INTRODUCTION TO TOPIC 1

LABOUR ECONOMICS
Introduction to Labour Economics

Labour economics is the study of the workings and

outcomes of the market for labour (Ehrenberg,
2012).
“Labour economics is primarily concerned with the
behaviour of employers and employees in response
to the general incentives of wages, prices, profits,
and non-pecuniary aspects of the employment
relationship (Ehrenberg, 2012).
Introduction to Labour Economics

Labour economics help us understand and address

many social and economic problems facing modern
societies.
The policy issues examined by modern labour
economics include:
¤ Labour force participation – ageing population,
migration, industry 4.0, etc.
¤ Minimum wages and unemployment,
¤ Wage inequality, etc.
Actors in the Labour Market

Workers Firms

To work or not? Type of How many to hire?

job? Hours of work? Types of workers?
When to retire? Working hours/weeks?
K/L ratio?
Labour Market
The labour supply curve is often upward sloping –
higher earning/payoff leads to higher supply of
labour.
A firmʼs demand for labour is a derived demand –
derived from the desires of consumers.
The labour demand curve is downward sloping –
higher wage rate reduces demand for labour.
In a free-market economy, equilibrium is attained
when supply equals demand.
Labour Market

Earnings ($)
Labour Supply
Curve

50,000

Equilibrium
40,000

Labour Demand
Curve
30,000

10,000 20,000 30,000 Employment

Actors in the Labour Market

Workers Firms

- Policies, rules, regulations.

Government - Minimum wages, tax, subsidy
- Occupational safety regulation.
Actors in the Labour Market
Nominal and Real Wages
The nominal wage is what workers get paid per
hour/day in current dollars.
The real wage is nominal wage divided by some
measure of prices (inflation adjustment).
Calculations of real wages are useful in comparing
the purchasing power of workers’ earnings over a
time period when both nominal wages and product
prices are changing.
Nominal and Real Wages

Year Wage CPI

1990 $13.39 129.90
2010 $21.24 213.88

Real wage in 1990 in terms of 2010 prices:

= 13.39 x 213.88 / 129.90 = $22.05

$22.05 is the purchasing power – how much the 1990 wage

can buy in 2010.
Positive & Normative Economics

Positive economics
“What is?” questions.
Addresses questions that can, in principle, be
answered with the tools of economics.
For example: What is the impact of the minimum
wage on unemployment?
Positive & Normative Economics

Normative economics
“What should be?” questions.
Addresses questions that require value judgments
that cannot be answered solely on the basis of the
theory of the facts.
For example: Should there be a minimum wage?
LABOUR TOPIC 2
SUPPLY
Definition
International Labour Organization (ILO):
The total population (P) comprises persons of all ages who
were living in the country during the reference period,
regardless of residency status or citizenship.

The working age population (WP) comprises all persons

above a specified minimum age threshold for which an
inquiry on economic activity is made. For purposes of
international comparability, the working age population is
commonly defined as persons aged 15 years and older.
Definition
ILO:
Labour force (LF) comprises all persons of working age who
furnish the supply of labour to produce goods and services
(as defined by the United Nations System of National
Accounts (SNA) production boundary) during a specified time-
reference period. It refers to the sum of all persons of
working age who are employed (E) and those who are
unemployed (U).
Definition
ILO:
The employed (E) comprise all persons of working age who
during a specified brief period, such as one week or one day,
were in the following categories: a) paid employment (whether
at work or with a job but not at work); or b) self-employment
(whether at work or with an enterprise but not at work).

The employment-to-population ratio (EPR) is calculated as the

number of persons who are employed during a given
reference period as a percent of the total of working age
population in the same reference period.
Definition
ILO:
The unemployed (U) comprise all persons of working age who
were:
a) without work during the reference period, i.e. were not in
paid employment or self-employment;
b) currently available for work, i.e. were available for paid
employment or self-employment during the reference period;
and
c) seeking work, i.e. had taken specific steps in a specified
recent period to seek paid employment or self-employment. For
purposes of international comparability, the period of job
search is often defined as the preceding four weeks.
Definition
ILO:
The unemployment rate (UR) is calculated as the
number of persons who are unemployed during the
reference period given as a percent of the total
number of employed and unemployed persons (i.e.,
the labour force) in the same reference period.
Persons outside the labour force comprise all
persons of working age who, during the specified
reference period, were not in the labour force.
Measuring the labour force

All persons aged 15 or older are classified into one

of the following categories:
¤In
the labour force: The employed & the unemployed.
¤Out of the labour force.

