Ch-1.pptx

Labor Economics
Course code: Econ 3011
Target Group: 3rd Year Economics Regular Students
By: Haymanot B.
October, 2019

Labor Economics and its Definition
Introduction
 The main problem that leads economics to be a distinct discipline is
scarcity of productive resources.
 Productive resources of any economic system like land, labor,
finance, building materials, and many others are limited and are
bounded not to produce enough to satisfy material needs of the
society.
 The economic system is incapable of providing all the products and
services that individuals and societies would like to have.
 Consequently it arises for the society to choose what to produce,
how to produce and to whom to produce given the limited amount
of productive resources.
 It guides the society to manage its scarce resources as effective as
possible to achieve the maximum fulfillment of its wants.

Cont..
 In the process of making a decision towards different economic
choices resulted from scarcity of resources.
 There are different actors: households, firms and governments.
 Economics studies the interaction between the different decision
makers in the market for goods and services. The market includes
factor market and product market.
 Labor is one of the scarce productive resources which the society
owns.
 Some special features of labor service and its great importance to an
economy paved the way for the development of Labor Economics,
which is the study of the market for one particular commodity in the
economy, labor service.

Cont.
 Labor economics is concerned with understanding the underlying
economic behavior of individual households and firms those are
decision makers in the market for labor service both in the
supply and demand for labor.
 It examines the organization, functioning and outcomes of labor
market; the decision of prospective and present labor market
participants; the public policies relating to the employment and
payment of labor services.
 It looks at the suppliers of labour services (workers) and the
demanders of labour services (employers), and attempts to
understand the resulting pattern of wages, employment, and income.
 Labour markets or job markets function through the interaction of
workers and employers.
 Mainly labor economics focuses on choice. It employs theories of
choice to analyze and predict behavior of labor market participants
and the economic consequence of labor market activities.

Cont.
 There are three implicit assumptions underlying the economics
of choice:
 Relative Scarcity: individuals face a relative scarcity of time and
spendable income.
 Purposeful Behavior: because relative scarcity keeps us from having
everything we want, we are forced to choose among alternatives.
 Adaptability: because relative scarcity forced people to make choice,
and because choices are made purposefully, labor market participants
respond to changes in perceived costs and benefits.
 Workers, employers and other participants adopt, adjust, or alter their
behaviors in response to changes in expected costs and gains.
 If so is all about economics and labor economics, what is the
justification behind the special field concerned solely with labor,
labor economics?
 What makes labor unique than other commodities sold in the market
but not have special field concerned about?
 There are three justifications behind labor economics:

Cont.
 Socio-economic issues: wages/salaries, job, productivity, labor legislation,
immigration etc… are major concerns of a society. For many households sales
of their labor service to firms constitute by far their major source of income.
 Hence their wages/salaries are the main determinant of their economic
wellbeing.
 To understand the distribution of income in society, who earns what and
why, we need to understand labor markets, how equilibrium wages and
quantity of labor service are determined.
 Quantitative Importance: for many capitalistic economies of the world, the
bulk of national income is received not as capitalistic income (profit, rent,
interest) but as wages.
 Labor is the most important resource to an economy.
 Unique Characteristics: The markets in which labor services are bought and
sold embody especial characteristics and peculiarities calling for separate study.
 A seller of labor service, the laborer, cares about many things; type of job, benefits,
retirement, promotion, job security, training, place, field (profession) and a lot about
type and characteristics of the job.

Labor and its Peculiar Features
 What is about labor as opposed to other factors of production has led to the
development of labor economics.
 Labor service can’t be separated from workers, the condition under which such
services are rented are often as important as prices.
 Workers themselves cannot be bought and sold.
 Non pecuniary factors such as work environment, risk of injury,
personality, perception of fair treatment and flexibility of work hours looms
larger in employment transactions than they do in markets for commodity.
 The major peculiarities of labor which help to distinguish labor from other
factors of production:
 Labour is inseparable from the labourer:
 Labour and the labourer go together.
 When the seller sells a commodity he does not necessarily go with the
commodity. But the labourer can supply his labour only when he goes with it.
 Moreover, when a seller sells a commodity he parts with it. But when a
labourer sells his labour, he retains the quality with him. He may gain the
satisfaction out of his services, but he cannot be separated from his labour.

Cont.
 Labour services are not transferable
 The individual must be present when the labour services are used.
 For example, a person who has agreed to carry out certain tasks cannot
‘transfer’ his services to someone else to do the work, while he does
something else.
 If the service of labour is required, the worker must himself (herself) go
to the workplace and provide labour service.
 This contrasts with commodities which can be transferred among
individuals.
 Labour services cannot be stored
 Labour cannot be ‘saved’ or stored for future use
 The worker sells his work (service) but retains capital in himself/
herself
 Workers have the ability to provide labor service by the virtue of the
productive skills they possess.
 While they can sell these services (labor service and skill), they cannot
sell the human being in which they are embodied

Cont.
 Each seller of labor possesses subjective preferences about the use
to which the labor is put, the location of employment and working
conditions.
 Workers are interested in the total net advantages of a job
 Employers may possess subjective preference about who they wish
to employ.
 Subjective preference also affects the nature of an employer’s demand for
labor.
 Employer preference who to employ for what wage is influenced not only
by productive capacity of that worker but also by certain other
characteristics like sex or race.
 The decision to supply labor and consumer goods is strongly
interdependent.
 Workers who supply labor services are also consumers who purchase the fruits
of labor effort.
 Consumption and labor supply decisions are thus simultaneously determined.

