FINC 407

Labour Economics

Session 1 – Why Study Labour

Economics
Lecturer: Dr. Edward Asiedu, UGBS
Contact Information: easiedu1@gmail.com

College of Education
Department of Distance Education
2017/2018
 Session Overview
• This session will equip students with knowledge of the reasons
behind the study of labour economics
• The labour market in developing economies
• Some basic concepts in labour economics
• The structure and patterns of unemployment in the Ghanaian
Labour market

Dr. Edward Asiedu Slide 2

 Session Outline
The key topics to be covered in the session are as follows:
• Why should Administrators /Economist be interested in labour
economics
• Why study labour market in developing Countries
• Some Basic Concepts
• Structures and patterns of unemployment and labour market
situations (Ghana)

Dr. Edward Asiedu Slide 3

 Reading List
• Borjas, G. J. (2000). Labour economics (Vol. 2). New
York: McGraw-Hill.
• Ehrenberg, R. G., & Smith, R. S. (2016). Modern
labour economics: Theory and public policy.
Routledge.
• Kaufman, B.E. and J.L. Hotchkiss (2003). The
Economics of Labour Markets, 6th edition, Dryden
Press, Fort Worth

Dr. Edward Asiedu Slide 4

 Topic one

WHY SHOULD
ADMNISTRATORS/ECONOMIST
BE INTERESTED IN LABOUR
ECONOMICS
Dr. Edward Asiedu Slide 5
 Why should Administrators /Economist
be interested in labour economics
• All of us will spend a substantial proportion of our
life in the labour market.
• How we do in the labor market helps determine our
wealth, the types of goods we can afford to consume,
who we associate with, which schools our children
attend, and even the types of persons who find us
attractive.
• And therefore we are all eager to learn how the labor
market works.

Dr. Edward Asiedu Slide 6

 Why should Administrator/Economist
be interested in labour economics
• As administrators, we should have a good
understanding of how labour market activities could
impact the firm.
• Finally, we should have a good understanding of the
different actors in the labour market.

Dr. Edward Asiedu Slide 7

 Topic Two

WHY STUDY LOBOUR

ECONOMICS IN DVELOPING
COUNTRIES
Dr. Edward Asiedu Slide 8
 Why Study Labour Market in
Developing Countries
• Unemployment in low income countries on average in
almost all dimensions much higher than in rich
countries.
• Unemployment among the youth is particularly very
high.
• Structure of employment that relies more heavily on
strength and endurance, and, therefore on good health.

Dr. Edward Asiedu Slide 9

 Why Study Labour Market in
Developing Countries
• Working conditions that are often harmful to health.
• Malfunctioning of labour markets is often given as a
principal explanation of the widespread poverty in
developing countries.
• The labour market (malfunctioning) is the immediate
locus of the problem of low and stagnant incomes of
workers at the bottom of the distribution.

Dr. Edward Asiedu Slide 10

 Topic Three

SOME BASIC CONCEPT

Dr. Edward Asiedu Slide 11

 Some Basic Concepts

• Labour Force: The term labour force refers to all

those over 15 years of age who are employed,
actively seeking work, or expecting recall from a
layoff.
• Unemployed: Those in the labour force who are not
employed for pay.
• People who are not employed and are neither
looking for work nor waiting to be recalled from
layoff by their employers are not counted as part of
the labour force.
Dr. Edward Asiedu Slide 12
 Some Basic Concepts
• Q1: The total labour force thus consists of the
employed and the unemployed. True/False
• Those in the labour force, whether employed or
unemployed, can leave the labour force by retiring or
otherwise deciding against taking or seeking work for
pay (dropping out).
• Those who have never worked or looked for a job
expand the labour force by entering it.

Dr. Edward Asiedu Slide 13

 Some Basic Concepts
• Unemployment rate: The ratio of those unemployed
to those in the labour force
• While this rate is crude and has several imperfections,
it is the most widely cited measure of labour market
conditions.
• Labour force participation rate: This is the
proportion of a country's working-age population that
engages actively in the labour market, either by
working or looking for work.

Dr. Edward Asiedu Slide 14

 Some Basic Concepts
• It provides an indication of the relative size of the
supply of labour available to engage in the production
of goods and services.
• When the unemployment rate is around 5 percent the
labour market is considered tight (nearing full
employment),indicating that jobs in general are
plentiful and hard for employers to fill vacant
positions and that most of those who are unemployed
will find jobs quickly.

Dr. Edward Asiedu Slide 15

 Some Basic Concepts
• When the unemployment rate is higher say, 7 percent
or above the labour market is described as loose, in the
sense that workers are abundant and jobs are relatively
easy for employers to fill vacant position.
• In principle, the labour market can be tight in some
occupations or locations (regions) but loose in others

Dr. Edward Asiedu Slide 16

 Topic Four

STRUCTURES AND PATTERNS OF

UNEMPLOYMENT AND LABOUR
MARKT SITUATION (GHANA)
Dr. Edward Asiedu Slide 17
 Structures and Patterns of Unemployment
and Labour Market Situation (Ghana)
• The Ghana Statistical Service (GSS) has been
conducting the Ghana Living Standards Survey
(GLSS) since 1987 to collect data for monitoring the
impact of policies and programs on the welfare of the
population.
• Until the year 2012, the GSS had conducted five
rounds of the GLSS; these surveys were undertaken in
1987, 1988, 1991/92, 1998/1999, and 2005/2006

Dr. Edward Asiedu Slide 18

 Structures and Patterns of Unemployment
and Labour Market Situations (Ghana)
• The Ghana Living Standards Survey (GLSS6)
contains a Labour Force Module that is meant to
collect data on labour indicators.
• Information on economic activity was collected on
persons 5 years and older who engaged in any
economic activity for pay (cash or in-kind) or profit or
family gain for at least one hour during the seven days
preceding the interview.
• Based on the GLSS6, almost four out of every five
persons 15 years and older is economically active
(79.6%).
Dr. Edward Asiedu Slide 19
 Structures and Patterns of Unemployment
and Labour Market Situations (Ghana)
• Out of this population, 94.8 percent are employed
and 5.2 percent unemployed.
• The unemployment rate is higher for females (5.5%)
than males (4.8%).
• About 4.2 million persons aged 15 years and older
(made up of 1.8 million males and 2.4 million
females) are estimated to be time-related
underemployed (under-utilization and one-hour
criteria leads to lower unemployment rates).
• 22.5% of workers are employees
Dr. Edward Asiedu Slide 20
 Structures and Patterns of Unemployment
and Labour Market Situations (Ghana)
• Agriculture continues to play a key role in
employment creation in Ghana with 44.3 percent of
the currently employed population working as skilled
agricultural and/or fishery workers.
• The manufacturing sector employs less than 10
percent of the currently employed population (9.1%).

Dr. Edward Asiedu Slide 21

 Structures and Patterns of Unemployment
and Labour Market Situations (Ghana)
• The results also show that the unemployment rate is
higher for persons with secondary education (11.7%)
and those with post-secondary diploma education
(9.1%) but lower for persons with post graduate
degrees (2.7%), teacher training and agriculture and
nursing training (2.8%).
• Youth unemployment is highest at 10.9 percent (15-24
years) and lowest at 2.5 percent for those aged 65
years and older

Dr. Edward Asiedu Slide 22

 Structures and Patterns of Unemployment
and Labour Market Situations (Ghana)
• The Ghana Statistical Service (GSS) has been
conducting the Ghana Living Standards Survey
(GLSS) since 1987 to collect data for monitoring the
impact of policies and programs on the welfare of the
population.

Dr. Edward Asiedu Slide 23

 Structures and Patterns of Unemployment
and Labour Market Situations (Ghana)

Dr. Edward Asiedu Slide 24

 FINC 407
Labour Economics

Session 2 – How the labour market works

Lecturer: Dr. Edward Asiedu, UGBS

Contact Information: easiedu1@gmail.com

College of Education
Department of Distance Education
2017/2018
 Session Overview
• By the end of this sections students should be
able to explain some working definitions of
unemployment’
• Explain how the labour market work
• And be able to distinguish the various
objective of the actors in the labour market.

Dr. Edward Asiedu Slide 2

 Session Outline
The key topics to be covered in the session are as
follows:
• Some definitions in the GLSS work
• How the labour market work
• Actors in the labour market

Dr. Edward Asiedu Slide 3

 Reading List
• Borjas, G. J. (2000). Labour economics (Vol. 2). New
York: McGraw-Hill.
• Ehrenberg, R. G., & Smith, R. S. (2016). Modern
labour economics: Theory and public policy.
Routledge.
• Kaufman, B.E. and J.L. Hotchkiss (2003). The
Economics of Labour Markets, 6th edition, Dryden
Press, Fort Worth

Dr. Edward Asiedu Slide 4

 Topic one

SOME DEFINITIONS IN THE

GLSS WORK

Dr. Edward Asiedu Slide 5

 Some Definitions in the GLSS
Work
• Wo r k : r e f e r s t o a n y e c o n o m i c a c t i v i t y
performed by the respondent that contributes to
the economic production of goods and services.
Examples are selling in a market/street, working
in an enterprise/business or for government,
working in one's own farm or enterprise,
working on a household member's farm, etc.

