Modern Labor Economics

Theory and Public Policy (International Student Edition)

Ronald G. Ehrenberg, Robert S. Smith

• Publisher: Routledge
• Year: 2017
• ISBN:
  9781351595261
• Edition: 13
• Topic: Economics
• Subtopic: Labour Economics
• Index: Economics

Modern Labor Economics: Theory and Public Policy, now in its thirteenth edition, continues to be the leading text for one-semester courses in labor economics at the undergraduate and graduate levels.

It offers a thorough overview of the modern theory of labor market behavior, and reveals how this theory is used to analyze public policy. Designed for students who may not have extensive backgrounds in economics, the text balances theoretical coverage with examples of practical applications that allow students to see concepts in action.

Experienced educators for nearly four decades, co-authors Ehrenberg and Smith believe that showing students the social implications of the concepts discussed in the course will enhance their motivation to learn. As such, this text presents numerous examples of policy decisions that have been affected by the ever-shifting labor market.

This new edition continues to offer:

• a balance of relevant, contemporary examples;

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• coverage of the current economic climate;

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• introduction to basic methodological techniques and problems;

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• tools for review and further study.

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In addition to providing updated data and examples throughout, the thirteenth edition offers greater coverage of inequality, healthcare policy, and labor-replacing technologies. The text is also supported by a full range of companion online materials.

Chapter 1 Introduction

Economic theory provides powerful, and surprising, insights into individual and social behavior. These insights are interesting because they help us understand important aspects of our lives. Beyond this, however, government, industry, labor, and other groups have increasingly come to understand the usefulness of the concepts and thought processes of economists in formulating social policy.

This book presents an application of economic analysis to the behavior of, and relationship between, employers and employees. The aggregate compensation received by U.S. employees from their employers was $9.9 trillion in the year 2016, while all other forms of personal income for that year—from investments, self-employment, pensions, and various government welfare programs—amounted to $5.8 trillion. The employment relationship, then, is one of the most fundamental relationships in our lives, and as such, it attracts a good deal of legislative attention. Knowing the fundamentals of labor economics is thus essential to an understanding of a huge array of social problems and programs, both in the United States and elsewhere.

As economists who have been actively involved in the analysis and evaluation of public policies, we obviously believe labor economics is useful in understanding the effects of these programs. Perhaps more importantly, we also believe policy analysis can be useful in teaching the fundamentals of labor economics. We have therefore incorporated such analyses into each chapter, with two purposes in mind. First, we believe that seeing the relevance and social implications of concepts studied enhances the student’s motivation to learn. Second, using the concepts of each chapter in an analytical setting serves to reinforce understanding by helping the student to see them “in action.”

The Labor Market

There is a rumor that a former U.S. Secretary of Labor attempted to abolish the term labor market from departmental publications. He believed that it demeaned workers to regard labor as being bought and sold like so much grain, oil, or steel. True, labor is unique in several ways. Labor services can only be rented; workers themselves cannot be bought and sold. Further, because labor services cannot be separated from workers, the conditions under which such services are rented are often as important as the price. Indeed, nonpecuniary factors —such as work environment, risk of injury, personalities of managers, perceptions of fair treatment, and flexibility of work hours—loom larger in employment transactions than they do in markets for commodities. Finally, a host of institutions and pieces of legislation that influence the employment relationship do not exist in other markets.

Nevertheless, the circumstances under which employers and employees rent labor services clearly constitute a market, for several reasons. First, institutions such as want ads and employment agencies have been developed to facilitate contact between buyers and sellers of labor services. Second, once contact is arranged, information about price and quality is exchanged in employment applications and interviews. Third, when agreement is reached, some kind of contract, whether formal or informal, is executed, covering compensation, conditions of work, job security, and even the duration of the job. These contracts typically call for employers to compensate employees for their time and not for what they produce. This form of compensation requires that employers give careful attention to worker motivation and dependability in the selection and employment process.

The end result of employer–employee transactions in the labor market is, of course, the placement of people in jobs at certain rates of pay. This allocation of labor serves not only the personal needs of individuals but the needs of the larger society as well. Through the labor market, our most important national resource—labor—is allocated to firms, industries, occupations, and regions.¹

Labor Economics: Some Basic Concepts

Labor economics is the study of the workings and outcomes of the market for labor. More specifically, labor economics is primarily concerned with the behavior of employers and employees in response to the general incentives of wages, prices, profits, and nonpecuniary aspects of the employment relationship, such as working conditions. These incentives serve both to motivate and to limit individual choice. The focus in economics is on inducements for behavior that are impersonal and apply to a wide range of people.

