Ehrenberg/SmithModernLaborEconomics:TheoryandPublicPolicy,TwelfthEdition,GlobalEdition

Chapter1
Introduction
Becausethetextbookstresseseconomicanalysisasitappliestothelabormarket,studentsmustunderstand
thewayseconomicanalysesareused.ThebasicpurposeofChapter1istointroducestudentstothetwo
majormodesofeconomicanalysis:positiveandnormative.Becausebothmodesofanalysisrestonsome
veryfundamentalassumptions,Chapter1discussesthebasesofeachmodeinsomedetail.
Inourtreatmentofpositiveeconomics,theconceptofrationalityisdefinedanddiscussed,asisthe
underlyingconceptofscarcity.Thereis,inaddition,alengthydiscussionofwhataneconomicmodelis
andanexampleofthebehavioralpredictionsflowingfromsuchamodelispresented.Thediscussion
ofnormativeeconomicsemphasizesitsphilosophicalunderpinningsandincludesadiscussionofthe
conditionsunderwhichamarketwouldfailtoproduceresultsconsistentwiththenormativecriteria.
Labormarketexamplesofgovernmentalremediesareprovided.
TheappendixtoChapter1introducesthestudenttoordinaryleastsquaresregressionanalysis.Itbegins
withunivariateanalysis,introducedinagraphicalcontext,explainingtheconceptsofdependentand
independentvariables,theinterceptandslopeparameters,theerrorterm,andthetstatistic.The
analysisthenmovestomultivariateanalysisandtheproblemofomittedvariables.

nList of Major Concepts

1. Theessentialfeaturesofamarketincludethefacilitationofcontactbetweenbuyersandsellers,the
exchangeofinformation,andtheexecutionofcontracts.
2. Theuniquenessoflaborservicesaffectsthecharacteristicsofthelabormarket.
3. Positiveeconomicsisthestudyofeconomicbehavior,andunderlyingthistheoryofbehaviorarethe
basicassumptionsofscarcityandrationality.
4. Normativeeconomicsisthestudyofwhatshouldbe,andtheoriesofsocialoptimalityarebasedin
partontheunderlyingphilosophicalprincipleofmutualbenefit.
5. Amarketfailswhenitdoesnotpermitallmutuallybeneficialtradestotakeplace,andthereare
threecommonreasonsforsuchfailure.
6. AgovernmentalpolicyisParetoimprovingifitencouragesadditionalmutuallybeneficial
transactions.Attimes,though,thegoalofimprovingParetoefficiencyconflictswiththegoalof
generatingmoreequity.

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7. Theconceptthatgovernmentalinterventioninamarketmaybejustifiedongroundsotherthanthe
principleofmutualbenefitisdiscussed.(Forexample,governmentinterventionmaybejustifiedon
thegroundsthatincomeredistributionisadesirablesocialobjective.)
8.

(Appendix)Therelationshipbetweentwoeconomicvariables(e.g.,wagesandquitrates)canbe
plottedgraphically;thisvisualrelationshipcanalsobesummarizedalgebraically.

9.

(Appendix)Awaytosummarizealinearrelationshipbetweentwovariablesisthroughordinary
leastsquaresregressionanalysisaprocedurethatplotsthebestline(theonethatminimizesthe
sumofsquareddeviations)throughthevariousdatapoints.Theparametersdescribingthislineare
estimated,andtheuncertaintysurroundingtheseestimatesissummarizedbythestandarderrorof
theestimate.

10. (Appendix)Themultivariateprocedureforsummarizingtherelationshipbetweenadependentvariable
andtwoormoreindependentvariablesisageneralizationoftheunivariateprocedure,andeach
coefficientcanbeinterpretedastheeffectonthedependentvariableofaoneunitchangeinthe
relevantindependentvariable,holdingtheothervariablesconstant.
11. (Appendix)Ifanindependentvariablethatshouldbeinanestimatingequationisleftout,estimates
oftheothercoefficientsmaybebiasedawayfromtheirtruevalues.

Chapter2
OverviewoftheLaborMarket
Ourgoalinthistextistomovestudentsalongverycarefullyfromwhattheydoknowtothemasteryof
newconcepts.Itisourbeliefthatstudentslearnmostefficientlyiftheycanassociatethesenewideas
withanoverallframework,anditisthepurposeofChapter2toprovidethatframework.Thischapter
hasbothadescriptiveandananalyticalpurpose.Oneaimistointroducestudentstotheessential
concepts,definitions,magnitudes,andtrendsofwidelyusedlabormarketdescriptors.Tothispurpose,
thechapterdiscussesandpresentsdataonsuchtopicsasthelaborforce,unemployment,thedistribution
ofemployment,andthelevelof(andtrendsin)laborearnings.Thesecondaimistoprovidestudents
withanoverviewoflabormarketanalysis.Tothisend,wediscussbasicconceptsofdemandandsupply
sothatstudentswillbeabletoseetheirinteractionattheveryoutset.
Westarttheoverviewwithadiscussionofdemandschedulesandtheircorrespondingdemandcurves.
Particularattentionisgiventothedistinctionbetweenmovementalongacurveandshiftsofacurve.
Distinctionsbetweenindividualandmoreaggregateddemandcurvesarediscussed,asisthedistinction
betweenshortrunandlongrundemandcurves.Asimilardiscussionandsetofdistinctionsaremadefor
thesupplysideofthemarket.

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Afterboththedemandandsupplysidesofthemarkethavebeendiscussedandgenerallymodeled,we
turntothequestionofwagedeterminationandwageequilibrium.Forcesthatcanaltermarketequilibria
arecomprehensivelydiscussed,andthechaptersmajorconceptsarereinforcedbydiscussionsofthe
effectsofunions,theexistenceofdisequilibrium,andtheconceptofbeingoverpaidorunderpaid
(including
adiscussionofeconomicrents).Thechapterendswithadiscussionofunemploymentacrossvarious
countries.

nList of Major Concepts

1. Thelabormarketanditsvarioussubclassifications(national,regional,local;external,internal;
primary,secondary)aredefined.
2. Thelaborforceconsistsofthosewhoareemployedorwhoareseekingworkandmajortrendsin
laborforceparticipationratesarediscussed.
3. Theunemployedarethosewhoarenotemployedbutareseekingwork(orawaitingrecall);trends
intheunemploymentratearenoted.
4. Changesintheindustrialandoccupationaldistributionofemploymentarefacilitatedbythelabor
market,whichalsofacilitatesadjustmentstothebirthanddeathofjobopportunities.
5. Thedistinctionbetweennominalandrealwageratesismade,andthecalculationofrealwagesis
illustrated.
6. Distinctionsamongwagerates,earnings,totalcompensation,andincomearedepictedgraphically.
7. Thelabormarketisoneofthreemajormarketswithwhichanemployermustdeal;inturn,labor
marketoutcomes(termsofemploymentandemploymentlevels)areaffectedbybothproductand
capitalmarkets.
8. Theconceptsunderlyingalabordemandscheduleareassociatedwithproductdemand,thechoiceof
technology,andthesupplyscheduleofcompetingfactorsofproduction;scaleandsubstitution
effectsareultimatelyrelatedtotheseforces.
9. Underlyingasupplyscheduleforlaborarethealternativesworkershaveandtheirpreferences
regardingthejobscharacteristics.
10. Distinctionsbetweenindividualandmarketdemandandsupplycurvesarediscussed.
11. Movementsalong,ratherthanshiftsof,demandandsupplycurvesoccurwhenwagesofthejobin
questionchange;whenavariablenotshownonthegraphchanges,thecurvestendtoshift.
12. Theinteractionofmarketdemandandsupplydeterminestheequilibriumwage.
13. Changesintheequilibriumwageratearecausedbyshiftsineitherthedemandorsupplycurves.
Disequilibriumwillpersistifthewageisnotallowedtoadjusttoshiftsindemandorsupply.
14. Theconceptsofoverpaidandunderpaidcomparetheactualwagetotheequilibrium(market)
wagerate.

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15. Individualspaidmorethantheirreservationwagearesaidtoobtainaneconomicrent.
16. Theconceptsofshortageandsurplusaredirectlyrelatedtotherelationshipbetweenactualand
equilibriumwagerates.
17. Unemploymentrates,andespeciallylongtermunemploymentrates,haveriseninEuroperelativeto
theUnitedStatesandCanadaovertherecentdecade;thisrisemayreflecttheexistenceofrelatively
strongernonmarketforcesinEurope.

Chapter3
TheDemandforLabor
Thischapterstudiesthedownwardslopingnatureofthelabordemandcurve.Itbeginswithasectionthat
discussesprofitmaximization,anditmovesdeductivelyfromtheassumptionofprofitmaximizationto
themarginalconditionswithrespecttolabor.Theseconditionsareexpressedinsimplemathematical
terms,andtheyarealsodiscussedverbally.Additionalinsightsintothemarginalproductivitytheoryof
demandareprovidedinasectiondiscussingcommonobjectionstothistheoryofdemand.
Theanalysisofdemandbeginswiththeassumptionthatbothlaborandproductmarketsarecompetitive;
inthiscontext,wefirstconsidertheshortrunbeforemovingontothelongrunandthecasewithmore
thantwoinputs.Wethenconsiderthedemandforlaborwhentheproductmarketisnotcompetitive.
Thechapterconcludeswithapolicyanalysisofpayrolltaxesthatdemonstratestheinsightsthatcanbe
derivedfromanunderstandingofthedemandforlabor.Theprincipalconceptualtoolemployedinvolves
distinguishingbetweenthewagerateemployerspayandthewagesemployeesreceive.Whenthesetwo
wagesdiffer,onemustbestatedintermsoftheotherforthedemandandsupplycurvestobeshown
together.Whenapayrolltaxisintroduced,oneofthetwocurvesmustthereforeshift,andtherewillbe
relatedchangesinbothwagesandemployment.
TheappendixtoChapter3isdesignedforstudentswhofeelcomfortableusingmicroeconomictheoryat
theintermediatelevel.Wederivethedemandforlaborgraphicallyusingatwofactormodelinboththe
longrunandshortrun.Bothsubstitutionandscaleeffectsaregraphicallyillustrated,andtheassumptions
underlyingthedemandcurvearemorerigorouslypresented.Anyinstructorswishingtoskipoverthe
appendixcandosowithoutlossofconceptsneededtounderstandthebasicsofthedemandforlabor.

nList of Major Concepts

1. Theassumptionofprofitmaximizationbyfirmsunderliesthetheoryoflabordemand.Theprocess
ofprofitmaximizationrequiresconsideringsmallchangesininputs(oroutputs),andcomparingthe
marginalrevenuegeneratedbyanadditionalinputwithitsmarginalexpense.

