Chapter 1
The Labor Market
Chapter Overview
This chapter introduces the issues and basic theoretical concepts encountered in later
chapters of the book. It also provides the student with some historical perspective on the
evolution of thought in labor economics.
The first section of the chapter describes the concept of a labor market and the relationship
of the labor market to the rest of the economy. One purpose of the discussion is to show the
important interconnections that exist between the product market and labor market. A second is to
point out that economists use the tools of supply and demand to analyze not only exchange in
product markets but also exchange in factor markets such as the labor market.
The second section of the chapter discusses various ways in which the labor market is
unique relative to other markets. These include the fact that labor is embodied in the seller, the
long-term nature of the employment relationship, the heterogeneity of workers and jobs, and the
multiplicity of markets.
The third section of the chapter describes five important labor market outcomes that are
focused on in labor economics. Labor market outcomes are defined as the events, developments,
or trends in the labor market that economists seek to explain. The five outcomes discussed in this
section are: the changing level and composition of labor supply, the changing level and
composition of labor demand, the structure of earnings, labor-management relations and
collective bargaining, and changes in the level and composition of unemployment.
The fourth section of the chapter describes the labor market process. The labor market
process is defined as the mechanics of how the labor market works. The labor market process
involves three broad forces. The first are the market forces of supply and demand in the labor
market. A model of labor demand and supply is developed to illustrate how changes in wage rates
and the mobility of labor work to efficiently allocate labor in the economy. The predictions of the
model are compared with the actual behavior of wages in the market for teachers from 1960 to
2001 in Empirical Evidence 1-1. The second part of the labor market process involves
institutional forces. Institutional forces represent the influence that various organizations such as
unions, governments, and corporations have on the pricing and distribution of labor. One example
discussed is the internal labor market. The third part of the labor market process is made up of
sociological forces. Sociological forces represent the influence of social norms and groups on the
,determination of wages and the allocation of labor. One example discussed is the effect of
ethnicity and culture on economic success in the labor market.
The fifth section of the chapter discusses the evolution of labor market theory. Two schools
of thought are introduced. The first is the neoclassical school. Neoclassical theory has two
important parts. The first is the rational actor model, the second is the model of competitive
markets. Neoclassical economists tend to emphasize the importance of market forces relative to
institutional and sociological forces. The institutional school is much the opposite. Institutional
theory gives more weight to the role of institutional and sociological forces in the labor market. It
also rejects the neoclassical rational actor model and holds that labor markets are imperfectly
competitive.
The sixth section of the chapter discusses the interconnection between theory and
hypothesis testing. Since there is often more than one theoretical explanation for a particular
event, to choose which theory is best requires a process of hypothesis testing with empirical data.
The pitfalls of hypothesis testing are briefly noted, and the concepts of normative and positive
economics are defined.
The final section of the chapter discusses the importance of labor market theory for public
policy. It is argued that every piece of proposed labor legislation is based on an explicit or
implicit theory of how the labor market works. Labor market theory is quite important, therefore,
because it heavily influences people’s opinions of the desirability or undesirability of legislation
such as a minimum wage law, an affirmative action law, and so on.
Chapter Outline
,The Labor Market and the Economy
Unique Features of the Labor Market
Labor Is Embodied in the Seller
The Long-Term Nature of the Employment Relationship
Heterogeneity of Workers and Jobs
The Multiplicity of Markets
Labor Market Outcomes
The Changing Level and Composition of Labor Supply
The Changing Level and Composition of Labor Demand
The Structure of Earnings
Labor–Management Relations and Collective Bargaining
Changes in the Level and Composition of Unemployment
The Labor Market Process
Market Forces
Institutional Forces
Sociological Forces
The Evolution of Labor Market Theory
The Neoclassical School
The Institutional School
The Importance of Theory and Hypothesis Testing
IN THE NEWS Different Views on the Merits of Ergonomics Standards
, The Importance of Theory for Public Policy
EMPIRICAL EVIDENCE 1-1 The Market for Teachers
Internet Assignments
1. Go to <http://www.visi.com/juan/congress/>
This site contains a database of congressional contact information. Find your Senators’
and Representative’s e-mail address. Turn in your Senators’ and Representative’s names and
e-mail addresses.
2. Go to <http://www.visi.com/juan/congress/>
This site contains a database of congressional contact information. To the left on the
first page is a link to all of the Congressional committees and sub-committees. Find out
which Senators are members of the Senate Committee on Health, Education, Labor, and
Pensions. Print out and turn in the list of Senators on the committee.
3. Go to <http://help.senate.gov/>
This is the home page for the Senate Committee on Health, Education, Labor, and
Pensions. Select “Schedule/Events.” Read through the list. Choose a event of interest, print
it out and turn it in with a brief sentence or two of why this bill is of interest to you.
4. Go to <http://www.uschamber.org>
This is the home page for the United States Chamber of Commerce. Scroll down and
select “Press Releases” under Media Center. Select one of the recent press releases and find
both a positive and normative statement in the same press release and identify them as such.
Turn in a copy of the press release with the positive and normative statements clearly
identified.
Answers to Review Questions
1. The factor markets for capital and land belong in the lower half of the circular flow diagram,
as illustrated in Figure 1.1. (For sake of space, the market for land is not drawn in). The
desire to earn an income motivates households to supply labor, land, and capital inputs,
represented by the arrows drawn from the household sector to the input markets. The desire
The Labor Market
Chapter Overview
This chapter introduces the issues and basic theoretical concepts encountered in later
chapters of the book. It also provides the student with some historical perspective on the
evolution of thought in labor economics.