Dr. Edward Asiedu Slide 6

 Some Definitions in the GLSS
Work
• Currently employed: There are two situations
in which a person can be classified as being
currently employed. Either the person was
actually engaged in any work (as defined above)
during the reference week, or he/she had an
attachment to a job or business but for some
reasons did not work during the reference week.

Dr. Edward Asiedu Slide 7

 Some Definitions in the GLSS
Work
• Currently unemployed (strict definition): A person
is considered as currently unemployed if he/she was
not engaged in any work (as defined above), had no
attachment to a job or business, reported that he/she
was available for work and had taken some specific
steps to look for work.
• Time-related underemployment: The concept of
time-related underemployment has been introduced to
complement the statistics on unemployment. While
unemployment represents a situation of total lack of
work during the reference period, many other people
Slide 8
may have jobs but suffer from partial lack of work.
Dr. Edward Asiedu
 Some Definitions in the GLSS
Work
• The currently employed group can, therefore, be sub-
classified as either in time-related underemployment
or not. In operational terms, the time-related
underemployed persons are defined as those whose
total actual hours of work were less than 35 hours.

Dr. Edward Asiedu Slide 9

 Some Definitions in the GLSS
Work
• Labour underutilization is a more comprehensive
measure than the unemployment rate. In developing
countries, the one-hour criterion defining employment
leads to lower unemployment rates and complicates the
interpretation of employment and unemployment statistics.
Labour underutilization consists of that part of the
population which has labour slack, low earnings and skill
mismatch among the employed population. In other
words, the employed population might have time-related
underemployment, low pay and skill mismatches which
are aspects of labour underutilization.
Dr. Edward Asiedu Slide 10
 Some Definitions in the GLSS
Work

Dr. Edward Asiedu Slide 11

 Topic Two

HOW DOES THE LABOUR

MARKET WORK

Dr. Edward Asiedu Slide 12

 How does the Labour Market Work?
• Labour economists typically assign motives to the
various "actors" in the labour market. We typically
view workers, for instance, as trying to find the best
possible job and assume that firms are trying to make
money.
• Workers and firms, therefore, enter the labour market
with different objective Workers are often trying to
sell their labour at the highest price, whereas firms
are often trying to buy labour at the lowest price

Dr. Edward Asiedu Slide 13

 How does the Labour Market Work?
• The types of economic exchanges that can occur
between workers and firms are limited by the set of
ground rules that the government has enacted to
regulate transactions in the labor market.
• Changes in these rules and regulations would
obviously lead to different outcomes.
• E.g, a minimum wage outlaws exchanges that pay
less than a particular amount per hour worked;
occupational safety regulations forbid firms from
offering working conditions that are deemed too risky
to the worker's health.
Dr. Edward Asiedu Slide 14
 How does the Labour Market Work?
• Thus, the deals that are eventually struck between
workers and firms determine the types of jobs that are
offered, the skills that workers acquire, the extent of
labour turnover (people leaving the company), the
structure of unemployment in the economy, and the
observed earnings distribution.
• In a nutshell, aside understanding theories of the
labour market, how the official unemployment rate is
calculated and it's trend, we also want to understand
which economic and social factors generate the levels
of unemployment, and why
Dr. Edward Asiedu Slide 15
 Topic Three

ACTORS IN THE LABOUR

MARKET

Dr. Edward Asiedu Slide 16

 Actors in the Labour Market
• Q1: There are two leading actors in the labour market.
True/False

• Workers, firms, and the government.

• Without workers, there is no "labour" in the labour

market.

• Workers decide whether to work or not, how many

hours to work, which skills to acquire, when to quit a
job, which occupations to enter, whether to join a
labour union, and how much effort to allocate to the job.
Dr. Edward Asiedu Slide 17
 Actors in the Labour Market
• Each of these decisions is motivated by the desire to
optimize WHAT?

• Maximize their well-being.

• This means that persons who want to maximize their

well-being will tend to supply more time and more effort
to those activities that have a higher payoff.

• This is why we say the labour supply curve is often

upward sloping.
Dr. Edward Asiedu Slide 18
 Actors in the Labour Market
• Adding up the decisions of millions of workers
generates the economy's labour supply not only in
terms of the number of persons who enter the labour
market, but also in terms of the quantity and quality
of skills available to employers.

Dr. Edward Asiedu Slide 19

 Actors in the Labour Market

Dr. Edward Asiedu Slide 20

 Actors in the Labour Market
• The labour supply curve gives the number of persons who
are willing to supply their services to finance/engineering
firms at a given wage.

• For example, 20,000 workers are willing to supply their

services to finance/engineering firms if the
finance/engineering wage is 1,000ghs per month.

• If the finance/engineering wage rises to 5,000ghs, then

30,000 workers will choose to be financial
analyst/engineers.

Dr. Edward Asiedu Slide 21

 Actors in the Labour Market
• More generally, the labour supply curve relates the
number of person-hours supplied to the economy to
the wage that is being offered. The higher the wage
that is being offered, the larger the labor supplied.

Slide 22
 Actors in the Labour Market
• Firms

• Each firm must decide how many and which types of

workers to hire and re, the length of the workweek,
how much capital to employ, and whether to offer
safe working conditions to its workers.

• Like workers, firms also have motives (profit

maximization).

Dr. Edward Asiedu Slide 23

 Actors in the Labour Market
• The labour demand curve gives the number of finance
analyst/engineers that the firms will hire at different
wages.

• Thus, at higher wages firms are willing to hire less people

(demand curve is downward sloping).

• Adding up the hiring and ring decisions of millions of

employers generates the economy's labour demand.

• Workers and firms, therefore, enter the labour market with

conflicting interests.

Dr. Edward Asiedu Slide 24

 Actors in the Labour Market
• Many workers are willing to supply their services
when the wage is high, but few firms are willing to
hire them. Conversely, few workers are willing to
supply their services when the wage is low, but many
firms are looking for workers.

• As workers search for jobs and firms search for

workers, these conflicting desires are "balanced out"
and the labour market reaches an equilibrium. In a
free-market economy, equilibrium is attained when
supply equals demand.
Dr. Edward Asiedu Slide 25
 Actors in the Labour Market
• As drawn in Figure 1 , the equilibrium wage is
1,000ghs and 20,000 finance analyst/engineers will
be hired in the labour market. This wage-employment
combination is an equilibrium because it balances out
the conflicting desires of workers and firms.

• Suppose, for example, that the finance/engineering

wage were 5,000ghs above equilibrium.

Dr. Edward Asiedu Slide 26

 Actors in the Labour Market
• Firms would then want to hire only 10,000 finance
analyst/ engineers, even though 30,000 finance analyst/
engineers are looking for work.

• What would happen to the excess labour?

• The excess number of job applicants would bid down the

wage as they compete for the few jobs available.

• Suppose instead that the wage were 300ghs-below

equilibrium
Dr. Edward Asiedu Slide 27
 Actors in the Labour Market
• Because workers are cheap, firms want to hire 30,000
workers, but only 10,000 are willing to work at that
wage. As firms compete for the few available engineers,
they bid up the wage.

Dr. Edward Asiedu Slide 28

 Actors in the Labour Market

• Government
• There is one last major player in the labour market, the
government.
• The government can impose taxes on a worker's
earnings, subsidize the training of more workers,
impose a payroll tax on firms, and increase the supply
of finance analysts/engineers by encouraging increased
enrolment in the universities.
Dr. Edward Asiedu Slide 29
 Actors in the Labour Market
• All of these actions will change the equilibrium that
will eventually be attained in the labour market. The
government regulations, therefore, set the ground
rules that will guide exchanges in the labour market.
• What would happen to labour market equilibrium
conditions in
• the fresh pineapple industry if government signs and
implements an export agreement between Ghana and
Europe for fresh pineapples. Discuss with the aid of
graphs.

Dr. Edward Asiedu Slide 30

 Actors in the Labour Market

• The agreement will shifted the labour demand curve

in the pineapple sector from Do to Dl` resulting in
higher wages and employment.

• If the agreement is canceled after 5years, the demand

curve reverted back to its original level and wages and
employment will fall.

Dr. Edward Asiedu Slide 31

 Actors in the Labour Market

Dr. Edward Asiedu Slide 32

 FINC 407
Labour Economics

Session 3 – Labour Supply

Lecturer: Dr. Edward Asiedu, UGBS

Contact Information: easiedu1@gmail.com

College of Education
School of Continuing and Distance Education
2017/2018
 Session Overview
• After going through this session, students should be able
to explain how preferences of a workers are formed.

• Know workers utility function and how the concept of

marginal utilities impact the hours of work.