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2. Themarginalproductoflaboristheaddedoutputgeneratedbyaddingaunitoflabor,holding
capitalconstant.
3. Ifmarketsarecompetitive,firmsperceivepricesasgiven.
4. Thedifferencebetweentheshortrunandlongrundependsonthefixityofcapital.
5. Theconceptofdiminishingmarginalproductivityisdiscussed.
6. Therelationshipbetweenthedemandforlaborcurveandthedownwardslopingportionofafirms
marginalproductoflaborcurveisanalyzed.
7. Thedemandforlaborcanbestatedintermsofeithertherealorthenominalwage.
8. Therelationshipbetweenthedemandcurveofindividualfirmsandthemarketdemandcurveis
brieflydiscussed.
9. Twoprincipalobjectionstothemarginalproductivitytheoryoflabordemandarepresentedand
discussed.
10. Theconditionsforprofitmaximizationwithrespecttocapitalarerelevantinthelongrun,and
adjustmentsofcapitaltochangesinrelativepricesgeneratesubstitutioneffectsonemployment.
11. Generalizingtomorethantwoinputs,thedemandforonegradeoflaborisinfluencedbythewages
ofothergradesoflabor.
12. Theconceptsofsubstitutesinproduction,grosssubstitutes,complementsinproduction,andgross
complementsaredefinedandrelated.
13. Productmarketmonopolyaffectstheprofitmaximizationconditions,andthusthedemandforlabor.
14. Theimpositionofpayrolltaxesontheemployerwillshiftthedemandforlaborcurve(whendrawn
asafunctionofemployeewages)totheleft,causingworkerwagesand/oremploymentlevelstofall.
15. (Appendix)Thegraphicaldepictionofaproductionfunctionispresented.
16. (Appendix)Thedemandforlaborintheshortrunisgraphicallyderived.
17. (Appendix)Thedemandforlaborinthelongrun,showingbothsubstitutionandscaleeffectsofa
wagechange,isgraphicallyillustrated.

Chapter4
LaborDemandElasticities

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WhileChapter3dealtwiththedownwardslopingnatureoflabordemandcurves,Chapter4dealswith
themagnitudeoftheemploymentresponsetoachangeinthewagerate.Webeginthechapterbydefining
anddiscussingtheownwageelasticityofdemand.InthisregardtheHicksMarshalllawsofderived
demandareexplained,witheachofthefourlawsbeingrelatedtothesubstitutionandscaleeffects
(conceptsthatwereintroducedinChapters2and3).
Afterdiscussingthelawsofderiveddemandinthecontextofownwageeffects,wemovetoadiscussion
ofthecrosswageelasticityofdemand.Herewestresstheconceptsofgrosssubstitutabilityandgross
complementarity(asdistinguishedfromsubstitutesorcomplementsinproduction).Anothersectionis
devotedtoadiscussionoftheempiricalevidenceonboththeownwageelasticityofdemandandcross
wageelasticities.
Thechapterconcludeswithsectionsthatapplytheconceptsofdemandelasticitytoanalyzingtheeffects
ofminimumwagelegislationandtechnologicalchange.

nList of Major Concepts

1. Theownwageelasticityofdemandisthepercentagechangeinemploymentofaclassoflabor
inducedbyaonepercentchangeinthewagesofthatclass.
2. Crosswageelasticitiesofdemandarethepercentagechangeinemploymentofaclassoflabor
inducedbywagechangesinanotherclass;theymaybepositiveornegative.
3. ThefourHicksMarshalllawsofderiveddemandareintroducedandrelatedtothesubstitutionand
scaleeffectsofawagechange.
4. Theconceptsofgrosssubstitutabilityandgrosscomplementarityaredefinedanddistinguishedfrom
substitutabilityorcomplementarityinproduction.
5. Empiricalevidenceconcerningtheownwageandcrosswageelasticitiesofdemand,basedonboth
statisticalstudiesandinferentialanalyses,ispresented.
6. Standardlabordemandtheorypredictsthatanincreaseintheminimumwagewillresultintheloss
ofemployment.
7. Actuallymeasuringtheemploymenteffectsofminimumwageincreasesrequiresthatwedistinguish
betweennominalandrealchangesintherate,thatotherthingsinfluencingemploymentlevelsbe
controlledfor,andthatthepresenceofuncoveredsectorsandintersectoralshiftsinproductdemand
bebuiltintothedesignofthestudy.
8. Theresultsofstudiesestimatingtheeffectsofminimumwageincreasesaresensitivetothespecification
employed,withsomestudiesfindingtheconventionalnegativeeffectsandsomefindingnone.
Eventhosestudieswithnegativeemploymenteffectsgenerallyfindlabordemandelasticitiesthat
aremuchsmallerthanthosesummarizedearlierinthechapter.
9. Technologicalchangeinproductmarketscanchangetheslopeandplacementofproductdemand
curves,therebyshiftingand/orchangingtheelasticityoflabordemandcurves.
10. Thelabordemandeffectsoftechnologicalimprovementsincapitaldependoncrosselasticities;in
attemptingtoanalyzethelikelydominanceofthesubstitutionorscaleeffectinthiscase,theHicks
Marshalllawsapplicabletoownwagechangescannotbeslavishlyapplied.

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11. Technologicalchangecausestotalemploymenttobereallocated,notpermanentlyreduced.
CompensationofthelosersfromtechnologicalchangeisessentialforParetooptimality.

Chapter5
FrictionsintheLaborMarket
Thischapter,whichisnewtotheninthedition,analyzestheimplicationsoflabormarketfrictionsonboth
theemployeeandemployersidesofthemarket.Frictionsworkersfaceinmovingamongemployers(that
is,mobilitycosts)meanthatthehorizontallaborsupplycurvetofirmsassociatedwithsimpletheory
whichimpliesthatwagesfollowthelawofonepricemustbereconsidered.Indeed,mobilitycosts
createupwardslopinglaborsupplycurvestoemployersthatcreatemonopsonisticconditionsinthelabor
market.Theimplicationsoftheseconditionsforemployment,wages,andtheemploymenteffectsof
mandatedwages(theminimumwage,forexample)areanalyzedinthefirstsectionofthechapter.Also
analyzedinthecontextofmonopsonisticconditionsaretherelationshipofwagestobothlabormarket
experienceandtenurewithanemployer.
Thesecondsectionconsiderstheeffectsoffrictions(thecostsofadjustingthelaborinput)foundon
theemployersideofthemarket.Thesectionbeginswithadescriptionofthemagnitudeandgrowthof
nonwagelaborcosts,becausethequasifixedcostsoflaboraregenerallynonwageinnature.One
implicationoftheexistenceofbothvariableandquasifixedlaborcostsisthattherearisesatradeoff
betweenincreasingemploymentthroughhiringaddedworkersandincreasingemploymentthroughhiring
workersforlongerhours.Thetradeoffbetweenworkersandhoursisthendiscussed,andtheimportance
ofdistinguishingbetweenemploymentandhoursishighlightedinourpolicyanalysisoftheovertimepay
premiumandmandatedbenefitsforparttimeworkers.
Thethirdandfourthsectionsofferdetailedanalysesofthetwoprincipaltypesoflaborinvestments:training
investmentsandhiringinvestments.Inthesectionontraininginvestmentsthestudentisintroducedtothe
notionofgeneralandspecifictraining,aswellastotheimplicationsoftraininginvestmentsforthe
demandforlabor.WhileChapter9alsocoversaspectsofeducationandtraining,itisourbeliefthatthis
introductiontohumancapitaltheoryinChapter5isuseful.Inthischapter,asthroughoutthetext,we
introduceparticularconceptsortoolsastheyarecalledforbythelargercontextofanalysis,becauseby
maintainingaclearviewoftheoverallcontextofanalysis,thestudentisbetterabletolearntheinsights
thateconomicshastooffer.Inthisparticularcase,wedeliberatelychosetospreadtheconceptsofhuman
capitaltheoryacrossdifferentchaptersusingtheseconceptsasnecessaryandmaintainingtheoverall
substantiveorganizationofthetext(builtarounddemandandsupply).
Forsimilarreasons,thesectiononhiringinvestmentsincludesadiscussionofcredentialsandsignaling,
aswellasanintroductiontotheconceptofinternallabormarkets.Thesetopicsarealsodiscussed

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elsewhereinthetext(notablyinChapters11and12),butwefeltthatacompletediscussionoftheeffects
ofquasifixedcostsonthedemandforlaborwasimpossiblewithoutadiscussionoftheseconcepts.
Again,wewantedtomaintaintheorganizationaloverviewinthemindsofthestudents.(Wealsofirmly
believethatdiscussingconceptsorphenomenainseveralcontextsandatdifferentpointsinthebook
reinforcesthelearningprocess.)

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nList of Major Concepts

1. Simpletheoryassumesthelaborsupplycurvetoindividualemployersishorizontalandthatfirms
canincreaseordecreaselaborwithoutcost.
2. Horizontallaborsupplycurvestoemployersimplythatworkersaresosensitivetosmallwage
differencesacrossemployersthatthelawofonepriceholds(workersofequalskillarepaidthe
samewage).
3. Wagedifferenceswithinskillgroupsacrossfirmsandregionssuggestthatmobilitycostsfor
workersacrossemployersarenonzero.
4. Highermobilitycostsforemployeesresultinmoresteeplysloped(lesselastic)laborsupplycurves
tofirms.
5. Anupwardslopinglaborsupplycurvetoafirmcreatesamarginallaborexpensecurvethatlies
above,andrisesmoresteeplythan,thelaborsupplycurve.Forthisreason,wecansaythatemployee
mobilitycostscreatemonopsonisticconditionsinthelabormarket.
6. Withmonopsonisticconditions,firmsmustdecideonbothemploymentlevels(foundwhere
marginalrevenueproductequalsmarginalexpenseoflabor)andwages(findingthewagerequiredto
yieldtheprofitmaximizingemploymentlevel).
7. Undermonopsonisticconditions,leftwardshiftsinthelaborsupplycurvethatmaintainthesupply
curvesupwardslopewillhavetheconventionaleffectofraisingwagesandreducingemployment.
8. Undermonopsonisticconditions,mandatedwageincreasescausethelaborsupplycurvetobe
horizontalatthemandatedwagelevel.Thiscanlowerthemarginalexpenseoflaborevenifwages
areincreased,potentiallyleadingtononnegativeemploymentchangesintheshortrun.
9. Inthelongrun,mandatedwageincreasesthatareaccompaniedbyincreasesinemploymentwill
increasefirmslaborcostsandcausesomefirmstoceaseproduction(whichofcoursereduces
employment).
10. Thepresenceofmonopsonisticconditionsinthelabormarketoffersanexplanationforwhy
estimatedemploymentlossesassociatedwithminimumwageincreaseshavebeensmallerthan
expected,giventheelasticityoflabordemandcurvesestimatedfromwagechangesarisingfrom
marketforces.
11. Monopsonisticconditionsimplythattosomeextentaworkerswageratedependsonluck.
12. Withemployeemobilitycosts,wagesreceivedbyanindividualwilltendtoimprovewithlabor
marketexperience,astheindividualaccumulatesopportunitiestosearchforimprovedemployment
offers.
13. Workersfortunatetofindhighwagejobswilltendtostickwiththeiremployers,whichhelps
explainwhyhigherwagesareassociatedwithlongerjobtenures.
14. Therelativegrowthofwageandnonwagecostsispresented.

