.However, the labour market differs from other markets in several ways. In particular, the labour market may act as a non-clearing market. While according to neoclassical theory most markets quickly attain a point of equilibrium without excess supply or demand, this may not be true of the labour market: it may have a persistent level of unemployment. Contrasting the labour market to other markets also reveals persistent compensating differentials among similar workers.
Models that assume perfect competition in the labour market, as discussed below, conclude that workers earn their marginal product of labour.
Neoclassical supply
Households are suppliers of labour. In microeconomic theory, people are assumed to be rational and seeking to maximize their utility function. In the labour market model, their utility function expresses trade-offs in preference between leisure time and income from time used for labour. However, they are constrained by the hours available to them.Formulas below will have to be updated as Major constraint: a problem with this is seven-day work week, made up usually of 5 work days and 2 off-days, built upon 8000 year old work-rest schedule, from the Sumerians. 5/2 schedule is asymmetrical, as labor supply and demand would considerably change as well as work participation; the new schedule is symmetrical, much more supply by women, and care-givers, willing workers constrained by having only three days availability.
Symmetrical: two 3-day part-time people can take on one job. the 5/2 is a major constraint on people work/life freedom, wreaks havoc on lives and productivity choices. People are so un-productive and un-free with their time/life that most are not able to have progeny. Most people are working for society/the rich, in a work-time prison, they are told when to check-in, when to eat, when to check out, and when to have rest, just like farming chickens. A two-day no-choice rest, usually un-productive, just throw away 2/7 of one's life.
To get out of this problem, different civilizations tried different combinations, the Romans used 8, the French Revolutionaries tried 10, Russians tried 6, then 5. all failed. but there is a solution described in John N. Peters ″Better Work/Life Balance Productivity Schedule for much Better Work/Rest/Exercise Quality of Life″
Let w denote the hourly wage, k denote total hours available for labour and leisure, L denote the chosen number of working hours, π denote income from non-labour sources, and A denote leisure hours chosen. The individual's problem is to maximise utility U, which depends on total income available for spending on consumption and also depends on the time spent in leisure, subject to a time constraint, with respect to the choices of labour time and leisure time:
This is shown in the graph below, which illustrates the trade-off between allocating time to leisure activities and allocating it to income-generating activities. The linear constraint indicates that every additional hour of leisure undertaken requires the loss of an hour of labour and thus of the fixed amount of goods that that labour's income could purchase. Individuals must choose how much time to allocate to leisure activities and how much to working. This allocation decision is informed by the indifference curve labelled IC1. The curve indicates the combinations of leisure and work that will give the individual a specific level of utility. The point where the highest indifference curve is just tangent to the constraint line, illustrates the optimum for this supplier of labour services.
If consumption is measured by the value of income obtained, this diagram can be used to show a variety of interesting effects. This is because the absolute value of the slope of the budget constraint is the wage rate. The point of optimisation reflects the equivalency between the wage rate and the marginal rate of substitution of leisure for income. Because the marginal rate of substitution of leisure for income is also the ratio of the marginal utility of leisure to the marginal utility of income, one can conclude:
where Y is total income and the right side is the wage rate.
Effects of a wage increase
If the wage rate increases, this individual's constraint line pivots up from X,Y1 to X,Y2. He/she can now purchase more goods and services. His/her utility will increase from point A on IC1 to point B on IC2.
To understand what effect this might have on the decision of how many hours to work, one must look at the income effect and substitution effect.
The wage increase shown in the previous diagram can be decomposed into two separate effects. The pure income effect is shown as the movement from point A to point C in the next diagram. Consumption increases from YA to YC and – since the diagram assumes that leisure is a normal good – leisure time increases from XA to XC.
The Income and Substitution effects of a wage increase
But that is only part of the picture. As the wage rate rises, the worker will substitute away from leisure and into the provision of labour—that is, will work more hours to take advantage of the higher wage rate, or in other words substitute away from leisure because of its higher opportunity cost. This substitution effect is represented by the shift from point C to point B. The net impact of these two effects is shown by the shift from point A to point B. The relative magnitude of the two effects depends on the circumstances. In some cases, such as the one shown, the substitution effect is greater than the income effect, but in other cases, the income effect will be greater than the substitution effect. The intuition behind this latter case is that the individual decides that the higher earnings on the previous amount of labour can be "spent" by purchasing more leisure.
If the substitution effect is greater than the income effect, an individual's supply of labour services will increase as the wage rate rises, which is represented by a positive slope in the labour supply curve. This positive relationship is increasing until point F, beyond which the income effect dominates the substitution effect and the individual starts to reduce the number of labour hours he supplies as wage increases; in other words, the wage elasticity is now negative.
The direction of the slope may change more than once for some individuals, and the labour supply curve is different for different individuals.
Other variables that affect the labour supply decision, and can be readily incorporated into the model, include taxation, welfare, work environment, and income as a signal of ability or social contribution.