• Knowledge of Indifference Curve (IC) and it properties.

• Understand how differences in the shape of the IC (steep

and flat indifference curves) impacts work decision.

Dr. Edward Asiedu Slide 2

 Session Outline
The key topic to be covered in the session is Labour Supply.
More specifically:

• Workers preferences.

• Utility functions.

• The concept of marginal utility.

• Indifference curve

Dr. Edward Asiedu Slide 3

 Reading List
• Borjas, G. J. (2000). Labour economics (Vol. 2). New
York: McGraw-Hill.
• Ehrenberg, R. G., & Smith, R. S. (2016). Modern
labour economics: Theory and public policy.
Routledge.
• Kaufman, B.E. and J.L. Hotchkiss (2003). The
Economics of Labour Markets, 6th edition, Dryden
Press, Fort Worth

Dr. Edward Asiedu Slide 4

 Topic one

LABOUR SUPPLY

Dr. Edward Asiedu Slide 5

 Labour Supply
• Worker's preferences: Labour supply decisions can be
roughly divided into two categories:

• Decisions about whether to work at all and, if so, how

long to work.

• The second category of decisions, deals with the

questions that must be faced by a person who has
decided to seek work for pay: the occupation or general
class of occupations in which to seek offers (chapters 8
and 9) and the geographical area in which offers should
be sought.

Dr. Edward Asiedu Slide 6

 Labour Supply

• Because labour is the most abundant factor of

production, any country's well-being in the long run
depends heavily on the willingness of its people to
work.

• Majority of economies relies heavily on it’s

production of goods and services.

Dr. Edward Asiedu Slide 7

 Labour Supply

• Typical framework that economists use to analyze

labour supply behavior is commonly called the
"neoclassical model of labour-leisure choice.

• In this framework, individuals seek to maximize their

wellbeing by consuming goods (such as food, cars
and homes) and leisure.

Dr. Edward Asiedu Slide 8

 Labour Supply
• The representative person in the model receives
satisfaction both from the consumption of goods
(which we denote by “C” and from the consumption
of leisure “L”).

• If we do not work, we can consume a lot of leisure.

• But we will have to forgo the cars and commodities

that make life much more enjoyable.

Dr. Edward Asiedu Slide 9

 Labour Supply
• Opportunity Cost of Leisure: The cost of spending an
hour watching television is basically what one could earn
if one had spent that hour working. Thus, the opportunity
cost of an hour of leisure is equal to one's wage rate; the
extra earnings a worker can take home from an extra hour
of work.

• The idea that individuals get satisfaction from consuming

goods and leisure is summarized by the utility function:

U = f (C, L)

Dr. Edward Asiedu Slide 10

 Labour Supply
• The utility function transforms the person's consumption
of goods and leisure into an index “U” that measures the
individual's level of satisfaction or happiness.

• This index is called utility. The higher the level of index

U, the happier the person.

• If we take the prices of goods as fixed, then they can be

compressed into one index that is measured by money
income (with prices fixed, more money income means.

Dr. Edward Asiedu Slide 11

 Labour Supply
• Since both leisure and money can be used to generate
satisfaction (or utility), these two goods are to some
extent substitutes for each other.

• If forced to give up some money income - by cutting

back on hours of work, for example - some increase
in leisure time could be substituted for this lost
income to keep a person as happy as before.

Slide 12
Dr. Edward Asiedu
 Labour Supply

• Suppose a thoughtful consumer/worker were asked to

decide how happy he or she would be with a weakly
income of 64Ghs combined with 8 hours of leisure
(point ‘a’ in Figure 6.2).

Slide 13
Dr. Edward Asiedu
 Labour Supply
• This level of happiness could be called utility level A. Our
consumer/worker could name other combinations of
money income (consumption) and leisure hours that
would also yield utility level A.

• Assume that our respondent named five other

combinations. All six combinations of money income and
leisure hours that yield utility level A are represented by
heavy dots in the Figure .

• The model of labor-leisure choice isolates the person's

wage rate and income as the key economic variables that
guide the allocation of time between the labor market and
leisure activities
Dr. Edward Asiedu Slide 14
 Labour Supply

Dr. Edward Asiedu Slide 15

 Labour Supply
• Our worker/consumer could achieve a higher level of
happiness if he or she could combines the 8 hours of
leisure with an income of 100ghs per week (see
graph).

• The curve connecting these dots is called an

indifference curve, which connects the various
combinations of money income (consumption) and
leisure that yield equal utility.

Dr. Edward Asiedu Slide 16

 Labour Supply
• Utility and Indifference Curve

Slide 17
Dr. Edward Asiedu
 Labour Supply
• As a result, the utility function can be represented
graphically in terms of a family (or a "map") of
indifference curves.

• Indifference curves have a number of important

properties:

 Indifference curves are downward sloping.

 Higher indifference curves indicate higher levels of
utility.
 Indifference curves are convex to the origin.
 Indifference curves do not intersect.
Dr. Edward Asiedu Slide 18
 Labour Supply

Dr. Edward Asiedu Slide 19

 Labour Supply
• Some basic definitions`
• What happens to a person's utility as she allocates one
more hour to leisure or buys an additional dollar's
worth of goods?

• The marginal utility of leisure is defined as the

change in utility from an additional hour devoted to
leisure activities, holding constant the amount of
goods consumed.

Dr. Edward Asiedu Slide 20

 Labour Supply

Dr. Edward Asiedu Slide 21

 Labour Supply

Dr. Edward Asiedu Slide 22

 Labour Supply

Dr. Edward Asiedu Slide 23

 Labour Supply
• Differences in Preferences Across Workers
• The map of the indifference curve presented
illustrates the way a particular worker values the
trade-o between leisure and consumption. Different
workers will typically value this trade-off differently.

• In other words, some persons may like to devote a

great deal of time and effort to their jobs, whereas
other persons would prefer to devote most of their
time to leisure.
Dr. Edward Asiedu Slide 24
 Labour Supply

• These interpersonal differences in preferences imply

that the indifference curve maps may look quite
different for different workers

• Figure below shows the indifference maps for two

workers, Ama and Adwoa.

Dr. Edward Asiedu Slide 25

 Labour Supply

Dr. Edward Asiedu Slide 26

 Labour Supply
• Ama's indifference curves tend to be very
steep . . . . . . indicating that her marginal rate of
substitution takes on a very high value.

• . . . . . . In other words, she requires a sizable

monetary bribe (in terms of additional consumption)
to convince her to give up an additional hour of
leisure.

Slide 27
 Labour Supply

• Adwoa, on the other hand, has relatively at

indifference curves, indicating that her marginal rate
of substitution takes on a low value. . . . . . . ..Adwoa,
therefore, does not require a large bribe to convince
her to give up an additional hour of work.

Slide 28
 Labour Supply

• Q3: Based on the IC of the two workers, we can say

that Adwoa likes leisure more than Ama. True/False

Dr. Edward Asiedu Slide 29

 Labour Supply

• These interpersonal differences in the "tastes for

work" are obviously important determinants of a
person's labour supply decision.

• Workers who like leisure a lot (Ama) will tend to

work few hours. And workers who do not attach a
high value to their leisure time (like Adwoa) will tend
to be workaholics

Dr. Edward Asiedu Slide 30

 FINC 407
Labour Economics

Session 4 – Labour Supply

Lecturer: Dr. Edward Asiedu, UGBS

Contact Information: easiedu1@gmail.com

College of Education
Department of Distance Education
2017/2018
 Session Overview
After going through this session, students should be able

• To derive the worker’s budget constraint.

• Graph the budget line of the worker.

• Be able to explain and graph the tangency condition.

• Be able to explain the impact of changes in non-labour

income on hours of work (paying attention to the
graphical illustrations)

Dr. Edward Asiedu Slide 2

 Session Outline
The key topic to be covered in the session is Labour
Supply.

More specifically:
• The budget constraint of a “typical worker”.
• Hours of work decisions.
• What happens to hours of work when non-labour
income changes.

Dr. Edward Asiedu Slide 3

 Reading List
• Borjas, G. J. (2000). Labour economics (Vol. 2). New
York: McGraw-Hill.
• Ehrenberg, R. G., & Smith, R. S. (2016). Modern
labour economics: Theory and public policy.
Routledge.
• Kaufman, B.E. and J.L. Hotchkiss (2003). The
Economics of Labour Markets, 6th edition, Dryden
Press, Fort Worth

Dr Edward Asiedu Slide 4

 Topic one

THE BUDGET CONSTRAINT

Dr. Edward Asiedu Slide 5

 Labour Supply

• The Budget Constraint

• The worker's consumption of goods and leisure are
constrained by her time and by her income.

• Part of the person's income (such as property

income, dividends, lottery prizes, unconditional
cash transfers) is independent of how many hours
she works. We denote this "non labour income" by
V.