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15. Frictionsontheemployersideofthemarketarisefromthecostsofadjustingthelaborinput.These
costshavebeencalledquasifixedcostsofemployment,andtheytaketheformofemployee
benefitsthatareassociatedwiththenumberofworkersratherthanthehoursofwork,andwithlabor
investmentsmadebyemployers.
16. Theessentialcharacteristicofaninvestmentisthatresourcesareexpendedinthecurrentperiod
andreturnsarereceivedlater;theprincipaltypesoflaborinvestmentsthatfirmsundertakerelate
totrainingandhiring.
17. Therearebothexplicitandimplicitcostsofjobtraining.
18. Employeebenefitsarecategorizedandthetypestypicallyreceivedarelisted.
19. Thepresenceofquasifixedcostscausesanemployment/hourstradeoff,andthefirmmustdetermine
itsoptimummixofemploymentandhoursperworker.
20. IncreasedovertimepaypremiumsthatmightberequiredundertheFairLaborStandardsActwould
tendtoreducetheuseofovertime,butwhethertheyincreasethenumberofworkersemployed
dependsonthesizeofthereductionintotallaborhoursdemanded.
21. Thedistinctionbetweengeneralandspecifictrainingisdefined,andtheeffectsofspecifictraining
ontherelationshipbetweenwagesandmarginalproductivityisanalyzed.
22. Traininginvestmentsarerecoupedthroughthecreationofasurplus(agapbetweenmarginal
productandwage)thatalsocushionstheworkerfromlayoffsoverthebusinesscycle.
23. Thepresenceofhiringcostsinducesfirmstousecredentialsandinternallabormarketsinthe
recruiting,selection,andpromotionprocesses.
24. Liketrainingcosts,hiringinvestmentsincreasetheproductivityofselectedjobapplicants
(bydistinguishingamongthemonthebasisofproductivity),andtheyarerecoupedbypaying
wageslessthanproductivity.

Chapter6
SupplyofLabortotheEconomy:
TheDecisiontoWork
Beyondintroducingsomedescriptivematerialonlaborforcetrendsinthiscentury,theprimarypurpose
ofChapter6istopresentananalysisofanindividualsdecisionconcerningwhetherandforhowlongto
work.Thecontextofthisdecisionisthetraditionallabor/leisurechoiceframeworkandthechapteris

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carefullyconstructedtobuildtheconceptsnecessaryforthisanalysis.Theanalysisbeginswithasection
thatdiscussesthechoiceprocessverbally,buildinguponwhatstudentsknowconcerningproductdemand.
Itthenmovestoaspecificanalysisofthedemandforleisuretime(whichinthiscontextistheobverse
ofthesupplyoflabor),andintroducestheconceptsofincomeandsubstitutioneffects(theyaremore
rigorouslydealtwithlater,inthecontextofagraphicanalysis).
Ourgraphicanalysisisintendedtoaccomplishtwoends.Oneistofixanddefinemorepreciselythe
conceptsofincomeandsubstitutioneffects.Thesecondistoequipstudentswithatoolnecessaryto
analyzemanypolicyissuesaffectingworkincentives.Asamplingofsuchpoliciesandtheiranalysesis
giveninthefinalsectionofthechapter(followingasectionthatdiscussesempiricalfindingsconcerning
laborsupplytotheeconomy).

nList of Major Concepts

1. Measuresofaggregatelaborsupplygenerallyfocusonlaborforceparticipationratesandweekly
hoursofwork;trendsinthesemeasuresarepresentedanddiscussed.
2. Therelationshipbetweenthedemandforleisure,thedemandforothergoods,andthesupplyof
laboristhefocalpointforbeginningouranalysisoflaborsupplytheory.
3. Thesubstitutioneffectisdefinedasthechangeinhourssuppliedattendantonachangeinthewage
(priceofleisure),holdingincomeconstant.
4. Theincomeeffectisthechangeinhourssuppliedforagivenchangeinincome,holdingthewage
constant.
5. Themajorforcesaffectinglaborsupplyarepreferences,wages,andincome;theseforcescanbe
graphicallydepicted.
6. Thefiveassumptionsunderlyingindifferencecurves(agraphicdepictionofpreferences)are
discussed.
7. Theincorporationofinformationonwagesandincomeintothedrawingofbudgetconstraintsis
illustrated.
8. Graphicalanalysesoftheincomeandsubstitutioneffectsarepresented.
9. Theconceptofreservationwageisdefinedandillustratedgraphically.
10. Empiricalfindingswithrespecttothelabor/leisurechoice,frombothnonexperimentalcrosssection
dataandexperimentalstudies,arepresented.
11. Analysesofthebudgetconstraintscreatedbyseveralgovernmentincomesupportprogramsare
presented.Analyzedarethosewithskikes,thosewithzeronetwagerates(includingthosewith
workrequirements),andthosewithpositiveeffectivewagerates(asillustratedbyananalysisofthe
EarnedIncomeTaxCreditprogram).

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Chapter7
LaborSupply:HouseholdProduction,
theFamily,andtheLifeCycle
Chapter7analyzesthelaborsupplydecision(thedecisiontoworkforpay)inthecontextofhousehold
productiontheory.Inthischapter,theprimaryalternativetoworkingforpayisnotassumedtobeleisure,
buthouseholdproduction.Thisframeworkquitenaturallyleadsthediscussionoflaborsupplyintothe
contextoffamilies,therebyraisingtheissueoffamilylaborsupplydecisions.Further,sinceones
householdproductivityvariesconsiderablyacrossthelifecycle(as,ofcourse,dowages),theconcepts
ofhouseholdproductionalsoleadtoadiscussionoflaborsupplyoverthelifecycle.
Instructorsfacingseveretimeconstraintsmaywishtoskipthischapter.Theinsightsprovidedbythe
analysisinChapter7arerefinementsofthebasicconceptsintroducedinChapter6,andtheydonot
contradicttheinsightsorpredictionsofChapter6.However,Chapter7summarizessomerecent
directionsinwhichlaborsupplytheoryhasbeengoing,andtosacrificeChapter7wouldmeanforgoing
conceptsandempiricalworkclosetothefrontiersofeconomicanalysis.
Thechapterbeginswithanintroductiontotheconceptthathouseholdscombinetimeandgoodsto
producecommoditiesthatareconsumedathome.Thegraphicanalysisofhouseholdproductionandthe
choiceofhouseholdproductiontechnologyisshowntobecompletelyanalogoustothegraphicanalysis
andfundamentalimplicationsofthelabor/leisurechoicediscussedinChapter6.Thehousehold
productioncontextofthelaborsupplydecision,however,yieldsinsightsaboutthatdecisionthatgo
beyondthoseofChapter6.Theseinsightsarediscussedafterourbriefintroductiontohousehold
productiontheoryinthefirstsection.
Inparticular,wepointoutthetripartitechoicebetweenmarketwork,householdwork,andleisurein
analyzingwhythesubstitutioneffectsforwomenmightbeexpectedtobelargerthanthoseformen.
Wediscusssuchfamilylaborsupplydecisionsaswhostayshometocareforchildren(ifanyonedoes),
whetherbothspouseswillworkforpay,andtheinterdependencyofthespouseslaborsupplydecisions.
Theadditionalworkeranddiscouragedworkerhypothesesarealsodiscussedinthiscontext.
Ourdiscussionofthelifecycleaspectsoflaborsupplybeginswiththeobservationthathousehold
productivitydoesindeedvaryoverthelifecycle.Thetraditionalinterruptedcareersofmarriedwomen
cannotbeexplainedwithoutreferencetotheshiftsinhouseholdproductivitythattakeplacewhen
childrenarebornandastheygrowolder.Laborsupplyoverthelifecycleisalsoaffectedbytheway
wagestypicallyvarywithage,causingintertemporalsubstitutioneffects;inthiscontext,wediscussthe
importantissueofchoiceofretirementage(includingdataonthewaylifetimeSocialSecuritybenefits
varywithageofretirement).
Thechapterconcludeswithapolicyanalysisofchildsupportassuranceprograms.

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nList of Major Concepts

1.

Thebasicconceptsofhouseholdproductiontheoryincludethecombiningofgoodsandtimeto
producecommoditiesthatyieldthefamilyutility.

2.

Householdcommoditiesmaybeproducedbytimeintensivemethodsorbygoodsintensive
methods;themethodchosenisinpartafunctionofthepriceplacedontime.

3.

Theprincipalpredictionsassociatedwiththeincomeandsubstitutioneffectsinthelabor/leisure
modelareunchangedinthecontextofthehouseholdproductionmodel.Thelattermodel,however,
addsathirddimensionofchoiceabouttimeusage(marketwork,householdwork,leisure).

4.

Aswageschange,therewillbechangesinthetimeintensityofcommoditiesconsumedaswellasin
thetimeintensityofhouseholdproductiontechnologies.

5.

Jointhouseholdproductiondecisions(whichspouse,ifeither,shouldremainhomeinsteadof
workingforpay)haveyettobecompletelymodeled,buttheymustclearlytakeaccountofthe
partnersmarginalproductivitiesathomeandthewagestheycancommandinthemarket.

6.

Thediscouragedworkerhypothesisandtheadditionalworkerhypothesisarediscussedinthe
contextofhouseholdproductiontheory.

7.

Laborsupplydecisionsoverthelifecycleareaffectedbyhouseholdproductivitychangesand
predictablechangesinwagesoverthelifecyclethatcreateintertemporalsubstitutioneffectswithout
correspondingincomeeffects.