In this book, we shall examine, for example, the relationship between wages and employment opportunities; the interaction among wages, income, and the decision to work; the way general market incentives affect occupational choice; the relationship between wages and undesirable job characteristics; the incentives for and effects of educational and training investments; and the effects of unions on wages, productivity, and turnover. In the process, we shall analyze the employment and wage effects of such social policies as the minimum wage, overtime legislation, safety and health regulations, welfare reform, payroll taxes, unemployment insurance, immigration policies, and antidiscrimination laws.

Our study of labor economics will be conducted on two levels. Most of the time, we shall use economic theory to analyze “what is”; that is, we shall explain people’s behavior using a mode of analysis called positive economics. Less commonly, we shall use normative economic analysis to judge “what should be.”

Positive Economics

Positive economics is a theory of behavior in which people are typically assumed to respond favorably to benefits and negatively to costs. In this regard, positive economics closely resembles Skinnerian psychology, which views behavior as shaped by rewards and punishments. The rewards in economic theory are pecuniary and nonpecuniary gains (benefits), while the punishments are forgone opportunities (costs). For example, a person motivated to become a surgeon because of the earnings and status surgeons command must give up the opportunity to become a lawyer and must be available for emergency work around the clock. Both the benefits and the costs must be considered in making this career choice.

Scarcity The pervasive assumption underlying economic theory is that of resource scarcity. According to this assumption, individuals and society alike do not have the resources to meet all of their wants. Thus, any resource devoted to satisfying one set of desires could have been used to satisfy another set, which means that there is a cost to any decision or action. The real cost of using labor hired by a government contractor to build a road, for example, is the production lost by not devoting this labor to the production of some other good or service. Thus, in popular terms, “There is no such thing as a free lunch,” and we must always make choices and live with the rewards and costs these choices bring us. Moreover, we are always constrained in our choices by the resources available to us.

Rationality A second basic assumption of positive economics is that people are rational —they have an objective and pursue it in a reasonably consistent fashion. When considering persons, economists assume that the objective being pursued is utility maximization; that is, people are assumed to strive toward the goal of making themselves as happy as they can (given their limited resources). Utility, of course, is generated by both pecuniary and nonpecuniary dimensions of employment.

When considering the behavior of firms, which are inherently non-personal entities, economists assume that the goal of behavior is profit maximization. Profit maximization is really just a special case of utility maximization in which pecuniary gain is emphasized and nonpecuniary factors are ignored.

The assumption of rationality implies a consistency of response to general economic incentives and an adaptability of behavior when those incentives change. These two characteristics of behavior underlie predictions about how workers and firms will respond to various incentives.²

The Models and Predictions of Positive Economics

Behavioral predictions in economics flow more or less directly from the two fundamental assumptions of scarcity and rationality. Workers must continually make choices, such as whether to look for other jobs, accept overtime, move to another area, or acquire more education. Employers must also make choices concerning, for example, the level of output and the mix of machines and labor to use in production. Economists usually assume that when making these choices, employees and employers are guided by their desires to maximize utility or profit, respectively. However, what is more important to the economic theory of behavior is not the particular goal of either employees or employers; rather, it is that economic actors weigh the costs and benefits of various alternative transactions in the context of achieving some goal or other.

One may object that these assumptions are unrealistic and that people are not nearly as calculating, as well informed about alternatives, or as amply endowed with choices as economists assume. Economists are likely to reply that if people are not calculating, are totally uninformed, or do not have any choices, then most predictions suggested by economic theory will not be supported by real-world evidence. They thus argue that the theory underlying positive economics should be judged on the basis of its predictions, not its assumptions.

The reason we need to make assumptions and create a relatively simple theory of behavior is that the actual workings of the labor market are almost inconceivably complex. Millions of workers and employers interact daily, all with their own sets of motivations, preferences, information, and perceptions of self-interest. What we need to discover are general principles that provide useful insights into the labor market. We hope to show in this text that a few forces are so basic to labor market behavior that they alone can predict or explain many of the outcomes and behav...