Labour economics
Overview
1. Introduction to labour economics
2. Labour supply
3. Labour demand
4. Competitive market equilibrium
5. Imperfectly competitive labour markets
6. Labour market policies
7. Unemployment
8. Wage distribution and inequality
9. Education
10. Migration
1. Introduction
What is labour economics?
o Labour economics examines how labour markets work.
o Why do we care about labour markets?
• Work (paid and unpaid) makes up important part of each individual’s life.
▪ Is the main source of income for most people, determining their
consumption
▪ It is intertwined with other important dimensions of life such as
education, health, partnership or fertility
• Labour is a key factor of production, effecting innovation or economic growth
f.e.
• The labour market is the subject of many social policies such as social security
systems, taxation, immigration legislation, etc.
Who are the actors in the labour market?
o Workers – labour supply
• Objective: want to maximise their well-being
▪ Utility from leisure, consumption, health, job satisfaction, etc.
• Constraints: limited number of hours in the day, job offers, income, etc.
• Decisions:
▪ Whether and how many hours to work
▪ Which occupation/sector to work in
▪ How much effort to make at work
▪ Which skills to acquire and how
▪ When and where to change jobs
1
, o Firms – labour demand
• Objective: want to maximise their profits
▪ Labour is an input of production which creates revenue but comes with
costs.
• Constraints: limited number of (qualified) workers or available capital,
consumer demand, competition, government regulations, etc.
• Decisions:
▪ How many workers to hire
▪ Which wages and other benefits to offer workers
▪ How much to invest in technology
▪ Which prices to set
• Derived demand: a demand derived from the desires of the consumers
o Government – rules of the game
• Objective: wants to maximise social welfare
• Constraints: tax income (, elections)
• Policy tools:
▪ Regulations: minimum wages, health and safety, equal job
opportunities, immigration legislation, etc.
▪ Public finance: social security, public education, employment subsidies,
etc.
▪ Taxation: income, payroll, etc.
Interaction: supply-demand model
o Supply curve: upwards sloping, workers are willing to work more if they receive higher
wages.
o Demand curve: downwards sloping, firms are willing to hire more workers if they can
offer lower wages.
o No government intervention: the intersection of the supply and demand curves (only)
determines market clearing wages and equilibrium.
How do we study Labour markets?
o Theory: develops a simplified model of the real world to focus on one specific
question at a time and understand driving forces behind it.
o Empirics: identifies facts about patterns in the real world (descriptive analysis) and
tests theories about cause and effect (causal analysis).
2
,Labour economic theory
o Simplification of the real world designed to isolate the core mechanism behind one
specific question.
o How?
• Make simplifying assumptions.
• Write down agents’ objective function and restrictions.
• Derive optimal behaviour (and equilibria).
• Derive comparative statics.
Example: labour supply in the neoclassical model
o Question: how does workers’ labour supply respond to a change in their non-labour
income?
o Set up/ simplifying assumptions:
• Workers’ wage rate is unique and exogenous (given by the labour market).
• Workers enjoy consumption and leisure and care about nothing else.
• Labour supply is an individual decision (no household bargaining).
• Workers can decide how many hours to work.
• Workers have full information.
• There is no government intervention (fully free market).
o Objective function and constraints:
• Utility function that increases (concavely) in consumption and leisure:
▪ u(c,l), u’(c,l) > 0.
• Budget constraint that limits consumption to non-labour + labour income, time
constraint that limits leisure + work time to 24h per day: c = w*(24-l) + v
o Optimal behaviour: Optimal work hours as a function of wages, non-labour income
and preferences, equilibrium as a set of best responses: FOCs, u*(c*,l*)
o Comparative statics: How does the optimal choice change if non-labour outcome
increases, all else equal?
Empirical research
o Descriptive analysis: establish facts about economic patterns we observe in the real
world, provide basis for theory.
• Example: how has the labour market participation of woman evolved over the
last fifty years?
o Causal analysis: test theoretical predictions with real world data, quantify effect sizes.
• Example: Do child care opportunities increase women’s labour market
participation?
• Challenge: How do we isolate changes in child care only?
3
, Commonly used data sources
o Cross- sectional household surveys
• Current population survey (US)
• European labor force survey
• Census
o Longitudinal household surveys
• Panel study of income dynamics
• British cohort study
• German socioeconomic panel
o Administrative data
• Taxation data
• Social registry data
Causal analysis
o To test theoretical predictions and establish causal relationships, we need to examine
the empirical effect of something happening all other things equal (ceteris paribus).
o However, in the real world (observational data) many things happen at the same time.
• Endogeneity: child care availability may react to women’s labour market
participation.
• Omitted variable bias: both may reflect changes in norms, local infrastructure,
etc.
• Selection: families taking out child care may differ systematically from families
that do not.
• How to isolate the effect of child care only?
o Applied econometrics: combine statistical methods with clever research designs to
identify causal effects.
• Most straightforward identification: randomised controlled trial.
• Most common identification: natural experiments.
Potential outcomes framework
o Ideal experiment: we compare outcomes (labour market participation, income,
education, etc) of an individual who received treatment X (access to child care,
unemployment benefits, an extra year of schooling, etc) to the outcomes of the same
individual had they not received said treatment.
o Challenges:
• We only ever observe people in one state of the world.