Dr. Edward Asiedu Slide 6

 Labour Supply

• The Budget Constraint

• Let “h” be the number of hours the person will

allocate to the labor market during the period, and
“w” be the hourly wage rate.

• Thus, the value of expenditures on goods (C) must

equal the sum of labour earnings (wh) and non-
labour income (V).
Dr. Edward Asiedu Slide 7
 Labour Supply
• The person's budget constraint can be written as:

C = wH +v ................. (1)

• We assume that the wage rate is constant, so the person

receives the same hourly wage regardless of how many hours
she works.

• In this model, the person has two alterative uses for her time:
work or leisure.

Dr. Edward Asiedu Slide 8

 Labour Supply
• The total time allocated to each of these activities must be equal to
the total time available in the period, say T hours per week, so that T
= h + L.

• The person's budget constraint can be rewritten (from equation1) as:

• C = w(T - L) + v .......................(2)
• C = (wT + v) - wL ......................(3)

• This last equation is in the form of a line, and the slope is the
negative of the wage rate (or -w).

• The budget line is illustrated by the Figure below:

Dr. Edward Asiedu Slide 9

 Labour Supply

Dr. Edward Asiedu Slide 10

 Labour Supply
• Point E in the graph indicates that if the person decides
not to work at all and devotes T hours to leisure
activities, she can still purchase V cedis worth of
consumption goods. Point E will be called the
endowment point.

• If the person is willing to give up 1 hour of leisure, she

can then move up the budget line and purchase an
additional w cedis worth of goods.

• Each hour of leisure has a price, and the price is given

by the wage rate.
Dr. Edward Asiedu Slide 11
 Labour Supply

• If the worker gives up all her leisure activities, she

ends up at the intercept of the budget line and can buy
(wT+ V) cedis worth of goods.

Slide 12
Dr. Edward Asiedu
 Labour Supply

• Q1: The consumption and leisure bundles that lie below

the budget line are available to the worker; the bundles
that lie above the budget line are not available to the
worker. True/False

• Q2: Point E (endowment point), tells the person how

much she can consume if she does not enter the labor
market. True/False

• Q3: The absolute value of the slope of the budget line is

the interest rate. True/False

Dr. Edward Asiedu Slide 13

 Topic Two

THE HOURS OF WORK

DECISION

Dr. Edward Asiedu Slide 14

 Labour Supply

• The Hours-Of-Work Decision

• We make one important assumption about the
person’s behavior: she wishes to choose the particular
combination of goods and leisure that maximizes her
utility.
• This means that the person will choose the level of
goods consumption and leisure activities that lead to
the highest possible level of the utility index U-given
the limitations imposed by the budget constraint.

Dr. Edward Asiedu Slide 15

 Labour Supply
• If a worker has 100 Ghc of non labor income per
week, faces a market wage rate of 10 Ghc per hour,
and has 110 hours of nonsleeping hours time to
allocate between work and leisure activities
(assuming she sleeps roughly 8 hours per day). Graph
the budget line for the worker.

Dr. Edward Asiedu Slide 16

 Labour Supply
• Hours of Work Decision

Slide 17
 Labour Supply

Slide 18
Dr. Edward Asiedu
 Labour Supply

• At the chosen level of consumption and leisure,

therefore, the marginal rate of substitution (the rate
at which a person is willing to give up leisure hours
in exchange for additional consumption) equals the
wage rate (the rate at which the market is willing to
let the worker substitute 1 hour of leisure time for
consumption)

Dr. Edward Asiedu Slide 19

 Topic Three

WHAT HAPPENS TO HOURS OF

WORK WHEN NON LABOUR
INCOME CHANGES
Dr. Edward Asiedu Slide 20
 Labour Supply

• What Happens to Hours of Work When Non

labour Income Changes?
• The increase in V might be caused by the payment of
higher dividends on the worker's stock portfolio or
perhaps because some distant relatives named the
worker as the beneficiary in their wills.

Dr. Edward Asiedu Slide 21

 Labour Supply

Slide 22
Dr. Edward Asiedu
 Labour Supply

• Illustrates what happens to hours of work when the

worker has an increase in V holding the wage
constant.
• The impact of the change in non labour income
(holding wages constant) on the number of hours
worked is called an income effect.
• As indicated earlier however, we assume leisure to be
a normal good.
• The income effect, therefore, implies that an increase
in non labour income, holding the wage rate constant,
reduces hours of work. Slide 23

Dr. Edward Asiedu

 FINC 407
Labour Economics

Session 5 – Labour Supply

Lecturer: Dr. Edward Asiedu, UGBS

Contact Information: easiedu1@gmail.com

College of Education
Department of Distance Education
2017/2018
 Session Overview
By the end of this session students should be able to:

• Explain the impact of wage change on hours of work.

• Tell when a worker should enter the labour market.
• Calculate the elasticity of labour supply.
• Explain the backward bending labour supply curve.

Dr. Edward Asiedu Slide 2

 Session Outline
The key topic to be covered in the session is Labour
Supply:

More specifically:
• What happens to hours of work when wage changes?
• To work or not to work?
• The backward bending labour supply curve.
• Elasticity of labour supply.

Dr. Edward Asiedu Slide 3

 Reading List
• Borjas, G. J. (2000). Labour economics (Vol. 2). New
York: McGraw-Hill.
• Ehrenberg, R. G., & Smith, R. S. (2016). Modern
labour economics: Theory and public policy.
Routledge.
• Kaufman, B.E. and J.L. Hotchkiss (2003). The
Economics of Labour Markets, 6th edition, Dryden
Press, Fort Worth

Dr Edward Asiedu Slide 4

 Topic one

WHAT HAPPENS TO HOURS

OF WORK WHEN WAGE
CHANGES
Dr. Edward Asiedu Slide 5
 Labour Supply
What Happens to Hours of Work When the Wage
Changes?

• Consider a wage increase from 10 to 20ghs an hour,

holding non labour income V constant.
• The wage increase rotates the budget line around
the endowment point E, as illustrated. The rotation
of the budget line shifts the opportunity set from FE
to GE.

Dr. Edward Asiedu Slide 6

 Labour Supply

Dr. Edward Asiedu Slide 7

 Labour Supply

• The two panels presented in Figure 2-8 illustrate the

possible effects of a wage increase on hours of work.

• In Figure a, the wage increase shifts the optimal

consumption bundle from point P to point R. At the
new equilibrium, the individual consumes more
leisure (the increase is from 70 to 75 hours), so that
hours of work fall from 40 to 35 hours.

Dr. Edward Asiedu Slide 8

 Labour Supply
• Figure b, however, illustrates the opposite result. The
wage increase again moves the worker to a higher
indifference curve and shifts the optimal consumption
bundle from point P to point R. This time, however,
the wage increase reduces leisure hours (from 70 to
65 hours); so the length of the workweek increases
from 40 to 45 hours.

• It seems, therefore, that the effect of wage increase is

ambiguous prediction without making more
assumptions.
Dr. Edward Asiedu Slide 9
 Labour Supply
• Both panels in show that regardless of what happens to
hours of work, a wage increase expands the worker's
opportunity set.

• Put differently, a worker has more opportunities when she

makes 20ghs an hour than when she makes 10ghs an hour.
We know that an increase in income increases the demand
for all normal goods, including leisure. The increase in the
wage thus increases the demand for leisure, which reduces
hours of work. The increase in the wage thus increases the
demand for leisure, which reduces hours of work.

Dr. Edward Asiedu Slide 10

 Labour Supply
• But this is not all that happens. The wage increase also
makes leisure more expensive. When the worker earns
20ghs an hour, she is giving up 20ghs every time she
devotes an hour to leisure activities. As a result, leisure
time is a very expensive commodity for high-wage
workers and a relatively cheap commodity for low-wage
workers.

• High wage workers, therefore, have strong incentives to

cut back on their consumption of leisure activities. A
wage increase thus reduces the demand for leisure and
increases hours of work.
Slide 11
Dr. Edward Asiedu
 Labour Supply

• This discussion highlights the essential reason for the

ambiguity in the relation between hours of work and
the wage rate.

• A high-wage worker wants to enjoy the rewards of

her high income, and hence would like to consume
more leisure. The same worker, however, finds that
leisure is expensive and that she simply cannot afford
to take time o from work.

Dr. Edward Asiedu Slide 12

 Labour Supply

• It is instructive to think of the move from point P to point

R as a two-stage move. The two stages correspond exactly
to our discussion that the wage increase generates two
effects: it increases the worker's income and it raises the
price of leisure.

• To isolate the income effect, suppose we draw a budget

line that is parallel to the old budget line but tangent to
the new indifference curve. This budget line generates a
new tangency point Q.

Dr. Edward Asiedu Slide 13

 Labour Supply
• The move from initial position P to final position R
can be decomposed into a first-stage move from P to
Q, and a second-stage move from Q to R. It is easy to
see that the move from point P to point Q is an
income effect.

