Reading instructions : Borjas . ch . 4

1. Reading instructions:Borjas. ch. 4 • Skip • ”Convergence of Regional Wage Levels” (pp. 149-152) • ”Employment subsidies” (pp. 157-159) • ”Employer sanctions as a payroll tax” (pp. 159-161) • Health insurance as a mandated benefit (pp. 163-164) • ”Do Natives Respond to Immigration?” (pp. 174-177) • 4.7 ”Hurricanes and the Labor Market” (pp. 182-185) • Read ”The Mariel boatlift”” (pp. 170-173) through as an illustration of the methodology of difference-in-difference estimates – and its limitations.

2. Preamble: Marginals and totals

3. The graph shows MPE at different levelsofemployment. What is total productionwith 2 workers?With 5 workers?

4. Total production is the area under the marginal productcurve. • Total cost is the area under the marginal costcurve. • Total utility is the area under the marginal utilitycurve.

5. Labour market equlibriumBorjas. ch. 4 • Competitive equilibrium: • The VMP of the last worker is w*. • The VMP of each of the other N-1 workers >w*. • The difference (blue triangle) = employer surplus • The reservation wage of the last worker is w* • The reservation wages of the other N-1 workers < w*. • The difference (the orange triangle) = worker surplus W* N Assumption: Employers and workers are price-takers

6. Efficiency W* With a wage that is higher or than w*, employment and the total surplus are smaller. There is also a redistribution from employers and unemployed to employed workers, compared to the equilibrium. wh N’

7. Efficiency W* With a wage that is lower than w* employment the total surplus is smaller. There is also a redistribution from workers to employers compared to the equilibrium. wh N’

8. ”The” labour market consists of manysub-markets • Different localities. regions or industries constitute separate labour markets. • But if workers and capital can be moved between them they are interdependent. • If the economic and non-economic costs of moving are less than the wage differential: • Workers may move to a labour market where wages are higher. • Firms may move capital to a labour market where the wage is lower. .

9. Workermobilitybetweenlabour markets tends toequalise the wage rate. • High-wage market • Low-wage market SH2 SL1 SH1 SL2 wH1 wL1 DH Exercise: Draw a similar diagram showingmobility of capital

10. Ifworkersmove to high-wageindustriestheymove to jobswheretheirproductivity is higher. National incomeincreases. • In aggregatethere is a gainbutsomeworkersloosewhenwages in the high-wage market are reduced. • The modelassumes that workers in the twolabour markets are perfectsubstitutes. • The model abstracts from costs of moving. • Empirically: There is evidence that regional differenceswithincountriestend to converge. There is less mobility and convergencebetweencountries. • Inter-industrywage differentials are often persistent.

11. Pay-rolltaxes • Paid by the worker • Paid by the firm W0+t S W1+t t W0 D0 W1 t t D1 E0 E1 E0 E1

12. The level of employment and take-home pay are the same irrespective of whether the pay-roll tax is paid by the employer or employee. Tax paid by workers – supply shift t Tax paid by firm – demand shift The incidence of the tax depends on the slope of the demand and supply curves. I.e. if S completely inelastic. the whole tax is paid by workers.

13. Dead-weight loss (excess burden) Employment ↓ from E1 to E2 The wage paid  from w1 to w2 the wage received↓ to w2-t Tax income T DEAD-WEIGHT LOSS A+B W2 A T W1 B W2-t E2 E1

14. (Mandated) benefits • The demand curve shifts down by the amount that the mandated benefit costs the employer (C). • The supply curye shifts down by the amount that the workers value the benefit (B) • If B=0 the effect is the same as a pay-roll tax of C • If 0 < B < C employment ↓ but less than with the pay-roll tax. w1+B<w0 • If B = C employment doesn’t change and w1+B=w0 • If B > C employment and w1+B>w0

15. S0 S0 Dollars Dollars S1 w* + C P P S1 w0 w0 w* + B Q w1 R w* w0  C w* R D0 D0 D1 D1 Employment Employment E0 E1 E* E0 The Impact of a Mandated Benefit E1 (a) Cost of mandate exceeds worker’s valuation (b) Cost of mandate equals worker’s valuation

16. Employersusuallydeductincome tax from salaries and payto the workers tax accountbuttheyalsopaymandated ”fees” or payrolltaxes.