The first section of the chapter describes the concept of a labor market and the relationship
of the labor market to the rest of the economy. One purpose of the discussion is to show the
important interconnections that exist between the product market and labor market. A second is to
point out that economists use the tools of supply and demand to analyze not only exchange in
product markets but also exchange in factor markets such as the labor market.
The second section of the chapter discusses various ways in which the labor market is
unique relative to other markets. These include the fact that labor is embodied in the seller, the
long-term nature of the employment relationship, the heterogeneity of workers and jobs, and the
multiplicity of markets.
The third section of the chapter describes five important labor market outcomes that are
focused on in labor economics. Labor market outcomes are defined as the events, developments,
or trends in the labor market that economists seek to explain. The five outcomes discussed in this
section are: the changing level and composition of labor supply, the changing level and
composition of labor demand, the structure of earnings, labor-management relations and
collective bargaining, and changes in the level and composition of unemployment.
The fourth section of the chapter describes the labor market process. The labor market
process is defined as the mechanics of how the labor market works. The labor market process
involves three broad forces. The first are the market forces of supply and demand in the labor
market. A model of labor demand and supply is developed to illustrate how changes in wage rates
and the mobility of labor work to efficiently allocate labor in the economy. The predictions of the
model are compared with the actual behavior of wages in the market for teachers from 1960 to
2001 in Empirical Evidence 1-1. The second part of the labor market process involves
institutional forces. Institutional forces represent the influence that various organizations such as
unions, governments, and corporations have on the pricing and distribution of labor. One example
discussed is the internal labor market. The third part of the labor market process is made up of
sociological forces. Sociological forces represent the influence of social norms and groups on the
,determination of wages and the allocation of labor. One example discussed is the effect of
ethnicity and culture on economic success in the labor market.
The fifth section of the chapter discusses the evolution of labor market theory. Two schools
of thought are introduced. The first is the neoclassical school. Neoclassical theory has two
important parts. The first is the rational actor model, the second is the model of competitive
markets. Neoclassical economists tend to emphasize the importance of market forces relative to
institutional and sociological forces. The institutional school is much the opposite. Institutional
theory gives more weight to the role of institutional and sociological forces in the labor market. It
also rejects the neoclassical rational actor model and holds that labor markets are imperfectly
competitive.
The sixth section of the chapter discusses the interconnection between theory and
hypothesis testing. Since there is often more than one theoretical explanation for a particular
event, to choose which theory is best requires a process of hypothesis testing with empirical data.
The pitfalls of hypothesis testing are briefly noted, and the concepts of normative and positive
economics are defined.
The final section of the chapter discusses the importance of labor market theory for public
policy. It is argued that every piece of proposed labor legislation is based on an explicit or
implicit theory of how the labor market works. Labor market theory is quite important, therefore,
because it heavily influences people’s opinions of the desirability or undesirability of legislation
such as a minimum wage law, an affirmative action law, and so on.
Chapter Outline
,The Labor Market and the Economy
Unique Features of the Labor Market
Labor Is Embodied in the Seller
The Long-Term Nature of the Employment Relationship
Heterogeneity of Workers and Jobs
The Multiplicity of Markets
Labor Market Outcomes
The Changing Level and Composition of Labor Supply
The Changing Level and Composition of Labor Demand
The Structure of Earnings
Labor–Management Relations and Collective Bargaining
Changes in the Level and Composition of Unemployment
The Labor Market Process
Market Forces
Institutional Forces
Sociological Forces
The Evolution of Labor Market Theory
The Neoclassical School
The Institutional School
The Importance of Theory and Hypothesis Testing
IN THE NEWS Different Views on the Merits of Ergonomics Standards
, The Importance of Theory for Public Policy
EMPIRICAL EVIDENCE 1-1 The Market for Teachers
Internet Assignments
1. Go to <http://www.visi.com/juan/congress/>
This site contains a database of congressional contact information. Find your Senators’
and Representative’s e-mail address. Turn in your Senators’ and Representative’s names and
e-mail addresses.
2. Go to <http://www.visi.com/juan/congress/>
This site contains a database of congressional contact information. To the left on the
first page is a link to all of the Congressional committees and sub-committees. Find out
which Senators are members of the Senate Committee on Health, Education, Labor, and
Pensions. Print out and turn in the list of Senators on the committee.
3. Go to <http://help.senate.gov/>
This is the home page for the Senate Committee on Health, Education, Labor, and
Pensions. Select “Schedule/Events.” Read through the list. Choose a event of interest, print
it out and turn it in with a brief sentence or two of why this bill is of interest to you.
4. Go to <http://www.uschamber.org>
This is the home page for the United States Chamber of Commerce. Scroll down and
select “Press Releases” under Media Center. Select one of the recent press releases and find
both a positive and normative statement in the same press release and identify them as such.
Turn in a copy of the press release with the positive and normative statements clearly
identified.
Answers to Review Questions
1. The factor markets for capital and land belong in the lower half of the circular flow diagram,
as illustrated in Figure 1.1. (For sake of space, the market for land is not drawn in). The
desire to earn an income motivates households to supply labor, land, and capital inputs,
represented by the arrows drawn from the household sector to the input markets. The desire