8.

Graphicanalysisofthechoiceofoptimumretirementageispresented,emphasizinghowdelaying
retirementbyayearcanaffectthepresentvalueofonestotalincomeovertheremainingyearsof
expectedlife.

9.

Childsupportassuranceprogramsensuretransferpaymentstocustodialparentsbasedontheageand
numberofchildren,notonincome.Incontrastwithwelfareprograms,whichtendtocreatebudget
constraintswithzeronetwagerates,childsupportassuranceprogramspreserveincentivestoengage
inmarketwork.However,forthosewhoworkedforpayintheabsenceofsuchprograms,thepure
incomeeffectcreatedbysupportassuranceprogramsshouldtendtoinducefewerhoursofpaid
work.

Chapter8
CompensatingWageDifferentials
andLaborMarkets

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Chapter8introducesstudentstotheconceptofcompensatingwagedifferentials.Followingthepractice
inearlierchapters,itseekstomovestudentsfromconceptstheyarefamiliarwithtonewconceptsand
tools.Again,theanalysisbeginswithaverbalexpositionofoccupationalchoiceandthewageoutcomes
thatflowfromthischoicewhenjobsdifferalongnonpecuniarydimensions.Oncetheessential
assumptionsandpredictionsofeconomictheoryinthiscontextareexplained,weintroducestudentstoa
graphicanalysisthatisintendedtoyieldadditionalinsights.Thegraphicanalysisoftheissueof
occupationalchoiceisalsointendedtoprovidestudentswithatoolforanalyzingtheeffectsof
governmentpoliciesonthelabormarket.
Wefirstapplytheconceptsofhedonictheorytoabad:jobinjuries.Policyimplicationsarerelatedto
occupationalsafetyandhealthlegislation.Wethenapplythetheorytoananalysisofhowelementsinthe
employmentpackageonwhichemployeesplaceapositivevalueaffectthewagerate.Theapplication
inthissectionofthechapterrelatestotheregulationofemployeebenefits,particularlypensions.
ForthosewhowishtoenrichthecoverageinChapter8,wehaveaddedanappendixthatanalyzesworker
choiceofjobsthathavedifferentprobabilitiesoflayoff.Thisappendixoffersanotherapplicationofthe
theoryofcompensatingwagedifferentialstoaninterestingpolicyproblem,andinsodoingelucidates
certainissuesnotcommonlyunderstood.Theanalysisalsointroducesthestudenttothenotionsofrisk
aversionandthewillingnesstopayforinsurance(certainty).

nList of Major Concepts

1. Inthecontextoffullinformationandchoice,workerbehaviorwillgeneratecompensatingwage
differentialsforjobcharacteristicsthatareunpleasantorcostly.
2. Compensatingdifferentialsplayadualroleinallocatinglabortounpleasantjobsandin
compensatingthosewhoacceptunpleasantwork.
3. Thepredictionthattherewillexistcompensatingwagedifferentialsforunpleasantworkrestson
assumptionsofutilitymaximization,workerinformation,andworkermobility.
4. Employeepreferencesaregraphicallyexpressedintheconcavityandslopeofindifferencecurves.
5. Employerswithdifferentcostsofeliminatingunpleasantjobcharacteristicscanbegraphically
represented.
6. Amarketequilibriumcurve(oroffercurve)isderivedfromthezeroprofitisoprofitcurvesofthe
employersinthemarket.
7. Ifthemarketisworkingproperly,employeeswhoareleastaversetoanunpleasantjobcharacteristic
becomeemployedwithfirmsthatfinditmostexpensivetoeliminatethatcharacteristic.
8. Thetheoryofcompensatingdifferentialscanonlybetestedusingtechniquesthatcontrolforother
influencesonjobcharacteristics.
9. Governmentattemptstoregulatetheoutcomeoflabormarketdecisionsthataremadeinaperfectly
functioningmarketcouldleadtoareductionofutilityfortheworkersthegovernmentisintending
tohelp.

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10. Governmentinterventionintothelabormarketcanincreaseworkerutilityifthemarketisnot
functioningperfectly(thatis,ifnotallcostsorbenefitsofthedecisionarebornebythosemaking
them).
11. Themixofwagesandbenefitsinthecompensationpackagedependsonbothemployeepreferences
andthetradeoffsemployersarewillingtomake.
12. (Appendix)Somejobcharacteristicsnormallyconsideredbadmaybeconsideredgoodbysome
workers(layoffsmaybepreferrediftheyareknowninadvance).
13. (Appendix)Therearetwoissuesrelatingtotheundesirablecharacteristicsoflayoffs:thedegreeto
whichyearlylayoffs(knowninadvance)constrainaworkershoursofworktoliebelowthose
otherwisedesired,andthedegreetowhichlayoffscausetheworkersincomeeachyeartofluctuate.
14. (Appendix)Theconceptofriskaversionisrelatedtothehypothesisthattheexpectedutilityofa
levelofincome($X)receivedwithcertaintyisgreaterthantheexpectedutilityofastreamof
incomethatmayfluctuateovertimebutyieldanexpectedyearlyvalueof$X.

Chapter9
InvestmentsinHumanCapital:
EducationandTraining
Chapter9introducesstudentstotheconceptofhumancapitalandtreatsindetaileducationandtraining
investments.Thechapterbeginswithasectiononthedemandforeducationbyworkers,inwhicha
theoryofhumancapitalinvestmentisformulatedandaformalmodelofchoiceispresented.Implications
ofthismodelforbothindividualandaggregate(market)behaviorarethenderived.

Ehrenberg/SmithModernLaborEconomics:TheoryandPublicPolicy,TwelfthEdition,GlobalEdition

Thesecondsectionofthechapteranalyzestherelationshipbetweeneducationandearnings.Weintroduce
age/earningsprofilesanddiscussthereasonsfortheirconvexity.Includedinthissectionisananalysisof
thedifferentialconvexityamongsuchprofilesformenandwomen.
Next,weconsiderthequestionofwhethereducationisagoodinvestment.Weanalyzethisquestionfrom
bothanindividualandasocialperspective.Themajorfindingsoftheliteraturewithrespecttothe
individualratesofreturntoeducationaresummarized,andwediscusspossiblebiases(including
selectionbiases)inherentinthesefindings.Whendiscussingeducationasasocialinvestment,we
introduceboththetraditionalanswersofthehumancapitalistsandthemoreagnosticviewsofthose
whoseeeducationaspurelyasignalingdevice.Inthiscontextofevaluatingeducationandtrainingas
investments,wedevoteasectiontoevaluationsofgovernmentjobtrainingprograms.
Appendix9Apresentsandexplainsacobwebmodeloflabormarketadjustment,inwhichtheneedfor
educationalinvestmentsslowsdownthesupplyresponsetochangesinmarketdemand.

nList of Major Concepts

1. Investmentsinhumanbeingsarepartofthegeneralcategoryofinvestments.
2. Investmentsentailcostsinthecurrenttermwithreturnsflowinginoverlaterperiods.
3. Costsofhumancapitalinvestmentsincludeoutofpocketexpenses,forgoneearnings,andpsychic
losses.
4. Becauseinvestmentreturnsflowinoverseveralyears,ananalyticaltooltoconvertfuturesumsto
presentvalueisrequired(theconceptofpresentvalueanddiscountingfuturesumsisexplainedin
somedetail).
5. Humancapitalinvestmentsaremorelikelytobemadebypeoplewhoarenotpresentoriented,by
peoplewhoareyoung,insituationsinwhichthecostsofhumancapitalinvestmentsarelower,and
insituationsinwhichthereturnstotheseinvestmentsarelarger.
6. Variationsinthereturnstohumancapitalinvestmentscallforthsupplyresponsesbyindividuals,
affectingcollegeenrollmentsinpredictableways.

Ehrenberg/SmithModernLaborEconomics:TheoryandPublicPolicy,TwelfthEdition,GlobalEdition

7. Becauseeducationiscostly,jobsthatrequiremoreeducationortrainingmustpayahigherwageto
attractworkers(thatis,tocompensatethemforthecostofinvestment).
8. Age/earningsprofilesareflatterforlesseducatedworkers,reflectingsmallerhumancapital
investmentcostsintheirearlyyearsandlowergrowthofproductivity.
9. Postschoolinginvestmentsinonthejobtrainingcanhelpaccountforboththeconvexityandthe
fanningoutofage/earningsprofiles.
10. Postschoolinginvestmentsreduceactualearningsbelowpotentialearnings,andassuchinvestments
declineoverage,onesactualearningsapproachpotential.
11. Somedifferencesbetweenmenandwomenintheacquisitionofeducationandtraining(including
universitymajors)canbeexplainedbylowerratesofreturntosomehumancapitalinvestments
amongtraditionalwomen,whoexpectinterruptedlabormarketcareers.
12. Evaluationsofwhethereducationisagoodindividualinvestmenttypicallypresentrateofreturn
estimatesthatinvolvethreesetsofbiases:upwardbiasesassociatedwiththecorrelationbetween
educationandability,downwardbiasesassociatedwiththefailureofmonetaryearningstoreflectall
thebenefitsofacollegeeducation,andselectivitybiasesarisingfromthefactthatpeoplewho
chooseonecareermaybemoreproductiveinthatcareerthanacomparablytrainedpersonwhodoes
notchoosethatcareer.
13. Evaluationsofwhethereducationisagoodsocialinvestmentmustconsiderthehypothesisthat
educationactsasascreeningdevice,ratherthananactivitythatenhancesproductivity.
14. Ifthefullcostofeducationisinverselyrelatedtoability,andifabilityispositivelyrelatedtoonthe
jobproductivity,thenfirmscanuseeducationalattainmentasascreeningdevice(workerswillsort
themselvesoutaccordingtoabilityinchoosingtheirlevelofeducationalattainment).
15. Publicsectorjobtrainingprogramshavecreateddemonstrableearningsgainsonlyforadultwomen,
andthepresentvalueofthesegainstypicallyexceedsprogramcosts.
16. (Appendix9A)Delaysinsupplyresponsesassociatedwiththelonggestationperiodsofsome
humancapitalinvestmentscancreateperiodsofoversupplyfollowedbyperiodsofshortage(the
cobwebmodelasitappliestothelabormarket).
17. (Appendix9B)Thehedonicmodelimpliesthatthosewhoobtainthemosteducationareleastaverse
tolearningandprobablymostabletolearnquickly.