• The second-stage move from Q to R is called the

substitution effect. It illustrates what happens to the
optimal consumption bundle as the wage increases,
holding utility constant.
Dr. Edward Asiedu Slide 14
 Labour Supply
• By moving along an indifference curve, the worker's
utility is held fixed. The substitution effect thus
isolates the impact of the increase in the price of
leisure on hours of work, holding utility or real
income constant.

• The move from point Q to point R generates a

substitution away from leisure time and toward
consumption of other goods.

Slide 15
 Labour Supply

Slide 16
Dr. Edward Asiedu
 Labour Supply

• As the wage rises, people have a larger opportunity

set and the income effect increases the demand for
leisure and decreases labour supply.

• As the wage rises, however, leisure becomes more

expensive, and the substitution effect generates
incentives for workers to switch from the
consumption of leisure to other types of
consumption activities. This shift frees up leisure
hours and thus increases hours of work.
Dr. Edward Asiedu Slide 17
 Labour Supply

To summarize the relation between hours of work

and the wage rate:

• An increase in the wage rate increases hours of work

if the substitution effect dominates the income effect.

• An increase in the wage rate decreases hours of work

if the income effect dominates the substitution effect.

Dr. Edward Asiedu Slide 18

 Topic Two

TO WORK OR NOT TO WORK?

Dr. Edward Asiedu Slide 19

 Labour Supply
• Our analysis of the relationship between non-labour
income, the wage rate, and hours of work assumed
that the person worked both before and after the
change in nonlabor income or the wage.

• But what factors motivate a person to enter the

labour force in the first place?

Slide 20
Dr. Edward Asiedu
 Labour Supply

Slide 21

Dr. Edward Asiedu

 Labour Supply
• Suppose initially that the person's wage rate is given
by w-low so that the woman faces budget line GE.
• No point on this budget line can give her more utility
than Va. At this low wage, the person's opportunities
are quite meager.
• If the worker were to move from the endowment
point E to any point on the budget line GE, she would
be moving to a lower indifference curve. For example,
at point X the woman gets only VG utils. At wage `w-
low' therefore, the woman chooses not to work

Dr. Edward Asiedu Slide 22

 Labour Supply
• In contrast, suppose that the wage rate was given by
`w-high’ so that the woman faces budget line HE. It is
easy to see that there are many points on this higher
budget line that would allow the worker to increase
her utility. For example, at point Y the woman gets
VH utils.

• At the wage `w-high' therefore, the woman would be

better off working.

Dr. Edward Asiedu Slide 23

 Labour Supply
• In sum, the analysis reveals that the woman does not
enter the labour market at low wage rates (such as w-
low) but does enter the labor market at high wage
rates (such as w-high).

• As we rotate the budget line from wage `w-low' to

wage `w-high' we will typically encounter a wage rate,
call it , that makes her indifferent between working
and not working. We call the wage the reservation
wage.

Dr. Edward Asiedu Slide 24

 Labour Supply

• The reservation wage gives the minimum increase in

income that would make a person indifferent between
remaining at the endowment point E and working that
first hour.

• In the Figure, the reservation wage is given by the

absolute value of the slope of the indifference curve
at point E.

Dr. Edward Asiedu Slide 25

 Labour Supply
• The reservation wage has one important property. The
person will not work at all if the market wage is less
than the reservation wage; and the person will enter
the labour market if the market wage exceeds the
reservation wage.
• The decision to work, therefore, is based on a
comparison of the market wage (which indicates how
much employers are willing to pay for an hour of
work) and the reservation wage (which indicates how
much the worker requires to be bribed into working
that first hour).
Dr. Edward Asiedu Slide 26
 Labour Supply

• This implies that a high reservation wage makes it

less likely that a person will enter the labour force.

• The reservation wage will typically depend on the

person’s tastes for work, which, as we have seen,
determine the slope of the indifference curve, as well
on many other factors.

Dr. Edward Asiedu Slide 27

 Labour Supply
• For instance, the assumption that leisure is a normal
good implies that a higher level of non labour income
increases the reservation wage, making it less likely
that a person will participate in the labour force.

• Q4: Hours of work will be zero for any wage

below the reservation wage. True/False

Dr. Edward Asiedu Slide 28

 Topic Thee

THE BACKWARD BENDING

LABOUR SUPPLY CURVE

Dr. Edward Asiedu Slide 29

 Labour Supply

Dr. Edward Asiedu Slide 30

 Labour Supply

Dr. Edward Asiedu Slide 31

 Labour Supply

Dr. Edward Asiedu Slide 32

 Labour Supply
• The labour supply elasticity gives the percentage
change in hours of work associated with a 1 percent
change in the wage rate.
• The sign of the labour supply elasticity depends on
whether the labour supply curve is upward sloping
(Dh/Dw > 0) or downward sloping (Dh/Dw < 0), and
hence is positive when substitution effects dominate
and negative when income effects dominate.

Dr. Edward Asiedu Slide 33

 Labour Supply

Dr. Edward Asiedu Slide 34

 Labour Supply
• When the labour supply elasticity is less than one in
absolute value, the labour supply curve is said to be
inelastic.

• If the labour supply elasticity is greater than one in

absolute value (indicating that hours of work are greatly
affected by the change in the wage) the labour supply
curve is said to be elastic.

• Q5: From our example, is labour supply elastic or

inelastic?

Dr. Edward Asiedu Slide 35

 FINC 407
Labour Economics

Session 6 – Labour Demand

Lecturer: Dr. Edward Asiedu, UGBS

Contact Information: easiedu1@gmail.com

College of Education
Department of Distance Education
2017/2018
 Session Overview
• By the end of this session students should be able to:

• Identify a production function.

• Calculate and distinguish between marginal and
average products, value of marginal and average
products.
• Determine the profit maximizing level of
employment of a firm.

Dr. Edward Asiedu Slide 2

 Session Outline
The key topic to be covered in the session is Labour
demand:

More specifically:
• Employer’s decision.
• The production function.
• Profit maximization.
• Th profit maximizing employment level.

Dr. Edward Asiedu Slide 3

 Reading List
• Borjas, G. J. (2000). Labour economics (Vol. 2). New
York: McGraw-Hill.
• Ehrenberg, R. G., & Smith, R. S. (2016). Modern
labour economics: Theory and public policy.
Routledge.
• Kaufman, B.E. and J.L. Hotchkiss (2003). The
Economics of Labour Markets, 6th edition, Dryden
Press, Fort Worth

Dr Edward Asiedu Slide 4

 Topic one

LABOUR DEMAND:
EMPLOYER’S DECISION

Dr. Edward Asiedu Slide 5

 Labour Demand

• Employer's Decisions
• Labour market outcomes, depend not only on the
willingness of workers to supply their time to work
activities, but also on the willingness of firms to
hire those workers.
• We now turn, to a discussion of on labour demand.
• The hiring and ring decisions made by firms create
and destroy many jobs at any time

Dr. Edward Asiedu Slide 6

 Labour Demand

• Our analysis of labour demand begins by recognizing

that firms do not hire workers simply because
employers want to see "bodies" filling in various
spots in the firm.

• Rather, firms hire workers because consumers want to

purchase a variety of goods and services.

Dr. Edward Asiedu Slide 7

 Labour Demand

• In effect, firms are the "middlemen" that hire workers

to produce those goods and services.

• The firm's labor demand-just like the firm's demand

for other inputs in the production process, such as
land, buildings, and machines-is a "derived demand,"
derived from the wants and desires of consumers

Dr. Edward Asiedu Slide 8

 Topic one

LABOUR DEMAND:
PRODUCTION FUNCTION

Dr. Edward Asiedu Slide 9

 Labour Demand
• Production Function

• We begin the study of labour demand by specifying the

firm’s production function.

• The production function describes the technology that the

firm uses to produce goods and services.

• For simplicity, we will initially assume that there are only

two factors of production: the number of employee hours
hired by the firm (E) and capital (K) the aggregate stock
of land machines, and other physical inputs.

Dr. Edward Asiedu Slide 10

 Labour Demand

• We write the production function as:

• q = f(E, K)
where q is the firm's output.

• We will simply refer to the labor input "E' as the

number of workers hired by the firm.

Dr. Edward Asiedu Slide 11

 Labour Demand

Slide 12
Dr. Edward Asiedu
 Labour Demand

Dr. Edward Asiedu Slide 13

 Labour Demand

Dr. Edward Asiedu Slide 14

 Labour Demand

• Figure below graphs the data in our example -the shape of the
production function. Figure 4-1a illustrates the total product
curve.

• This curve describes what happens to output as the firm hires

more workers.

• The total product curve is obviously upward sloping.

• The marginal product of labour is the slope of the total product

curve-that is, the rate of change in output as more workers are
hired.

Dr. Edward Asiedu Slide 15

Labour Demand

Slide 16
 Labour Demand
• In our numerical example, output first rises at an
increasing rate as more workers are hired.

