CH 5: Frictions in the Labor Market

1. CH 5: Frictions in the Labor Market • Quasi-fixed labor costs • Types of QF costs • Effects of QF costs on hours/workers • Training as a QF cost & consequences of training investments for structure of pay.

2. Monopsony • The firm’s labor supply curve is upward sloping • Sources of monopsony: • Mobility costs • Job search and information costs • Small # of competing employers

3. Monopsony • The firm’s labor supply curve is upward sloping MEL LS MRP • Profit maximizing wage? Level of employment? • MRP vs. W in a monopsony? Perfect competition? • Effect of a change in MRP? Perfect competiton vs. monopsony?

4. Quasi Fixed Labor Costs, Walter Oi (1962). The cyclical behavior of labor markets reveals a number of puzzling features for which there are no truly satisfying explanations. Included among these are • occupational differences in the stability of employment and earnings • the uneven incidence of unemployment • the persistence of differential labor turnover rates • discriminatory hiring and firing policies I believe that the major impediment to rational explanations for these phenomena lies in the classical treatment of labor as a purely variable factor.

5. Quasi-fixed labor costs • Examples • Hiring costs • Maintenance of payroll records, issuing checks • Training costs • Explicit monetary costs • Implicit opportunity costs of trainer’s time and capital used • Implicit opportunity cost of trainee’s time

6. Quasi-fixed labor costs

7. Employee Benefits

8. Quasi-fixed labor costs • Hiring and training costs are quasi-fixed • Some benefits are quasi-fixed, others are not. • pensions • Are contributions a fixed dollar amount per employee, % of pay, or % of pay up to a maximum value? • legally required benefits • many are % of pay up to a maximum. • health insurance • typically, a worker is either covered or not and the employer contribution is independent of incremental hours worked.

9. Optimal Mix of Workers and Hours • MEM = marginal expense of an additional worker = W*H + Q where W =wage rate, H=hours per week, Q=QFC per worker • MEH = marginal expense of an additional hour of work for all its existing workforce. = W*N where W=wage rate and N=number of workers • MPM = MP of an additional worker for H hours. • MPH = MP of an additional hour of work for N workers.

10. Optimal Mix of Workers and Hours MEM /MPM = MEH /MPH What should firm do if • QFC rises? • Wage rate rises?

11. Optimal Mix of Workers and Hours • APPLICATIONS • raising the salary cap for payroll taxes • increasing the payroll tax rate on capped payroll taxes. • effect of training costs on likelihood of part-time work. • the over-time premium. • mandatory health insurance coverage for full-time workers • worker preferences for part-time as opposed to full-time work • why do firms sometimes institute mandatory over-time rules • would firms ever pay an over-time premium even in the absence of federal legislation?

12. Training Investments The firm's decision to invest in training a worker in a two-period model: Period 0: • pay Z to train the worker • pay W0 in wages to the worker • worker produces MP0 Period 1: • pay W1 in wages to the worker • worker produces MP1 If worker is not trained, MP is fixed at MP* in both periods and the worker can receive a wage of W*=MP* at a competing firm.

13. Training Investments Optimal employment will be at E*

14. Training Investments • How are W0 & W1 determined? • Must offer a competitive PV of compensation • W0 + W1/(1+r) > W* + W*/(1+r)

15. Training Investments Examples: Suppose that W*=100 and r=6%. Alternative W0 W1 Present value (r=6%) • A 128 70 194 • B 100 100 194 • C 81 120 194 • D 62 140 194 • E 43 160 194 Why would the firm be reluctant to offer A or B? Why is worker reluctant to accept C, D, or E?

16. Training Investments • Firms that invest in training will want to • Defer pay • Find ways to restrict mobility of workers

17. Training Investments GENERAL VERSUS SPECIFIC TRAINING. • General training increases productivity at all firms. • Specific training increases productivity only at a specific firm (presumably the firm providing the training). • If training is general, a firm will have difficulty recouping its investment in training.

18. Training Investments • With general training, firm must pay W1>MP1 in second period unless there is a way to prevent worker from quitting. • Since W1>MP1, firm cannot recoup training investments by underpaying in second period • With specific training, firm can pay MP1*<W1<MP1 and recoup some of its training investments. Firms can recoup investment in specific training with restricting mobility.

19. Training Investments • How should training investments affect firm layoff behavior if product demand falls? • How does the above affect the cyclical nature of productivity? • If there are large training costs, firms should be concerned about screening out quitters. • Statistical discrimination • Fringe benefit packages • Discount rates

20. Investments in Training • Employer investments in general training • Armed forces • Sports contracts • Employer pays for employee education while “on the job”