Chapter10
WorkerMobility:Migration,
Immigration,andTurnover

Ehrenberg/SmithModernLaborEconomics:TheoryandPublicPolicy,TwelfthEdition,GlobalEdition

Thischapteremploysthehumancapitalframeworktoanalyzethephenomenaofgeographicmobility
andworkerturnover.Itdemonstrateshowtheinsightsofhumancapitaltheorycanexplaintheobserved
patternsofmobilityandturnover,includingthepersonalcharacteristicsofthosemostlikelytoexhibit
eitherkindofmobility.
ThechapteralsodescribesandanalyzesimmigrationpolicyintheUnitedStates.Itconsiderstheproblem
ofillegalimmigrationanduseseconomictheorytoidentifythegainersandlosersfromamorerestrictive
immigrationpolicy.Finally,thesectiononimmigrationconcludeswithananalysisoftheoveralleffects
ofimmigration(includingillegalimmigration)onthenativepopulation.
ThelengthysectiononU.S.immigrationpolicyis,ofcourse,motivatedbyourhumancapitalanalysisof
individualmigration.However,thesectiondoesnotdirectlyemployhumancapitalanalytics.Thus,instructors
whowanttheirstudentsexposedtohumancapitalanalysisasitappliestogeographicalmobilityand
turnover,andwhoarewillingtoforgoananalysisoftheverytopicalissueofillegalimmigrationand
whattodoaboutit,couldsavesometimeinthecoursebyeliminatingthesectionofthechapteron
immigrationpolicy.

nList of Major Concepts

1. Workermobilitycanbeviewedasahumancapitalinvestment,inwhichthebenefitisaddedutility
inthefutureandthecostsarethedirectandpsychiccostsofquittingoneemployerandseekingwork
elsewhere.
2. Peoplewillmovefromjobsorareaswherepayisrelativelylowtojobsorareaswherepayisrelatively
highunlesssuchmobilityisinhibitedbyashorttimehorizon(orhighdiscountrate),costsoffinding
outaboutalternativeselsewhere,orhighcostsofthemoveitself.
3. Thereisanelementofselfselectioninimmigrationbecausethosewhoaremostlikelytomigrate
arethoseforwhomthenetbenefitsofmigrationarelargest(althoughthebenefitsareofteninitially
depressedbyunfamiliaritywiththelanguageorcustomsoftheareatowhichtheyhavemoved).
4. CountriesinwhichtheearningsdistributionsaremorecompressedthanintheUnitedStateswill
tendtosendrelativelyskilledworkerstotheUnitedStates,whilethosewithdistributionsthatexhibit
greatervariancewilltendtosendlessskilledworkerstotheUnitedStates.U.S.immigrationhas
tendedtobecomelessskilledinrecentyears.
5. Likeotherinvestments,migrationinvestmentscanfailtoworkoutasexpected,resultinginreturn
migration.

Ehrenberg/SmithModernLaborEconomics:TheoryandPublicPolicy,TwelfthEdition,GlobalEdition

6. Alargeinfluxofimmigrantswilltendtolowerwagesintherelevantlabormarketsandcreatemore
employment,butonlyinspecialcircumstanceswouldaninfluxofXimmigrantstakeXjobsaway
fromnatives.
7. Theargumentthatimmigrantsfilljobsnonativewouldtakeoverlooksthefactthatinducementsto
workinaparticularoccupationarenotindependentofthewagebeingoffered.
8. Immigrationmayincreaseproductdemandandthedemandforotherskillgradesoflabor.
9. Ifimmigrantsreceivewagesequaltotheirmarginalproduct,thenativepopulationasawholewill
notexperiencealossofincomeunlesstheimmigrantsreceivegovernmentserviceswhosevalue
exceedsthetaxestheypay.
10. Matchesbetweenemployerandemployeeareimprovedthroughtheprocessofvoluntaryquitsand
involuntarylayoffs.Thehumancapitalmodelcanbeusedtomodelquitbehavior.
11. Humancapitaltheorycanshedlightonthecyclicalpatternofquitrates,thepatternofquitrates
acrossagegroups,andinternationaldifferencesinquitrates.
12. Thecostsofquittingandsearchingforanewjobmayproduceanupwardslopingsupplycurveto
individualfirms,leadingtomonopsonisticbehavior.

Chapter11
PayandProductivity:WageDetermination
withintheFirm
Thischapterexploresindetailtherelationshipbetweencompensationandproductivity.Itbeginswith
adiscussionoftheemploymentcontract,whichislargelyimplicitandlegallyunenforceable.Howthis
contractcanbemadeselfenforcingwithinthecontextofasymmetricinformationistheprincipalfocus
ofthissection.
Afterdiscussionofsomegeneralissuesrelevanttoworkermotivation,weturn(insequence)toan
analysisofhowmotivationisaffectedbythebasisofpay,thelevelofpay,andthesequencingofpay.
Thus,wediscussinturnissuesrelatedtopiecerates,commissions,profitsharing,andhourlypay
(includingmeritpay);efficiencywages;anddeferredpaymentschemes,promotiontournaments,andthe
issueofcareerconcerns.Thechapterendswithashortsectionontwopuzzles:whyearningsincrease
withtenureandwhytheyincreasewithfirmsize.

nList of Major Concepts

Ehrenberg/SmithModernLaborEconomics:TheoryandPublicPolicy,TwelfthEdition,GlobalEdition

1. Productivityvariesacrossworkersandovertimeforagivenworker,anditinvolvestakingthe
initiativeinamyriadofhardtoobservewaysthatadvancetheemployersinterests.
2. Contractscanbebothformalandimplicit,withthelatterbeingincompletelyspecifiedandhence
legallyunenforceable.
3. Foranimplicitcontracttobeselfenforcing,thepartiescanrelyonsignalsthattheyarecontracting
withtherightkindofperson;alternatively,theycanstructurethecontractsothattheotherparty
derivesmorefromhonestcontinuationoftheemploymentrelationshipthanfromrenegingontheir
promises.
4. Dividingasurplusbetweenmarginalrevenueproductandthealternativewageiscriticaltoaself
enforcingemploymentcontract;thissurpluscanbecreatedbylaborinvestmentsofonesortorother.
5. Workerscanbemotivatedtobehighlyproductivebyclosesupervisionorbyhavingtheirearningstied
totheirperformance;thelattermethodrequiresthatthemeasuresoftheirperformancebecorrelated
withtheireffortandtheemployersobjectives.
6. Becauseofgroupconsiderations,motivationtechniquesmusttakeintoaccounttheperceptionsof
fairnessandissuesofgrouployalty.
7. Compensationschemesarejointlychosenbyemployerandemployee.
8. Schemesthattiepaytoindividualproductivitymusttakeworkerriskaversionintoaccount,butthey
areusefulinelicitingsignalsaboutworkercharacteristics.
9. Outputisnotnormallyonedimensional,andifpayisbasedonobjectivelymeasuredaspects
ofoutput(quantity),workerswillputforthlittleefforttoincreaseoutputalongtheother
(subjective,orquality)dimensions.
10. Groupincentiveschemesruntheriskofcreatingfreeriderproblems.
11. Timebasedpaywithmeritincreasescanbebasedoneitherabsoluteorrelativeoutput;absolutemeasures
donotcorrelateascloselywithindividualeffort,butrelativemeasurescaninducecounterproductive
behaviorsamongemployees.
12. Employeeswhofeelgenerouslytreatedbytheiremployersmayputforthgreatereffort;hence,by
increasingtheirwagesemployerscanincreasetheproductivityoftheirworkers(theefficiency
wage).
13. Efficiencywagesaremosteffectivewhentheemployeremployeetenureisexpectedtobelong.
14. Withlongexpectedtenures,thesequencingofpayisalsoanoption;thisoptionpromiseshandsome
futurerewardsforcurrenteffort.
15. Oneschemeinvolvesaperiodofunderpaymentfollowedbylateroverpayment,whichbothhas
signalingvalueinobtainingfutureoriented,hardworkingemployeesandoffersincentivesfor
currentworkerstoputfortheffort.
16. Promotiontournamentsalsohavesignalingandincentivevalue.
17. Employeecareerconcerns(whichcaninvolvefuturepayoffswithotheremployers)canboth
distortandenhanceeffortswithonescurrentemployer.

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18. Conceptsinthischaptercontributetotheclusterofhypothesesthatseektoexplainwhywagesrise
withtenureandwhylargefirmspayhigherwages.
19. Asfirmsincreaseinsizeitbecomesincreasinglycostlytomonitorworkereffort,andonewayto
copewiththismonitoringproblemistopayhigherwages.Thehigherlaborcostsassociatedwith
greaterfirmsizesuggeststhatthelaborsupplycurvetoafirmmaybeupwardsloping,andthismay
explainmonopsonisticbehavioramongfirmsinthelabormarket.

Chapter12
Gender,Race,andEthnicity
intheLaborMarket

Ehrenberg/SmithModernLaborEconomics:TheoryandPublicPolicy,TwelfthEdition,GlobalEdition

Thischapterrepresentsacomprehensiveinquiryintowagedifferentialsacrossgender,racial,andethnic
groups.Itbeginswithasectiononearningsdifferencesbygender,inwhichtheoveralldifferentialis
brokenintotwoparts:thatassociatedwithmeasurableproductivitydifferencesandthatassociatedwith
unobserved(unexplained)differences.Thelatterdifferencesareassociatedwith(butnotconfinedto)
currentmarketdiscrimination.Discriminationisdefinedandproblemsofitsmeasurementarediscussed
inthecontextofanalyzinggenderdifferencesinearnings.
Blackwhiteearningsdifferentialsareanalyzednextinasubsectionthatincludesabrieftreatmentof
differencesintheratiosofemploymenttopopulation.Earningsbyethnicityarealsodiscussed.Ineach
case,theanalysisincludesareviewofattemptstoestimatetheeffectsofdiscrimination,withspecial
emphasisontheeffectsofsuchhardtoobservefactorsasEnglishlanguageproficiency,cognitive
achievement,andschoolquality.
Thesecondmajorsectionofthechapteranalyzestheoriesofmarketdiscrimination.Beckerstheoriesof
employer,customer,andemployeediscriminationarediscussed,andthetheoryofstatisticaldiscrimination
isexplained,alongwithnoncompetitivemodelsofdiscrimination(occupationalcrowding,duallabor
markets,searchbasedmonopsony,andtheoriesinvolvingcollusiveaction).
Thechapterconcludeswithindepthdiscussionsofgovernmentaleffortstoreduceoreliminatemarket
discrimination:theEqualPayActof1963andtheCivilRightsActof1964.Includedinourdiscussion
ofthelastaretheevolutionofthedisparateimpactstandardbythecourts(asopposedtoadisparate
treatmentstandard),legaldecisionsinvolvingseniority,andtheemergingcomparableworthremedy.
Thechaptercloseswithananalysisofthefederalcontractcomplianceprogram,includingthestandards
againstwhichaffirmativeactionplansarejudgedandtheresultsofstudiesthathavetriedtoassessthe
effectsoftheprogram.
TheappendixtoChapter12containsanintroductiontotheproblemsofestimatingcomparableworth
earningsgaps.Thepurposeofthisappendixistwofold:togivestudentsabriefillustrationoftheuse
ofregressionanalysisandtoshowthemhowcomparableworthcomparisonsaremade.