• This implies that the marginal product of labour is rising,

perhaps because of the initial gains resulting from
assigning workers to specific tasks.

• Eventually, output increases at a decreasing rate. In other

words, the marginal product of labour begins to decline,
so the next worker hired adds less to the firm's output
than a previously hired worker.

Slide 17
Dr. Edward Asiedu
 Labour Demand
• In our example, the marginal product of the third worker
hired is 20 units, but the marginal product of the fourth
worker is 19 units, and that of the fifth worker declines
further to 17 units.

• The assumption that the marginal product of labour

eventually declines follows from the law of diminishing
returns.
• Recall that the marginal product of labour is defined in
terms of a fixed level of capital. The first few workers hired
may increase output substantially because the workers can
specialize in narrowly defined tasks.
Dr. Edward Asiedu Slide 18
 Labour Demand

• As more and more workers are added to a fixed

capital stock (that is, to a fixed number of machines
and a fixed amount of land), the gains from
specialization decline and the marginal product of
workers declines.

• We can also define the average product of labour (or

APE) as the amount of output produced by the typical
worker. This quantity is defined by APE = q/E.

Dr. Edward Asiedu Slide 19

 Topic Two

LABOUR DEMAND: PROFIT

MAXIMIZATION

Dr. Edward Asiedu Slide 20

 Labour Demand

• Profit Maximization
• To analyze the hiring decisions made by the firm, we
make an assumption about the firm's behavior.

• In particular, the firm’s objective is to maximize its

profits.

Slide 21
Dr. Edward Asiedu
 Labour Demand
• Profit Maximization
The firm's profits are given by:
• profit = pq - wE - rK

• q is the output;
• w is the wage rate (that is, the cost of hiring an
additional worker);
• and r is the price of capital;
• where p is the price at which the firm can sell its output.

Slide 22
Dr. Edward Asiedu
 Labour Demand

Slide 23

Dr. Edward Asiedu

 Labour Demand
• The value of the marginal product of labour is the
increase in revenue generated by an additional
worker-holding capital constant. Suppose the price of
the output equals 2ghs. The eighth worker hired
would then contribute 22ghs to the firm’s revenue.

Dr. Edward Asiedu Slide 24

 Labour Demand

Dr. Edward Asiedu Slide 25

 Topic Three

LABOUR DEMAND: HOW

MANY WORKERS SHOULD A
FIRM HIRE?
Dr. Edward Asiedu Slide 26
 Labour Demand
How Many Workers Should the Firm Hire?
• Firm's employment is at the point where the value of
marginal product of labour equals the wage rate and the
value of marginal produfct curve is downward sloping.
• VMPE = W ................... and VMPE is declining
• In other words, at the point where the firm maximizes
profits, the marginal gain from hiring an additional
worker equals the cost of that hire, and it does not pay
to further expand the firm because the value of hiring
more workers is falling.
Dr. Edward Asiedu Slide 27
 Labour Demand
• The intuition for this result is as follows: Suppose the
firm decides to hire only six workers. If the firm hired
the seventh worker, it would get more in additional
revenues than it would cost to hire that worker (the
value of marginal product of the seventh worker is
Ghc26 and the wage is only Ghc22).

• A profit-maximizing firm, therefore, will want to

expand and hire more labour. If the firm were to hire
more than eight workers, however, the value of
marginal product is lower than the cost of the hire.
Dr. Edward Asiedu Slide 28
 Labour Demand

Dr. Edward Asiedu Slide 29

 Labour Demand
• Note that the figure also indicates that the wage
would equal the value of marginal product if the firm
hired just one worker. At that point, however, the
value of marginal product curve is upward sloping.

• If the firm hired another worker, the second worker

hired would contribute even more to the firm's
revenue than the first worker.

Dr. Edward Asiedu Slide 30

 FINC 407
Labour Economics

Session 7 – Labour Demand

Lecturer: Dr. Edward Asiedu, UGBS

Contact Information: easiedu1@gmail.com

College of Education
Department of Distance Education
2017/2018
 Session Overview
By the end of this session students should be able to:

• Graph and explain the short run labour demand curve.

• Explain the properties of an isoquant.
• Draw an isocost and isoquant.
• Determine the long and short run profit maximizing
conditions of a firm.
• Explain the dynamics of equilibrium conditions in the
labour market.
Dr. Edward Asiedu Slide 2
 Session Outline
The key topic to be covered in the session is Labour
demand:

More specifically:
• The short run labour demand curve.
• Long run employment decision.
• Equilibrium in the labour market.

Dr. Edward Asiedu Slide 3

 Reading List
• Borjas, G. J. (2000). Labour economics (Vol. 2). New
York: McGraw-Hill.
• Ehrenberg, R. G., & Smith, R. S. (2016). Modern
labour economics: Theory and public policy.
Routledge.
• Kaufman, B.E. and J.L. Hotchkiss (2003). The
Economics of Labour Markets, 6th edition, Dryden
Press, Fort Worth

Dr Edward Asiedu Slide 4

 Topic One

LABOUR DEMAND: THE SHORT

RUN LABOUR DEMAND CURVE
FOR A FIRM
Dr. Edward Asiedu Slide 5
 Labour Demand

Dr. Edward Asiedu Slide 6

 Labour Demand

• The position of the labour demand curve depends

on the price of the output.

• Q1. What happens to the labour demand curve

when output becomes expensive?

Dr. Edward Asiedu Slide 7

 Labour Demand

Dr. Edward Asiedu Slide 8

 Labour Demand
• The short-run demand curve shifts up if the output
becomes more expensive.

• If the wage were 22ghs, the increase in output price raises

the firm's employment from 8 to 12 workers. Therefore,
there is a positive relationship between short-run
employment and output price.

• We use an elasticity to measure the responsiveness of

labour demand in the industry to changes in the wage rate.

Dr. Edward Asiedu Slide 9

 Labour Demand

Dr. Edward Asiedu Slide 10

 Topic Two

LABOUR DEMAND:
EMPLOYMENT DECISION IN
THE LONG RUN
Dr. Edward Asiedu Slide 11
 Labour Demand
Employment decision in the long-run
• In the long run, the firm's capital stock is not fixed. The
firm can expand or shrink its plant size and equipment.

• Therefore, in the long run the firm maximizes profits

by choosing both how many workers to hire and how
much plant and equipment to invest in.

• An isoquant describes the possible combinations of

labour and capital that produce the same level of output.

Dr. Edward Asiedu Slide 12

 Labour Demand

Slide 13
Dr. Edward Asiedu
 Labour Demand

• The isoquant, therefore, describes the production

function in exactly the same way that indifference
curves describe a worker's utility function.

Dr. Edward Asiedu Slide 14

 Labour Demand

Dr. Edward Asiedu Slide 15

 Labour Demand

Dr. Edward Asiedu Slide 16

 Labour Demand
• Isocosts

• The firm's costs of production, which we denote by C, are

given by;

• C = wE + rK

• The line connecting all the various combinations of labor and

capital that the rm could hire with a cost outlay of C cedis is
called an isocost line.

• Let's draw the isocost line.

Slide 17
 Labour Demand

Slide 18
Dr. Edward Asiedu
 Labour Demand

Dr. Edward Asiedu Slide 19

 Labour Demand

Dr. Edward Asiedu Slide 20

 Labour Demand

Slide 21
Dr. Edward Asiedu
 Labour Market Equilibrium
• Note that the figure also indicates that the wage
would equal the value of marginal product if the firm
hired just one worker. At that point, however, the
value of marginal product curve is upward sloping.
• If the firm hired another worker, the second worker
hired would contribute even more to the firm's
revenue than the first worker.

Dr. Edward Asiedu Slide 22

 Labour Demand

Slide 23

Dr. Edward Asiedu

 Labour Demand

Dr. Edward Asiedu Slide 24

 Labour Demand

Dr. Edward Asiedu Slide 25

 Labour Demand
• The elasticity of substitution gives the percentage
change in the capital-labor ratio resulting from a 1
percent change in the relative price of labor. As the
relative price of labor increases, the substitution effect
tells us that the capital-labor ratio increases (that is,
the firm gets rid of labor and replaces it with capital).

Dr. Edward Asiedu Slide 26

 Topic Thee

EQILIBRIUM IN THE LABOUR

MARKET

Dr. Edward Asiedu Slide 27

 Labour Market Equilibrium

Dr. Edward Asiedu Slide 28

 Labour Market Equilibrium

Dr. Edward Asiedu Slide 29

 FINC 407
Labour Economics

Session 8– Compensating wage differential and

Human Capital

Lecturer: Dr. Edward Asiedu, UGBS

Contact Information: easiedu1@gmail.com

College of Education
Department of Distance Education
2017/2018
 Session Overview
By the end of this session students should be able to:

• Explain the theory of compensating wage differential.