Labour Force (LF) = Employed (E) + Unemployed (U)

LF Participation rate = LF/Working age Population (WP)
Employment to Population Ratio (EPR) = E/WP
Unemployment rate (UR) = U/LF
Measuring the labour force
Persons who have given up and stopped looking for
work are considered to be “out of the labour force”.

Hidden unemployed – persons who have given up in

their search for work and have therefore left the
labour force.
Brunei Darussalam: Population
Brunei
Darussalam:
Population
Population Pyramid (Brunei)
Population Pyramid (Brunei)
Population Pyramid (UK)
Population Pyramid (Singapore)
Population Pyramid (Japan)
Measuring the labour force in
Brunei Darussalam

Labour force 1981 1991 2001 2011

Employed 68,128 106,746 146,254 183,715
Unemployed 2,562 5,209 11,340 18,815
Total 70,690 111,955 157,594 202,530
LFPR 59.6 65.6 67.9 68.9
UR 3.6 4.7 7.2 9.3
Measuring the labour force in
Brunei Darussalam
Measuring the labour force
Neoclassical model of labour-leisure choice

This model isolates the factors that determine

whether a particular person works and, if so, how
many hours she chooses to work.
It lets us to predict how changes in economic
conditions or in government policies will affect work
incentives.
In the model, the person is assumed to receive
satisfaction both from the consumption of goods (C)
and from the consumption of leisure (L).
Model of labour-leisure choice
𝑈 = 𝑓(𝐶, 𝐿)

The higher the level of consumption and leisure

hours, the higher the level of index U, hence the
happier the person.

Different combinations of C and L yield the same

level of utility – indifference curve.
Indifference Curves
4 important properties of indifference curves:
¤ Indifference curves are downward sloping
¤ Higher indifference curves indicate higher levels of
utility.
¤ Indifference curves do not intersect.
¤ Indifference curves are convex to the origin
Indifference Curves
Consumption ($)
𝑈 = #(%,
! 𝑓(𝐶, ')
𝐿)

500 W

450
Z

400
X Y
V
40,000 Utils

25,000 Utils

100 125 150 175

Hours of Leisure
Indifference Curves
The marginal utility of leisure (MUL)

The marginal utility of consumption (MUC)

Differences in Preferences across
Workers

Consumption ($) Consumption ($)

U1

U1

U0 U0

Hours of Hours of
leisure leisure
The Budget Constraint
The budget constraint defines the workerʼs
opportunity set, indicating all of the consumption –
leisure combinations the worker can afford.

C = wh + V
¤ Consumption equals labour earning (wages × hours of
work) plus nonlabour income (V).
¤ As h = T – L, can rewrite C = w(T – L) + V or C=(wT+V) -
wL
Budget Constraint
Consumption ($)

wT+V

Budget Line

Endowment point

V E

Hours of
0 Leisure
T
The Hours of Work Decision
Individuals choose consumption and leisure to
maximize their utility.
Optimal consumption is given by the point where the
budget line is tangent to the indifference curve.
¤At this point the marginal rate of substitution (MRS)
between consumption and leisure equals the wage.
¤Any other consumption – leisure bundle on the budget
constraint would give the individual less utility.
MU L
MRS = =w
MU C
Optimal Consumption and Leisure

F
$1200
A Y Interior solution to the labour-
$1100
leisure decision

P
$500
U1

U*

$100 E
U0 Hours of
0 70 110 Leisure
Hours of
110 40 0 Work
The Effect of a Change in Nonlabour Income on
Hours of Work

Consumption ($)

F1

F0
P1
U1
P0
$200 E1
U0

$100 E0

70 80 110 Hours of Leisure

The Effect of a Change in Nonlabour Income on
Hours of Work

Consumption ($)

F1

P1
F0
U1

$200 P0 E1
U0

$100
E0

60 70 110 Hours of Leisure

The effect of a change in the wage rate on hours
of work

Consumption ($)

U1

U0
F P

V
E

0 70 75 110 Hours of Leisure

The effect of a change in the wage rate on
hours of work
When the income effect (PQ)dominates the
substitution effect (QR):

Consumption ($)

U1

R
D Q
U0
D
F P

V
E

0 70 75 85 110 Hours of Leisure

The effect of a change in the wage rate on
hours of work
When the substitution effect dominates the income
effect:

Consumption
($)
U1
G

R
D
Q
U0
D

F P
V
E

0 65 70 80 110 Hours of Leisure

To Work or Not to Work?