Cont.
 Mobility of labour
 Labour is more mobile both geographically (movement between regions)
and occupationally mobile(movement between jobs).
 Differences in Quality(Heterogeneity of workers and jobs)
 Labour is not homogeneous.
 Individual workers differ by age, race, gender, education, experience, skills, and
complex personality factors, such as motivation and congeniality, each individual
worker posing unique feature to firms;
 Workers also face similar diversity in choosing employers as employers and jobs
differ in the type and difficulty of the work, commuting distance, fringe benefits, and
equality of employee relations and wages.
 The quality of labour demanded for same kind of job differs from labourer to
labourer and even from time to time for the same labourer.
 Psychological factors can have an important influence on the
relationship between employers and employees.
 Concepts such as trust, loyalty, fairness and motivation are very important.

Cont.
 Labour is affected by surroundings
 The supply of labour depends not only on wages or price of labour but
on various non-monetary (psychological) factors, such as conditions of
work, change in atmosphere, treatment by employers, health and safety
measures taken by employers inside the workplace, and so on…
The suppliers of labor often form independent labor
unions, and take collective action in pursuit of their goals
(buyers of labor service can also band together).
 This formation of labor unions and union of employers leads to create
interface between labor economics and industrial relations.
 Workers form a group that acts as a single seller (monopoly) and
employer’s band together and acts as a single buyer (monopsony); which
we call bilateral monopoly (i.e. a single buyer and a single seller of labor
service).
 Labour services are enhanced by training
 Skill acquisition is often a lengthy and costly process.
 However, adjustments in the labour market, such as increasing the supply of
a particular skill, often requires a long time.

Cont.
 Multiplicity of markets
 Labor market is segmented and fragmented and there are a multiplicity of individual
sub markets separated by geographic location, occupation , skill, and so on.
 Long-term employment relationship
 Unlike the commodity market, the relationship between the labor supplier
and labor service buyer is expected to continue for some time.
 The most important implications of the long term nature of employment
relationship between workers and firms is that it reduces the sensitivity of
wages to changes in supply and demand and, thus, the ability of wages to
clear the market.
 In commodity market, excess supply leads to a drop in its prices as sellers
underbid each other to attract a buyer.
 But in the labor market, excess supply of labor typically does not lead to a
fall in money wage rates.
 While workers who are unemployed might offer to work at a lower wages, most
firms would find it unprofitable to hire them, because the costs of hiring and
training as well as the effect on morale of existing workers would far outweigh
the saving in lower wages.

Interrelationship with Other Fields of Economics
 Since labor economics deals with wage determination, employment relations,
unemployment and related policy issues, it is highly interrelated with sub fields
of economics.
 Since industrial economics is related with manpower and market for factors
and products, it has great relation with labor economics, especially in
case of industrial labor relations.
 Sub fields like development economics are concerned with income inequality
and poverty in which the later are focus of labor economics.
 Labor economics is both an application of microeconomic theories and
macroeconomic theories.
 As an application of microeconomic theories,
 It deals with the role of individuals and firms in labor market.
 It tries to examine the behavior of these economic agents and how they affect wage
and quantity of employment supply at equilibrium.
 Work- leisure decision of employees, employers decision to hire additional
employees and the resulting wage and employment level determined by the
interaction of these two decision makers are by large the application of
microeconomic theories.

Cont.
 As an application of macroeconomic techniques, labor economics looks at:
 The interaction between labor market, goods market, the money market and
foreign trade market.
 It looks at how these interactions influence macro variables such as
employment level, participation rates, aggregate income and GDP.
Labor Economics in Historic Perspective
 Until its emergence as a distinct sub discipline, it remained as “an integral
part of the central tradition of theoretical speculation in economics”.
 The central tradition of the theoretical speculation, in classical, Marxian
and neo-classical economics, focused on explaining how the market
economy worked and how prices of goods and services were determined
and resources were allocated on the process.
 Labor theory of value for classicals /Marxians and Theory of wages for
Neo-classicals were central to the whole body of speculations in
economics.
 As per Schumpeter's typology, labor economics evolved through the
interaction of economic theory, social economics and political economy.

Cont.
 According to Schumpeter:
 Economic Theory is distinguished by its "explanatory hypotheses" that
make use of "simplifying schematics and models";
 Economic Sociology is distinguished by its concern additionally with "
social facts"," institutional frameworks" and "general forms of human
behavior";
 Political economy is distinguished by its concentration on the "economy
of the state" and on "public policies of an economic nature" within the
"historical-political framework.“
 Labor economists more involved in the study of economic
theory have been more attracted by rigor (strictly, rigidity);
those involved in social economics have been more attracted
by relevance; those in political economy were more attracted
by visions of reform.

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