• The concept of human capital (finding the present
value of future income

Dr. Edward Asiedu Slide 2

 Session Outline
The key topics to be covered in the session are :
• Compensating wage differential.
• Human capital

Dr. Edward Asiedu Slide 3

 Reading List
• Borjas, G. J. (2000). Labour economics (Vol. 2). New
York: McGraw-Hill.
• Ehrenberg, R. G., & Smith, R. S. (2016). Modern
labour economics: Theory and public policy.
Routledge.
• Kaufman, B.E. and J.L. Hotchkiss (2003). The
Economics of Labour Markets, 6th edition, Dryden
Press, Fort Worth

Dr Edward Asiedu Slide 4

 Topic One

COMPENSATING WAGE
DIFFERENCIAL

Dr. Edward Asiedu Slide 5

 Compensating Wage Differential
• The model of competitive labour markets that we
developed in the last chapter implies that as long as
workers or firms can freely enter and exit the
marketplace, there will be a single wage in the
economy if all jobs are alike and all workers are alike.

• It is obviously the case that the labour market is not

characterized by a single wage: workers are different
and jobs are different. Workers differ in their skills.
And jobs differ in the amenities they offer.
Dr. Edward Asiedu Slide 6
 Compensating Wage Differential

• Firms that have unpleasant working conditions

must offer some offsetting advantage (such as a
higher wage) in order to attract workers; firms that
offer pleasant working conditions can get away
with paying lower wage rates.

Dr. Edward Asiedu Slide 7

 Compensating Wage Differential
• Compensating wage differentials arise to
compensate workers for the nonwage characteristics of
jobs.
• Workers differ in their preferences for job
characteristics, and firms differ in the working
conditions they offer.

Dr. Edward Asiedu Slide 8

 Compensating Wage Differential
• The Market for Risky Jobs

• Suppose there are only two types of jobs in the labour

market.
• Some jobs offer a completely safe environment, and
the probability of injury in these jobs is equal to zero.
• Other jobs offer an inherently risky environment, and
the probability of injury in those jobs is equal to one.

Dr. Edward Asiedu Slide 9

 Compensating Wage Differential
• We will assume that the worker has complete information
about the risk level associated with every job. In other
words, the worker knows whether she is employed in a
safe job or a risky job.

• Workers care about whether they work in a risky job or a

safe job. And they also care about the wage (w) they earn
on the job. We can then write the worker's utility function
as:

• Utility = f(w, risk of injury on the job)

Dr. Edward Asiedu Slide 10

 Compensating Wage Differential
• The marginal utility of income gives the change in
utility resulting from a Ghc1 increase in the worker's
income, holding constant the risk on the job.

• We assume that workers prefer higher wages so that the

marginal utility of income is positive.

• The marginal utility of risk gives the change in utility

resulting from a one-unit change in the probability of
injury, holding constant the worker's income.
Dr. Edward Asiedu Slide 11
 Compensating Wage Differential

• We assume initially that risk is a "bad" so that the

marginal utility of risk is negative.

• Suppose the "safe job" (that is, the job where workers do
not get injured) offers a wage rate of Wo cedis.

• Figure 6-1 illustrates the worker's indifference curve (Uo)

that goes through the point summarizing the "employment
package" offered by the safe job.
Slide 12
Dr. Edward Asiedu
 Compensating Wage Differential

• At point P the worker gets a wage of Wo and has a

zero probability of injury.

• The indifference curves that describe a worker's

choices between income and risk of injury are upward
sloping because risk is a “bad”.

• Suppose that the worker is currently at point P in the

indifference curve.

Dr. Edward Asiedu Slide 13

 Compensating Wage Differential

• The only way to persuade the worker to move to the riskier

job and hold her utility constant is by increasing her wage.

• She would obviously be worse o if she moved to a riskier

job and her wage fell.

• The curvature of the indifference curve reflects the usual

assumption that indifference curves are convex.

Dr. Edward Asiedu Slide 14

 Compensating Wage Differential

Dr. Edward Asiedu Slide 15

Compensating Wage Differential

Slide 16
 Compensating Wage Differential
• We defend the worker's reservation price as the
amount of money it would take to bribe her into the
accepting the risky job - - - or the difference Dw^ =
w^1- w0. If the worker’s income were to increase by
D^ w dollars as she switched from the safe job to the
risky job, she would be indifferent about being
exposed to the additional risk. The reservation price ,
therefore, is the worker’s answer to the old-age
question, “How much would it take for you to do
something that you would rather not do?”

Slide 17
Dr. Edward Asiedu
 Compensating Wage Differential

• We define the worker's reservation price as the

amount of money it would take to bribe her into
accepting the risky job--or the difference aw = WI -
wo0. If the worker's income were to increase by aw
dollars as she switched from the safe job to the
risky job, she would be indifferent about being
exposed to the additional risk.
• The reservation price, therefore, is the worker's
answer to the age-old question, "How much would
it take for you to do something that you would
rather not do?"
Dr. Edward Asiedu Slide 18
 Topic Two

HUMAN CAPITAL

Dr. Edward Asiedu Slide 19

 Human Capital
• The theory of compensating differentials suggests that
wages will vary among workers because jobs are different.

• Wages will also vary among workers because workers are

different.

• We each bring into the labor market a unique set of

abilities and acquired skills, or human capital. For
instance, some persons learn how to be research biologists
while other persons lea how to be musicians.

Dr. Edward Asiedu Slide 20

 Human Capital
• Under this chapter we will discuss how we choose the
particular set of skills that we offer to employers and
how our choices affect the evolution of earnings over
the working life.

• We acquire most of our human capital in school and

in formal and informal on the-job training programs.

• The skills we acquire in school make up an

increasingly important component of our stock of
knowledge. Slide 21
Dr. Edward Asiedu
 Human Capital

• This chapter analyzes why some workers obtain a lot of

schooling and other workers drop out at an early age.

• Workers who invest in schooling are willing to give up

earnings today in return for higher earnings in the future.

• For example, we earn a relatively low wage while we

attend college or participate in a formal apprenticeship
program.

Slide 22

Dr. Edward Asiedu

 Human Capital
• However, we expect to be rewarded by higher
earnings later on as we collect the returns to our
investment.

• We will also discuss if the money spent on education

is a good investment.

• In particular, how does the rate of return to schooling

compare with the rate of return on other investments?

Dr. Edward Asiedu Slide 23

 Human Capital
Present Value

• Any study of an investment decision-whether it is an

investment in physical or in human capital-must
contrast expenditures and receipts incurred at
different time periods.

• In other words, an investor must be able to calculate

the returns to the investment by comparing the
current costs with the future returns.
Dr. Edward Asiedu Slide 24
 Human Capital
• For reasons that will become obvious momentarily,
however, the value of a dollar received today is not quite
the same as the value of a dollar received tomorrow.

• The widely used notion of present value allows us to

compare cedis amounts spent and received in different
time periods.

• Suppose somebody gives you a choice between two

monetary offers: You can either have 100ghs today or
100ghs next year. Which offer would you take?

Dr. Edward Asiedu Slide 25

 Human Capital
• A little reflection should convince you that 100ghs
today is better than 100ghs next year.

• After all, if you receive 100ghs today, you can invest

it, and you will then have 100 X (1 + 0.05) Ghc next
year (or Ghc105), assuming that the rate of interest is
5%.

• Note, that receiving 95.24ghs today (or 100Ghc

/1.05) would be worth 100Ghc next year.

Dr. Edward Asiedu Slide 26

 Human Capital

Dr. Edward Asiedu Slide 27

 Human Capital

• In effect, a future payment of y Ghana cedi is

discounted so as to make it comparable to current
cedis.

• The discussion clearly suggests that receiving y Ghc2

years from now is not equivalent to receiving y Ghc
today or even to receiving y Ghc next year.

Dr. Edward Asiedu Slide 28

 Human Capital

Dr. Edward Asiedu Slide 29

 FINC 407
Labour Economics

Session 9– Human Capital and Labour Mobility

Lecturer: Dr. Edward Asiedu, UGBS

Contact Information: easiedu1@gmail.com

College of Education
Department of Distance Education
2017/2018
 Session Overview

By the end of this session students should be able to:

• Understand the schooling model.

• Understand the wage gap among workers with
different level of education.
• Understand the stopping rule of education.
• Examine the migration decision of family.

Dr. Edward Asiedu Slide 2

 Session Outline

The key topics to be covered in the session are :

• Human capital (Schooling model)

• Labour mobility

Dr. Edward Asiedu Slide 3

 Reading List
• Borjas, G. J. (2000). Labour economics (Vol. 2). New
York: McGraw-Hill.
• Ehrenberg, R. G., & Smith, R. S. (2016). Modern
labour economics: Theory and public policy.
Routledge.
• Kaufman, B.E. and J.L. Hotchkiss (2003). The
Economics of Labour Markets, 6th edition, Dryden
Press, Fort Worth

Dr Edward Asiedu Slide 4

 Topic One

HUMAN CAPITAL: THE

SCHOOLING MODEL

Dr. Edward Asiedu Slide 5

 Human Capital – The Schooling Model

• What factors motivate some workers to remain in

school while other workers drop out before they finish
high school?
• We begin our analysis of this important question by
assuming that workers acquire the skill level that
maximizes the present value of lifetime earnings.