Reservation wage:

¤Rule1: if the market wage is less than the reservation

wage, then the person will not work.
¤Rule 2: the reservation wage increases as nonlabour
income increases, assuming that leisure is a normal good.
The Reservation Wage
Consumption ($)

H
Has Slope -whigh

G
X
UH
E
Has Slope -wlow
U0
UG Has Slope –w~

0 T Hours
Hours of of Leisure
Leisure
Labour Supply Curve
Relationship between hours worked and the wage
rate.
¤ At wages slightly above the reservation wage, the labour
supply curve is positively sloped.
¤ If the income effect begins to dominate the substitution,
hours of work decline as the wage rate increases.
The Backward Bending Labour Supply Curve
The Market Labour Supply Curve
Labour Supply Elasticity

The labour supply elasticity (σ) measures

responsiveness in hours worked to changes in
the wage rate.

¤σ = Percent change in hours of work divided by percent

change in wage rate.
Δh Δh w
σ= h = .
Δw Δw h
w
Labour Supply Elasticity
Suppose that the worker’s wage is initially $10 per hour
and that she works 1,900 hours per year. The worker gets
a raise to $20 per hour, and she decides to work 2,090
hours per year. This worker’s labour supply elasticity can
then be calculated as:
Δh
σ= h = Δh . w
Δw Δw h
w
Δh
σ= h = 190 . 10 = 0.1
Δw 10 1900
w
Labour Supply Elasticity

¤ Labour supply elasticity less than 1 is inelastic as

hours of work respond proportionally less than the
change in wages.

¤ Labour supply elasticity greater than 1 is elastic as

hours of work respond proportionally more than the
change in wages.
Estimates of the Labour Supply
Elasticity
• The typical regression model used to estimate the empirical
relationship between hours of work and wages:

• hi = βwi + γVi + other variables

• Where hi gives the number of hours that person i works; wi

gives his wage rate; and Vi gives his nonlabour income. ß
measures the impact of a one-dollar wage increase on hours
of work, holding nonlabour income constant; γ measures the
impact of a one-dollar increase in nonlabor income, holding
the wage constant.
Estimates of the Labour Supply
Elasticity
•
• hi = βwi + γVi + other variables
•The sign of β depends on whether income (-ve) or substitution
effects (+ve) dominate.

•Thesign of γ should be negative as leisure is expected to be

a normal good.

•The estimate of β can be used to calculate the labour supply

elasticity.
 Effect of a Cash Grant on Work
56 Incentives
• A take-it-or leave-it cash grant of $500 per month
to be given as long as an individual remains outside
the labour force. Will the worker leave the labour
force?
Consumption
($)
F

U0

E Hours
0 70 110 of
Leisure
 Effect of a Cash Grant on Work
57 Incentives
• A take-it-or leave-it cash grant of $500 per month
moves the worker from point P to point G, and
encourages the worker to leave the labour force.
Consumption
($)
F

P
G
500 U1

U0
E
Hours
0 70 110 of
Leisure
 Effects of a Welfare Program on
58 Hours of Work
• Now assume a welfare program that gives a worker a cash
grant of $500 per month but takes away 50 cents from the cash
grant for every dollar earned in the labour market.

• For example, if a worker works one hour at a wage of $10, her

labour earnings increase by $10 but her grant is reduced by
$5. Her total income, therefore, is $505. If she decides to work
two hours, her labour earnings are $20 but her grant is reduced
by $10. Total income would be $510.
 Effect of a Welfare Program on
59 Hours of Work
Consumption ($) U0

F slope = -$10

E
Hours of
0 70 110 Leisure
 Effect of a Welfare Program on
60 Hours of Work
Consumption ($)

U0

F slope = -$10

slope = -$5

$500
G

E
Hours of
0 70 100 110 Leisure
 Effect of a Welfare Program on
61 Hours of Work
Consumption ($) U0 U1

F slope = -$10

H
D

slope = -$5
Q

R
P

$500
D G

E
0 100
Hours of
70 110 Leisure