nList of Major Concepts

1. Incomedisparitiesbetweenmenandwomenmayhavetheirrootsindifferentincentivestoacquire
productivecharacteristics.
2. Currentlabormarketdiscriminationissaidtoexistwhenthemarketplacesvaluesonpersonal
characteristicsofworkersthatareunrelatedtoproductivity.
3. Earningsdifferentialscausedbydifferencesinproductivecharacteristicsaretermedpremarket.
4. Occupationalsegregationisoneformofdiscrimination,anditcanbemeasuredbyanindexof
occupationaldissimilarity;however,itisdifficulttodistinguishbetweentheeffectsofoccupational
choiceandthoseofemployerdiscrimination.
5. Tomeasuretheextentofwagediscrimination,onemustdeterminewhattheearningsratiowouldbe
iftheprotectedclassandwhitemaleshadthesameproductivecharacteristics.However,theadjusted
differentialisinrealityanunexplaineddifferential,anditcouldreflecttheeffectsofunmeasured
workercharacteristicsaswellasmarketdiscrimination.
6. Muchofwhatappearstobelabormarketdiscriminationagainstwomentakestheformof
occupationalsegregation,which,whilestillrathermarked,seemstobedecliningsomewhatrecently.

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7. Whenproductivecharacteristicsarecontrolledinananalysisofearningsdifferentials,theyaccount
forallbutroughly10percentagepointsofthegenderwagedifferential.
8. Differencesintheblackwhiteemploymenttopopulationratioareafunctionofbothhigher
unemploymentratesandlowerlaborforceparticipationratesamongblacks.
9. Studiesusingconventionallymeasuredvariablesforproductivecharacteristicssuggestthatabout
11percentagepointsoftheobserveddisparitybetweenblackandwhitemalesmaybeduetocurrent
labormarketdiscrimination.Studiesthatcontrolforcognitiveachievementscoresaswellsuggest
thatblackmenearnfrom8%moreto8%lessthanwhitemenwithcomparableproductive
characteristics.
10. Humancapitalandlanguageproficiencydifferencesaccountforabout3to7percentagepointsof
theHispanicwagedifferential.
11. Ifemployersdiscriminateagainstsomegroupofworkers,theywillactasiftheybelievethe
marginalproductofthoseworkersislowerthanitreallyis.Thus,theywillhirefewersuchworkers
thanwouldbecalledforbyprofitmaximization,andthosewhoarethemostdiscriminatorywill
maketheleastprofits.
12. Underemployerdiscrimination,thebehaviorofprejudicedemployerswillreducedemandforthe
minoritygroupandcauseawagedifferentialtoexist.Thesizeofthedifferentialdependsonthesize
oftheminoritypopulationrelativetothedistributionofprejudicedemployersinthemarket.
13. Theimplicationthatprejudicedemployerswillbelessprofitablesuggeststhatdiscriminationought
tobeeliminatedovertimeasnonprejudiced(profitable)employersbuyoutlessprofitable,
prejudicedemployers.
14. Likeemployerdiscrimination,customerdiscriminationimpliesashifttotheleftofthedemand
curvefortheservicesofaprotectedclass.However,withcustomerdiscrimination,areductionin
productivityis,fromtheemployersperspective,genuine.
15. Employeediscriminationgeneratessupplyrelatedbehaviorthatmightcauseemployerstosegregate
theirplantsbyraceorsexifpossible.Ifnot,wagedifferentialswillariseasaresultoftheneedof
employerstoretainworkersintheprejudicedgroup.
16. Statisticaldiscriminationarisesfromascreeningprobleminwhichjobapplicantsareevaluatedboth
ontheirindividualcharacteristicsandonaveragecharacteristicsofthegrouptowhichtheybelong.
Statisticaldiscriminationshouldbereducedinsituationsinwhichthevarianceofindividual
characteristicsaroundthegroupaveragewidens.
17. Boththecrowdinghypothesisandtheoriesemphasizingtheduallabormarketsuggestthepresence
ofnoncompetinggroups,buttheydonotsatisfactorilyexplainthecreationofthesegroups.
18. Ifsearchcostscreateupwardslopinglaborsupplycurvestoindividualemployers,andif
discriminationraisesthesearchcostsofcertaingroupsofworkers,thenmonopsonisticbehaviorwill
createwagedifferentialsamongotherwiseidenticalworkers.

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19. Sometheoristsusecollusiveactiononthepartofemployerstoexplainthecreationandpersistence
ofnoncompetinggroups.Employersareseenasdeliberatelydividingthelaborforcetoguardagainst
cohesivecollectiveactionbyworkers,butthetheorydoesnotexplainhowanemployercartelis
maintainedinthefaceofclearcutincentivestocheat.
20. Antidiscriminationprogramsbythegovernmentmustsetstandardsforbothemploymentand
wages.Ifemploymentstandardsaretheonlyonesused,prejudicedemployersmaycomplyby
payingprotectedclassworkerslessthanwhitemales.Ifawagestandardistheonlyoneapplicable,
thenprejudicedemployerswillrespondtoincreasedwagesforprotectedclassesbyreducing
employment.
21. AdisparatetreatmentstandardimposedundertheCivilRightsActjudgesthatdiscriminationhas
occurredifdifferentproceduresareusedfordifferentgroupsofpeopleandifitcanbeshownthat
therewasanintenttodiscriminate.Provingintentisdifficult,andpoliciesthatmayappeartobe
neutralonthesurfacemayneverthelessperpetuatetheeffectsofpastdiscrimination.
22. Courtshavemovedtowardadisparateimpactstandard,bywhichitislabormarketresults,not
motivation,thatcounts.Underthisstandard,policiesthatleadtodifferenteffectsbyraceandsex
areprohibitedunlessabusinessnecessitycanjustifytheiruse.
23. Becauseofoccupationalsegregation,menandwomenoftenoccupydissimilarjobs.Thecomparable
worthremedyisbasedoncomparingtheskillcontent,responsibility,andworkingconditionsinjobs
forpurposesofpaycomparisons;however,mandatingwageincreasesforwomencouldreducethe
incentivesofemployerstohirethem.
24. TheFederalContractComplianceProgramseekstoshiftthedemandcurveforprotectedclassesto
theright.Federalcontractorsarerequiredtofileaffirmativeactionplansthatstatetheirgoalsfor
hiringandpromotingmembersofprotectedclasses(takingintoaccountavailability).
25. Realisticestimatesofavailabilityshouldaccountforthecompensationpolicyofthefirm,the
willingnessofworkerstocommutetothefirm,thedegreetowhichthefirmhasincentivestotrain
newemployees,andtheextenttowhichjobapplicantscanbeinducedtomovetothefirmslabor
marketarea.
26. Studiestoevaluatetheeffectsofgovernmentantidiscriminationeffortshavefocusedontimeseries
analysesofearningsratiosandeffectsonfederalcontractors(emphasizingchangesinemployment
levels,wages,andquitratesforprotectedclassworkers).
27. (Appendix)Estimatingcomparableworthearningsgapstypicallyinvolvesevaluatingcharacteristics
ofjobsformenandwomenandestimatingtherelationshipbetweenthesecharacteristicsand
compensationforwhitemales.Thisrelationshipcanthenbeusedtoestimatewhatwomenwould
receiveiftheywerepaidonabasiscomparabletomen.
28. (Appendix)Apreciseandinformativewayofestimatingtherelationshipbetweenpointscoresand
compensationwouldbetouseordinaryleastsquaresregressiontechniquestofitthebestline
throughtheobservedpointsonthegraph.Theestimatedcoefficientonthepointscorevariableisan
estimateofhowmuchaunitchangeinthatvariableaffectsearnings.

Ehrenberg/SmithModernLaborEconomics:TheoryandPublicPolicy,TwelfthEdition,GlobalEdition

Chapter13
UnionsandtheLaborMarket
Themajorfocusofthischapterisontheeconomiceffectsofunions,inboththeprivateandpublic
sectors.ItbeginswithsomenecessarydefinitionsanddescriptionsofunionismintheUnitedStates
comparedtoelsewhereintheworld,beforeturningtoelementarycoverageofmajorpiecesoflabor
legislationintheUnitedStates.
Inseekingtheirobjectives,unionsareconstrainedbythedemandfortheirmembersservices.Unions
facingrelativelyinelasticdemandcurvesarebetterabletoraisewageswithoutadverselyaffecting
employmentlevelsverymuch.Thesimplestmodelofunionsobjectivesisthemonopolyunionmodel,
inwhichtheunionsetsthewageandtheemployeradjustsbysettingtheemploymentlevel.Amore
complexmodelistheefficientcontractsmodel,inwhichtheunionandfirmjointlybargainoverwage
andemploymentlevels.
Inattemptingtoexplainthemajoractivitiesofunions,wehaveorganizedtheanalysisaroundthedemand
forunionsbyworkersandthesupplyofunionservicesbylaborunions.Weusethisanalysistohelp
understandthemajortrendsinAmericanunionization.Nodiscussionofunionbehaviorwouldbecomplete
withoutananalysisofstrikeactivityand(forthepublicsector)interestarbitration.Thesectiononstrikes
includesanexpositionoftheHicksmodelofbargainingandtheAshenfelterJohnsonpoliticalmodelof
strikebehavior(includingtheeffectsoftheLandrumGriffinAct).Thesectiononarbitrationdiscusses
thecontractzoneinthecontextofbothconventionalandfinalofferarbitration.
Havinganalyzedsomekeycharacteristicsofunionbehavior,weturntoananalysisoftheeffectsof
unionsonwagesandotherworkplaceoutcomes.Themeasurableeffectofunionsonwagesistherelative
wageadvantage,foundbycomparingunionwagestowagesinthenonunionsector.Thetrue(orabsolute)
effectsofunionsonwagesarenotmeasurable,andthepossiblebiasesinherentinmeasuringtheabsolute
effectsusingrelativeeffectmeasuresarediscussedatlength.Weclosethechapterbysummarizing
empiricalevidenceontheeffectsofunionsonrelativewages,totalcompensation,employment,
productivity,andprofit,anddiscussbothtraditionalandalternativeviewsofunioneffectsonthe
overallsocialwelfare.
TheappendixtoChapter13analyzeshowtheuncertaintyofarbitratorsdecisionsaffectsbargaining
outcomes.AsintheappendixtoChapter8,thediscussiondefinesandillustratestheconceptofrisk
aversion.

nList of Major Concepts

1. UnionmembershipasafractionofthepopulationintheUnitedStatesislowrelativetotheother
majorindustrialcountries,andAmericanunionactivitiesarerelativelydecentralized.
2. Unionsareconstrainedintheirobjectivesbythelabordemandcurve.
3. Themonopolyunionmodelassumesthattheunionsetsthewageandtheemployersetsthe
employmentlevel.