• Individuals who receive treatment X may differ systematically from those who
do not.
o Example: Does health insurance improve health outcomes? (Angrist & Pischke (2014))
4
Overview
1. Introduction to labour economics
2. Labour supply
3. Labour demand
4. Competitive market equilibrium
5. Imperfectly competitive labour markets
6. Labour market policies
7. Unemployment
8. Wage distribution and inequality
9. Education
10. Migration
1. Introduction
What is labour economics?
o Labour economics examines how labour markets work.
o Why do we care about labour markets?
• Work (paid and unpaid) makes up important part of each individual’s life.
▪ Is the main source of income for most people, determining their
consumption
▪ It is intertwined with other important dimensions of life such as
education, health, partnership or fertility
• Labour is a key factor of production, effecting innovation or economic growth
f.e.
• The labour market is the subject of many social policies such as social security
systems, taxation, immigration legislation, etc.
Who are the actors in the labour market?
o Workers – labour supply
• Objective: want to maximise their well-being
▪ Utility from leisure, consumption, health, job satisfaction, etc.
• Constraints: limited number of hours in the day, job offers, income, etc.
• Decisions:
▪ Whether and how many hours to work
▪ Which occupation/sector to work in
▪ How much effort to make at work
▪ Which skills to acquire and how
▪ When and where to change jobs
1
, o Firms – labour demand
• Objective: want to maximise their profits
▪ Labour is an input of production which creates revenue but comes with
costs.
• Constraints: limited number of (qualified) workers or available capital,
consumer demand, competition, government regulations, etc.
• Decisions:
▪ How many workers to hire
▪ Which wages and other benefits to offer workers
▪ How much to invest in technology
▪ Which prices to set
• Derived demand: a demand derived from the desires of the consumers
o Government – rules of the game
• Objective: wants to maximise social welfare
• Constraints: tax income (, elections)
• Policy tools:
▪ Regulations: minimum wages, health and safety, equal job
opportunities, immigration legislation, etc.
▪ Public finance: social security, public education, employment subsidies,
etc.
▪ Taxation: income, payroll, etc.
Interaction: supply-demand model
o Supply curve: upwards sloping, workers are willing to work more if they receive higher
wages.
o Demand curve: downwards sloping, firms are willing to hire more workers if they can
offer lower wages.
o No government intervention: the intersection of the supply and demand curves (only)
determines market clearing wages and equilibrium.
How do we study Labour markets?
o Theory: develops a simplified model of the real world to focus on one specific
question at a time and understand driving forces behind it.
o Empirics: identifies facts about patterns in the real world (descriptive analysis) and
tests theories about cause and effect (causal analysis).
2
,Labour economic theory
o Simplification of the real world designed to isolate the core mechanism behind one
specific question.
o How?
• Make simplifying assumptions.
• Write down agents’ objective function and restrictions.
• Derive optimal behaviour (and equilibria).
• Derive comparative statics.
Example: labour supply in the neoclassical model
o Question: how does workers’ labour supply respond to a change in their non-labour
income?
o Set up/ simplifying assumptions:
• Workers’ wage rate is unique and exogenous (given by the labour market).
• Workers enjoy consumption and leisure and care about nothing else.
• Labour supply is an individual decision (no household bargaining).
• Workers can decide how many hours to work.
• Workers have full information.
• There is no government intervention (fully free market).
o Objective function and constraints:
• Utility function that increases (concavely) in consumption and leisure:
▪ u(c,l), u’(c,l) > 0.
• Budget constraint that limits consumption to non-labour + labour income, time
constraint that limits leisure + work time to 24h per day: c = w*(24-l) + v
o Optimal behaviour: Optimal work hours as a function of wages, non-labour income
and preferences, equilibrium as a set of best responses: FOCs, u*(c*,l*)
o Comparative statics: How does the optimal choice change if non-labour outcome
increases, all else equal?
Empirical research
o Descriptive analysis: establish facts about economic patterns we observe in the real
world, provide basis for theory.
• Example: how has the labour market participation of woman evolved over the
last fifty years?
o Causal analysis: test theoretical predictions with real world data, quantify effect sizes.
• Example: Do child care opportunities increase women’s labour market
participation?
• Challenge: How do we isolate changes in child care only?
3
, Commonly used data sources
o Cross- sectional household surveys
• Current population survey (US)
• European labor force survey
• Census
o Longitudinal household surveys
• Panel study of income dynamics
• British cohort study
• German socioeconomic panel
o Administrative data
• Taxation data
• Social registry data
Causal analysis
o To test theoretical predictions and establish causal relationships, we need to examine
the empirical effect of something happening all other things equal (ceteris paribus).
o However, in the real world (observational data) many things happen at the same time.
• Endogeneity: child care availability may react to women’s labour market
participation.
• Omitted variable bias: both may reflect changes in norms, local infrastructure,
etc.
• Selection: families taking out child care may differ systematically from families
that do not.
• How to isolate the effect of child care only?
o Applied econometrics: combine statistical methods with clever research designs to
identify causal effects.
• Most straightforward identification: randomised controlled trial.
• Most common identification: natural experiments.
Potential outcomes framework
o Ideal experiment: we compare outcomes (labour market participation, income,
education, etc) of an individual who received treatment X (access to child care,
unemployment benefits, an extra year of schooling, etc) to the outcomes of the same
individual had they not received said treatment.
o Challenges:
• We only ever observe people in one state of the world.
• Individuals who receive treatment X may differ systematically from those who
do not.
o Example: Does health insurance improve health outcomes? (Angrist & Pischke (2014))
4