17. Labour market equilibrium and immigration (More about immigration and the labour market outcomes for immigrants in Sweden after chapters 8 & 9 and in Schröder) Simplest model: Assume immigrants and natives are perfect substitutes in production. (i.e. have same skills & compete for the same jobs.) Percent of population born in other country:

18. Shortrun 1: Immigrants and natives are perfectsubstitutes S1 Immigration: Labour supply: S1→ S2 Total empl.: N1 → E2 Native empl. N1 → N2 Wage: W1 → W2 (N is empl. of native workers) S2 W1 W2 E2 N2 N1

19. Shortrun 2: Immigrants and natives are perfectcomplements • The labour market for natives: Immigration increases the MP of native workers. the demand curve shifts outwards. Increase in native employment and wage S D2 D1

20. Long run • In the longer run. the capital stock adjusts • Lower wages increase profits • Higher profits → more investment • Expansion of production → demand curve for labour shifts outwards • The long term reduction in wages is smaller than in the short term

21. Assumptions: • Capital stock expands until the rate of return on capital is the same as before (r is constant in the long run) • There are constant returns to scale in production in the long run Under these assumptions in the long run: The capital/labour ratio returns to the pre-immigration level The wage rate returns to the pre-immigration level! but we don’t know how long the long run is.

22. Are immigrant and native workerscomplements or substitutes? • In other words, are wages higher or lower when there is immigration? • How to find out? • Compare wages in places/regions with smaller or larger proportions of immigrants? • Problems: • Heterogeneity (other things differ between the places too…) • Reverse causality (immigrants may choose to go where wages are higher). • Mitigating effects (natives may move out due to the decrease in wage. whereby keeping it smaller)

23. ”A natural experiment” and difference-in-differenceestimates • In 1980 125 000 Cubans were allowed to emigrate to the US. Most went to Florida. The population of Miami 7%. But unemployment and wages developed ≈ as in comparable cities. • The criterion is not ”change in wages and employment in Miami”. It is these changes compared to cities where other conditions were similar (difference-in-difference comparison). • Question mark: Would there have been large differences in development of unemployment between Miami and these cities in later year without influx of immigrants?

24. A digression on difference-in-differenceestimates Example: Two cities. A and B. Two sectors: M and S In year 1: wM=120. wS=80

25. If wages increase by 10 % in both sectors the wage differential from year 1 to year 2 will be 9.6 in A and 10.4 in B. • Difference-in-difference comparison (in %) will correctly show that the wage dynamic is the same in A and B. • If wages increase by 20 % in sector M and 10 % in sector S in both cities: • Wage Y1 Wage Y2 Percent difference A 96 110.4 15% B 104 121.5 17% Difference-in-difference 17%-15% = 2% What conclusions should we draw?

26. Immigration surplus 1 S1 S2 Assumptions: Inelastic labour supply Immigrant & native workers are perfect substitutes B w1 A A – what workers get without immigration B Employers’ surplus without immigration w2 N M

27. Immigration surplus 2 S1 S2 A –native workers’ income B – immigrant workers’ income C – Employers’ surplus C w1 w2 A B

28. Immigration surplus S1 S2 A+B gain of employers A loss of native workers B immigration surplus for natives (workers and employers) w1 A B w2

29. The (short run) decrease in wages implies a transfer from native labour to capital. • The increase in employment with a lower wage increases the profit part of national income by the immigration surplus = = ½*Δw* ΔE • (Note that this is an increase in GNP, not GNP/capita).

30. Distributionaleffects of immigration • The wages of different skill groups are differently affected by immigration. • US studies find • a negative relation between immigration in a skill group and its wage growth • that there is greater impact on the wages of native workers with lower education • that the aggregate long-run effect is zero but for workers with low and high education it is negative and workers with middle education it is positive.

31. Cobwebmodel • Supply and demand tend to adjust to wage changes – but it takes time. • The supply of labour with a particular skill has very low elasticity in the short run. Getting people to move takes time. Re-training to add skills takes longer and education of new workers longer still.

32. D2 S Example: Assume that there is an increase in the demand for computer programmers(an outwardshift in the demandcurve) W1 W* D2 W0 D1

33. Market forms • Perfect competition • Monopoly • Monopsony (discriminating and not discriminating) • There is some degree of monopoly power if the firm faces a downward-sloping demand curve for its product. • There is some degree of monopsony power if the firm faces an upward-sloping labour supply curve

34. A profit maximising firm employs more workers until the marginal revenue from hiring one more unit of labour (marginal revenue product. MRPE) = the marginal cost of hiring one more unit of labour (MCE) • For the perfectly competitive firm MR=p (product price) so MRPE = p*MPE and MCE =w • For the monopsonist MCE >w • For the monopolist MR < p

35. Monopoly and labourdemand • From • MRPE = MR*MPE • MRPE = w • MR < p • It follows that w < p *MPE =VMPE

36. Aggregate production when input price increases MC2 D D MC2 MC1 p2 p1 MC1 MR Perfect competition Monopoly

37. SinceMPE is decreasing, a higher MPE for the monopolist meansthat it employs less workers.With a monopoly, employmentwill be lowerthan in perfectcompetition. • w VMPE MRPE

38. Public sector: • The public sector has elements of both monopoly and monopsony but is not profit maximising.