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4. Theefficientcontractsmodelemphasizesthatifunionsandemployersbargainonlyoverwages,
theresultingemployment/wageoutcomewillbeinferiortoanothersetofoutcomesthatwould
improvethewelfareofbothparties.Underthismodel,thetwopartiesbargainoverbothwageand
employmentlevels.
5. ThedeclineinAmericanunionmembershipcanbeunderstoodinpartbyreferencetoshiftsinthe
demandandsupplycurvesforunionservices(causedbythefeminizationoftheworkforce,a
changeinindustrialcomposition,regionalshifts,competitivepressures,andemployerresistance).
6. Unionsoftentakeactionsdesignedtoshiftthedemandcurveforlabortotherightand/ortoreduce
theelasticityofdemandforunionlabor.
7. Strikesareintendedtoimposefinancialcostsonemployersiftheydonotagreetounionoffers,but
becausetheyalsoimposecostsonemployees,bothsidesbecomemorewillingtomakeconcessions
asstrikedurationincreases.TheHicksbargainingmodelsuggestswhenstrikeswillend,butitdoes
notexplainwhystrikesoccurinthefirstplace.
8. Whilestrikescanoccurbecauseonepartymistakestheotherstrueposition,theycanalsooccur
because,inthecontextofasymmetricinformation,onepartywantstoelicitasignalfromtheother
aboutitstruepreferencesorconstraints.
9. TheAshenfelterJohnsonmodelofstrikeactivity,whichistripartiteinnature,viewsunionleaders
andunionmembersassometimeshavingconflictingperspectives.Unionleaders,whohavebetter
informationthantheirmembers,maypursuethetwingoalsofmaintainingtheirpositionsinthe
unionandeducatingunionmembersbyrecommendingastrike.
10. Unionspropensitiestostrikevaryoverthebusinesscycleandhavetrendeddownovertime,butthe
increaseinuniondemocracyassociatedwiththeLandrumGriffinActcausedaonetimeincreasein
strikeactivity(aspredictedbytheAshenfelterJohnsonmodel).
11. Interestarbitrationisusedinthepublicsector,wherestrikesaregenerallynotpermitted,andinterest
arbitrationcanbeconventionalorfinaloffer.
12. Thecontractzoneintowhichprearbitrationofferswillfallcanbewidenedbyboththe
uncertaintyaboutwhatanarbitratormightdecideandthepartiesaversiontotheriskofanadverse
outcome.However,itisnotclearwhetherawidercontractzoneincreasesorreducesthechances
thatadisputewillgotoarbitration.
13. Onewouldliketomeasuretheeffectsofunionsonwagesintheabsolute(comparingwagesina
worldwithunionstowagesinaworldwithout);however,measuringthisabsolutewageadvantageis
impossible.Wecanonlymeasureunionwagesrelativetononunionwages,butthisisnotagood
measureoftheabsoluteeffectbecausethepresenceofunionsaltersthenonunionwagealso.
14. Ifthenonunionlabormarketisinequilibrium,thepresenceofunionsshouldlowerthenonunion
wagebelowwhatitwouldhavebeenotherwiseandcausetherelativewageeffecttooverstatethe
absoluteeffectofunions.
15. Ifemployersraisewagesinthenonunionsectortokeepunionsout(thuscreatingunemploymentin
thatsector),therelativewageeffectissmallerthantheabsoluteunionwageeffect.
16. Thepresenceofwaitunemploymentintheunionsectorwillinhibitthegrowthinlaborsupplyinthe
nonunionsectorandcouldevencausethesupplycurvetheretoshiftleft.Whetherwait

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unemploymentcausestherelativewageeffecttobegreaterorsmallerthantheabsolutewageeffect
dependsonwhetherthesupplycurveoflabortothenonunionsectorshiftstotherightorleft.
17. Inanoverallsense,unionsappeartoraisethewagesoftheirmembersabovethenonunionwageby
somethinglike10to20%.Thesewageeffectsarelargerintheprivatethanthepublicsector,larger
intheUnitedStatesthanelsewhere,andlargestamongunskilled(andminority)workers.
18. Unioneffectsonemployeebenefitsasapercentageoftotalcompensationtendtobepositive;thus,
thetotalcompensationeffectsofunionsmaybegreaterthantherelativewageeffects.
19. Thecompensationadvantagesenjoyedbyunionmembers,however,maybeinpartacompensating
wagedifferentialforthemorestructured,morehazardous,andlessflexibleworksettingsin
unionizedfirms.
20. EmpiricalevidencetendstosuggestthatintheUnitedStates,unionizationreducesemploymentor
employmentgrowth,hasanambiguouseffectonproductivity,andhasanegativeeffectonprofits.
21. Thetraditionalviewofunioneffectsstressesthesociallosscausedbyinequalityinwages(and
marginalproductivities)amongworkersofcomparableskill.Thetraditionalviewalsostressesthe
lossesassociatedwithunionstaffingrequirements,restrictiveworkpractices,andstrikes.
22. Thealternativeviewofunionsisthattheyprovideamethodofcollectivevoicethattendsto
reduceturnoverandencouragesfirmstoprovidespecifictrainingtoemployees.Improved
communicationsbetweenlaborandmanagementmayalsoincreaseproductivityandworker
motivationdirectly,butemployerresistancetounionsandthedegreetowhichstockmarketprices
aredepressedwhenunionorganizationdrivesareinitiatedsuggestawidespreadbeliefthatunions
reduceprofitability.
23. (Appendix)Whencollectivebargainingimpassescanbedecidedbyarbitration,therangeofpossible
nonarbitratedsettlementsiswidenedbygreateruncertaintyabouthowthearbitratorwilldecide
(ifanagreementisnotreached)andbygreaterriskaversiononthepartoftheparties.

Chapter14
Unemployment
Thischapterdefinestheunemploymentrateanddiscussesitsstrengthsandweaknessesasameasureof
economicwelfare.Further,itemphasizesthatwhiletheunemploymentrateisastockconcept,thereisan
underlyingsetofflowsintoandoutofthatstock.Thus,differentdemographicgroupsmayhavedifferent
unemploymentratesbecauseofdifferentpropensitiestoquitorbelaidofffromjobs.

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Next,wediscussfourgeneraltypesofunemployment:frictional,structural,demanddeficient,andseasonal.
Inthesectiononfrictionalunemploymentwediscusssearchtheoryandtheeffectsofunemployment
benefitsonjobsearch.Whenanalyzingstructuralunemployment,occupationalandgeographical
imbalances,governmentpolicies,andefficiencywages(includingthewagecurve)arediscussed.The
sectionondemanddeficientunemploymentanalyzeswagerigidity,thefinancingofunemployment
benefits,andpoliciesandadjustmentsfoundinEurope.
Thechapteralsotreatstheissueoffullemployment.Thestructureofunemploymentratesacross
demographicgroupsispresented,andwethendiscusseffectsofthechangingage,race,andsex
compositionofthelaborforceonthefullemploymentrateofunemployment.

nList of Major Concepts

1. Theunemploymentrateisthenumberofnonemployedpeopleseekingworkdividedbythenumber
ofpeoplewhoareinthelaborforce.Whilethismeasurehasanumberofseriousdrawbacks,it
remainsausefulindicatoroflabormarketconditions.
2. Whilewecanthinkofapool(orstock)ofunemployedpersons,thisstockisconstantlychanging.
Focusingonlyonthestockmasksthehighlydynamicnatureoflabormarkets.Unemploymentrates
areaffectedbylayoffsandquits,newhiresandrecalls,andretireesfromandnewentrantsintothe
labormarket.Astheseflowschangerelativetoeachother,theunemploymentratechangesin
predictableways.
3. Frictionalunemploymentoccursbecauselabormarketinformationisimperfect.Ittakestimeevenin
thebestofmarketsforunemployedworkersandemployerswithjobvacanciestofindeachother.
Governmenteffortstoimprovetherapidityofthejobmatchingprocesscouldreducetheextentof
frictionalunemployment.
4. Aperiodofunemploymentcanbelookeduponasatimewhenajobsearchcanbeundertaken,and
theextenttowhichsomeonewillspendtimesearchingforworkdependsupontheexpectedbenefits
andcostsofcontinuingsearch.
5. Sincethereceiptofunemploymentinsurancebenefitsreducesthecostsofextratimespentsearching
forwork,themoregenerousthesebenefitsare,thelongerunemployedworkerswilltendtosearch
forjobs.Thus,moregenerousunemploymentinsurancebenefitsmaybeexpectedtoincreasethe
durationofunemployment.

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6. Structuralunemploymentoccurswhenflowsofworkersintoandoutofparticularlabormarkets
definedbyskillorgeographyareimpeded.Governmenteffortstosubsidizemobilityand/orjob
trainingwouldservetoreducetheincidenceofstructuralunemployment.
7. Structuralunemploymentisalsoassociatedwithfirmsdecisionstopayefficiencywages;insuch
cases,someworkerswithoutjobswaitforjobsinthehighpayingsectoranddonotseekjobsin
lowerpayingfirms.
8. Efficiencywagesmayunderliethewagecurvefoundinalmostallcountriesstudied;thiscurve
plotsanegativerelationshipbetweentheregionswageratesandtheirunemploymentrates.
9. Demanddeficientunemploymentoccurswhentheaggregatedemandforlabordeclinesintheface
ofdownwardinflexibilityofnominalorrealwages.
10. Thereareseveralreasonsforthedownwardinflexibilityofmoneywages,includingthepreference
ofunionsforlayoffsoverwagecuts,theasymmetryofinformationbetweenemployersand
employees,firmspecifictraining,riskaversionofolderworkers,concernsaboutstatus,andimplicit
contractualagreementsthatafteraninitialperiod,whentheriskoflayoffishigh,yearlyearningsof
workerswillstabilize.
11. Thegovernmentstaxtreatmentofmostunemploymentinsurancebenefitsanditsfailuretoperfectly
experienceratetheunemploymentinsurancechargesleviedonemployersleadtoahigherlayoffrate
thanwouldotherwiseprevail.
12. InEurope,cyclicalfluctuationsinlabordemandaremorelikelytobemanifestinadjustmentsin
hours,notemploymentlevels.Onereasonforthegreateradjustmentsinhoursofworkmaylie
inthewideruseofpartialunemploymentcompensationbenefitsinEurope.
13. Seasonalunemploymentmaybeassociatedwithchangesintheweatherorwithmodelchangeovers,
butitisalsoaffectedbydownwardrigidityofmoneywagesandthegovernmentsunemployment
insuranceprogram.
14. Thefullemploymentrateofunemployment(i.e.,unemploymentinnormaltimes)appearstohave
changedinrecentyears,inpartduetothechangingproportionofwomen,teenagers,andethnic
minoritiesinthelaborforce.

Chapter15
InequalityinEarnings
Thischapterisintendedtoaccomplishtwopurposes:toanalyzechangesinearningsinequalityafterthe1980s
andtoreviewmajorconceptsofeconomictheoryintroducedinpriorchapters.Itbeginswithasectionon

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measuringinequalityandthenmovestoonethatdescribeschangesinthe1980sandearly1990salong
variousdimensions:theoccupationaldistribution,relativewages,hoursofwork,andearningsdispersion
withinnarrowlydefinedhumancapitalgroups.
Theunderlyingcausesofgrowinginequalityarethengroupedintosupplyfactors,institutionalchanges,
anddemandsideinfluences.Empiricalstudiesaresurveyed,withtheconclusionthatdemandfactors
weredominantinthe1980s(especiallycomputerrelatedtechnologicalchangesthataffectedthemixof
productivefactors,leadingtoincreasedrelativedemandforeducatedworkers).Theappendixdiscusses
thederivationofLorenzcurvesandGinicoefficients.

nList of Major Concepts

1. Earningsinequalityisafunctionofthedispersionoftheearningsdistribution,andthisdispersion
canbemeasuredinvariousways,whichdifferintheeasewithwhichtheycanbecompletedand
widelyunderstood.
2. Themostwidelyusedmeasuresinvolverankingthepopulationandanalyzingearningsbypercentile
(comparingeithersharesofthetotalreceivedbyagrouportheearningslevelsatpercentile
boundaries).
3. Earningsdistributionsforbothmenandwomenbecamestretchedinthe1980s,morebecause
wagesofthoseintheupperendgrewrelativetoothersthantoamovementofjobsfromthemiddle
ofthedistributiontoeitherend.
4. Themostnotablechangeinearningsforbothmenandwomenwastheincreaseintherelativeearnings
ofmoreeducatedworkers;formenthisincreaseoccurredmainlybecauseearningsofthelesseducated
fellinrealterms,whileforwomenitwasassociatedmainlywiththeincreasedrealearningsof
moreeducatedwomen.
5. Thereturnstoexperiencerosemodestly,butonlyforthelesseducated.
6. Changesintherelativehoursofworkplayednoroleinthegrowthofinequality.
7. Earningsalsobecamemoredispersedwithinhumancapitalgroups.
8. Growingdisparitiescouldresultfromlaborsupply,institutional,orlabordemandchanges.
9. Thefactthatskilledemploymentgrewfasterthanunskilledemploymentinthe1980sappearstorule
outsupplychangesasthedominantfactorunderlyingthegrowthofinequality.
10. Suchinstitutionalfactorsasafrozenminimumwageanddecliningunionizationcouldhaveplayed
aroleinthegrowinginequality,buttheyapparentlyplayedaminorone.
11. Bothproductdemandchangesandchangesinthemixofproductivefactorscontributedtogrowing
inequality,withthelatterchangesthedominantforceinthegrowthofeducationrelated
differentials.
12. Thegrowthofcontingentpayplansmightunderlietheincreaseddispersionwithinhumancapital
groups,butdefinitiveworkhasyettobedone.
13. (Appendix)TheLorenzcurveandGinicoefficientarerelatedmeasuresofdisparitiesthatarebased
ongroupssharesamongthetotal.

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Chapter16
TheLaborMarketEffectsofInternationalTrade
andProductionSharing
Thischapteranalyzesthelabormarketaspectsofglobalization,andinsodoingitprovidesareviewof
basicconceptspresentedearlierinthetext.Thus,ithasthetwofoldpurposeofdiscussingahottopic
andprovidingaforumforthereviewofsomebasicprinciplesandconcepts.
Thechapterstartswithanexplanationofcomparativeadvantage,whichisfirstpresentedinthecontextof
tradebetweenindividuals(themakeorbuychoice).Itthenmovestotradeacrosscountries,using
productionpossibilitiescurves(firstpresentedinChapter4)asthevehicleforillustratingthegainsfrom
trade.Theeffectsoftradeareshowntobeanalogoustothoseaccompanyingtechnologicalchange(also
analyzedinChapter4).Attheendofthefirstsection,werecalltheimplicationofnormativeanalysisthat
toensurethatsocietyactuallygainsfromtrade(inthesenseofutilitymaximization),thegainersfrom
expandedtrademustcompensatethelosers.
Thesecondmajorsectionofthischapteranalyzestheeffectsoftradeonthedemandforlabor,firstasa
resultofproductdemandshiftsandthenthroughtheeffectsoftradeonthesupplyofalternativefactors
ofproduction.Wethenreviewtheempiricalestimatesoftheeffectsoftrade(andproductionsharing)on
employmentandwages.
Thefinaltwosectionsaddressthequestionsofwhetherexpandedtradeandproductionsharingwillcause
wagestoconvergeacrosscountriesandthebestpoliciesforreallocatingresourcesfromthegainersfrom
globalizationtothelosers.

nList of Major Concepts

1. Weallmakemakeorbuydecisions(forexample,referbacktoChapter7);doweproducesome
goodorserviceourselves,orbuyitfromothers?
2. Thefirststepinmakingthesedecisionsistocalculatehowmuchitwouldcostustoproducethe
goodorserviceourselves,andwethencomparethattowhatotherswouldcharge.
3. Ifwecanproduceagoodorserviceatless(opportunity)costthanothers,economistssaythatwe
haveacomparativeadvantageinproducingthisgoodorservice.

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4. Aproductionpossibilitiescurveillustratestheopportunitycostsofmakingeitheroftwogoodsor
services,withtheslopeofthecurveprovidinganindicationoftheopportunitycostofproducing
eachgood.
5. Itisunlikelythattwocountrieswouldhavethesameproductionpossibilitiescurves,andwhenthe
opportunitycostsdiffer,therearegainsfromtrade.
6. Inthecontextofacountrythatcanproducetwogoods,acomparativeadvantagethatCountryA
(say)hasoverCountryBintheproductionofonegoodmeansthatAhasacomparative
disadvantageintheproductionoftheothergood.Thatis,onecountrycannothaveacomparative
advantageinbothgoods!
7. Trade(whencomparedtoautarky)shiftstheproductionpossibilitiescurvetotherightinexactlythe
waythattechnologicalchangedoes;indeed,trade(whenittakesplacevoluntarily)doesofferanew,
improvedwayforacountrytoobtainthegoodbeingimported.
8. Trade(includingproductionsharing)liketechnologicalchangealsocausesresourcesinthe
tradingcountriestobereallocated.Resourceswillflowtowardthesectorinwhichthecountryhasa
comparativeadvantage(theexportsector)andawayfromthesectorwhosegoodsorservicesare
nowbeingimported.
9. Toensurethatsomegainandnoonelosesfromenhancedtradeorproductionsharing,theprinciples
ofnormativeeconomicsrequirethatthegainerscompensatethelosers.
10. Expandedtradeshiftstheproductdemandcurvesfacingdomesticandforeignproducers,andwill
causelabordemandtoshifttotheleftinsomesectorsandtotherightinothers.
11. Expandedtrade(includingproductionsharing)alsoaffectstheavailabilityandpricesoffactorsof
production,whichcreatessubstitutionandscaleeffectsonthedemandforU.S.labor.Thedirection
andsizeoftheseeffectsareafunctionoftheHicksMarshalllaws(Chapter4)asappliedtothe
crosswagecase.
12. Economictheoryimpliesthattotalemploymentinacountryisunaffected(inthelongrun)by
productiontechnologies,includingtrade,aslongasthelabormarketfacilitatestheflowoflabor
resourcesfromsectortosector.
13. Empiricalestimatesoftheeffectsonemploymentoftradeandoffshoring(productionsharing)are
difficulttomake,butthefractionofworkersaffectedbyproductionsharingappearstoberelatively
small.
14. Theeffectsofincreasedtradeandproductionsharingonwagesalsoappeartoberelativelysmall,
especiallyincomparisontotheeffectsoftechnologicalchange.
15. Liketheeffectsoftechnologicalchange,tradeappearstoraisethewagesofskilledrelativeto
unskilledworkersinbothrichandpoorcountries(inthelatterbecausetradeshiftsdemandfrom
farmingtomanufacturing,andlabormobilityisrelativelysluggish).
16. Thelawofonepriceimpliesthatnotthatwageswillconvergethroughtrade,butthattheratioof
wagetomarginalproductoflabor(thecostofproducinganextraunitusinglabor)willconverge;
however,thisassumesthattransactionsarecostless.

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17. Internationaltransactionsarefarfromcostless,withonestudyestimatingthatthecostsof
transactionacrossbordersadds75%tothecostofthetypicalproduct.Thus,theconvergence
impliedbythelawofonepriceseemsunlikely.
18. Convergenceisalsounlikelyinjobsthatmustbedoneatthepointofsaleandthereforecannotbe
offshored.
19. Normativeprinciplesrequirethatthegainerscompensatethelosers;however,opportunitycosts
(includingtransactioncosts)mustbetakenintoaccountsothatthenetbenefitsofanytransferare
bothpositiveandaslargeaspossible.
20. Trainingsubsidies,employmentsubsidies,andincomesupportprogramsmayentailcoststhatare
largerthanbenefits;thus,thecompensationmightbesttaketheformofensuringthatworkerswith
modesteducationallevelshavethegeneralliteracyandquantitativeskillstoenablethemtoadaptto
thedemandsofachangingeconomicenvironment.