Dr. Edward Asiedu Slide 6

 Human Capital – The Schooling Model

• Consider the situation faced by an 18-year-old female

who has just received his high school cert and who is
contemplating whether to enter the labor market or
attend college and delay labour market entry by an
additional 4 years?

• Suppose that there is no on-the-job training and that

the skills learned in school do not depreciate over
time.
Dr. Edward Asiedu Slide 7
 Human Capital – The Schooling Model

• These assumptions imply that the worker's

productivity does not change once he leaves school,
so that real earnings (that is, earnings after
adjusting for inflation) are constant over the life
cycle

Dr. Edward Asiedu Slide 8

 Human Capital – The Schooling Model

Dr. Edward Asiedu Slide 9

 Human Capital – The Schooling Model

Dr. Edward Asiedu Slide 10

 Human Capital – The Schooling Model

• The student also has to pay for tuition, books, and a

variety of other fees.

• Because college has no intrinsic value to the

student, employers who wish to attract a highly
educated (and presumably more productive)
workforce will have to offer higher wages, so that
Wcol> WHS.

Dr. Edward Asiedu Slide 11

 Human Capital – The Schooling Model

• In a sense, the high wage paid to workers with

more schooling is a compensating differential that
compensates workers for their training costs.

Dr. Edward Asiedu Slide 12

 Human Capital – The Schooling Model

• If university graduates earned less than high school

graduates, no one would get a university education
because we are assuming that workers do not get any
other benefits from attending college.

• Present Value of Age-Earnings Profiles.

Slide 13
Dr. Edward Asiedu
 Human Capital – The Schooling Model

Slide 14
Dr. Edward Asiedu
 Human Capital – The Schooling Model

• Where r gives the worker's rate of discount. There are

47 terms in the sum, one term for each year that
elapses between the ages of 18 and 64.

• The present value of the earnings stream if the worker

gets a college diploma is:

Dr. Edward Asiedu Slide 15

 Human Capital – The Schooling Model

Dr. Edward Asiedu Slide 16

 Human Capital – The Schooling Model

• The first four terms in this sum give the present value
of the direct costs of a college education, whereas the
remaining 43 terms give the present value of lifetime
earnings in the post-college period.

• We assume that a person's schooling decision

maximizes the present value of life time earnings.

Dr. Edward Asiedu Slide 17

Human Capital – The Schooling Model

Slide 18
 Human Capital – Wage Schooling
Locus
• The simple rule that a person should choose the level
of schooling that maximizes the present value of
earnings obviously generalizes to situations when
there are more than two schooling options.

• The person would then calculate the present value

associated with each schooling option (for example, 1
year of schooling, 2 years of schooling, and so on),
and choose the amount of schooling that maximizes
the present value of the earnings stream.

Slide 19
Dr. Edward Asiedu
 Human Capital – Wage Schooling
Locus
• There is, however, a different way of formulating
this problem that provides an intuitive "stopping
rule.
• This stopping rule tells the individual when it is
optimal to quit school and enter the labor market.
• Figure 7-2 illustrates the wage-schooling locus,
which gives the salary that employers are willing to
pay a particular worker for every level of schooling.

Dr. Edward Asiedu Slide 20

 Human Capital – Wage Schooling
Locus

• The salary for each level of schooling is determined

by the intersection of the supply of workers with that
particular schooling and the demand for those
workers. From the worker's point of view, the salary
associated with each level of schooling is a constant

Dr. Edward Asiedu Slide 21

 Human Capital – Wage Schooling
Locus

Slide 22
Dr. Edward Asiedu
 Human Capital – Wage Schooling
Locus
• The person would then calculate the present value
associated with each schooling option (for example, 1
year of schooling, 2 years of schooling, and so on),
and choose the amount of schooling that maximizes
the present value of the earnings stream.
• There is, however, a different way of formulating this
problem that provides an intuitive "stopping rule.
This stopping rule tells the individual when it is
optimal to quit school and enter the labor market.

Dr. Edward Asiedu Slide 23

 Human Capital – Wage Schooling
Locus
• Because the wage-schooling locus is concave, the
marginal rate of return to schooling must decline as a
person gets more schooling.
• The Marginal Rate Return (MRR) to schooling
schedule gives the percentage change in annual
earnings resulting from each additional year of
school..

Dr. Edward Asiedu Slide 24

 Human Capital – Wage Schooling
Locus

Dr. Edward Asiedu Slide 25

 Human Capital - Stopping Rule
• Stopping rule
• In other words, the stopping rule that tells the worker
when he should quit school is given by:
• Stop schooling when the marginal rate of returns to
schooling = r

Dr. Edward Asiedu Slide 26

 Human Capital - The Wage Gap among
Workers who Differ in Education
• The schooling model summarized tells us how a
particular worker decides how much schooling to
acquire, and as a result also tells us how a worker
places in the income distribution in the post school
period.
• Workers who get more schooling ear more (although
they also give up more).
• The model isolates two factors that lead different
workers to obtain different levels of schooling and
hence to have different earnings.

Dr. Edward Asiedu Slide 27

 Human Capital - The Wage Gap among
Workers who Differ in Education
• Workers either have different rates of discount or they
face different marginal rate of return schedules
• Consider a labor market with two workers who differ
only in their discount rates, as illustrated in Figure 7-
4a.
• AI's discount rate is rAL and Bo's lower discount rate
is rB0.
• The figure shows that Al (who has a higher discount
rate) drops out of high school and gets only 11 yeas
of education: Bo gets a high school diploma.
Dr. Edward Asiedu Slide 28
 Human Capital - The Wage Gap among
Workers who Differ in Education

• As we saw earlier, workers who discount future

earnings heavily do not go to school because they are
"present oriented”.

Dr. Edward Asiedu Slide 29

 Human Capital - The Wage Gap among
Workers who Differ in Education

Dr. Edward Asiedu Slide 30

 Human Capital – Differences in Ability
• It is often assumed that higher ability levels shift the
marginal rate of return schedule to the right, so that
the earnings gain resulting from an additional year of
schooling outweighs the increase in forgone earnings.
• In other words, a more able person gets more from an
additional year of schooling.
• As illustrated in Figure 7-5a, Bob's MRR schedule
lies to the right of Ace's. Because both Bob and Ace
have the same rate of discount and because Bob gets
more from an additional year of schooling.

Dr. Edward Asiedu Slide 31

 Human Capital – Differences in Ability
• Bob gets more schooling (12 years versus 1 1 years).

Dr. Edward Asiedu Slide 32

 Human Capital – Estimating the Rate
of Return to Schooling
• As suggested by the discussion in the previous
section, the typical method for estimating the rate of
return to schooling uses data on the earnings and
schooling of different workers and estimates the
percentage wage differential associated with one
more year of schooling-after adjusting the data for
differences in other worker characteristics, such as
age, sex etc.
• The typical study estimates a regression of the form:

Dr. Edward Asiedu Slide 33

 Human Capital – Estimating the Rate
of Return to Schooling
• Log = αs + other variables

• Where w gives the worker's wage and s gives the

number of years of schooling acquired by this worker.
The α gives the percent wage differential between
two workers who differ by 1 year schooling (holding
other variables constant), and is typically interpreted
as the rate of return to schooling.

Dr. Edward Asiedu Slide 34

 Topic Two

LABOUR MOBILITY

Dr. Edward Asiedu Slide 35

 Labour Mobility
• A competitive labor market equilibrium allocates
workers to firms so as to maximize the total value of
labor's product. Workers are continually searching for
better jobs (that is, jobs where they are more
productive and earn higher wages), and firms are
searching for better workers.

• This chapter describes the mechanism that labor

markets use to improve the allocation of workers to
firms, namely labor mobility.

Dr. Edward Asiedu Slide 36

 Labour Mobility
• Like all other human capital investments, mobility
decisions are guided by the comparison of the present
value of lifetime earnings in the alterative
employment opportunities.

• Let PV (NY) be the present value of the earnings

stream if the person stays in Kumasi. This quantity is
given by:

Dr. Edward Asiedu Slide 37

 Labour Mobility

• Similarly, the present value of the earing stream if the

person moves to California is given by:

Dr. Edward Asiedu Slide 38

 Labour Mobility
• The worker moves if the net gain is positive.

A number of empirically testable propositions follow

immediately from this framework:

• An improvement in the economic opportunities available

in the destination increases the net gains to migration and
raises the likelihood that the worker moves.

• An improvement in the economic opportunities at the

current region of residence decreases the net gains to
migration, and lowers the probability that the worker
moves.
Dr. Edward Asiedu Slide 39
 Labour Mobility

• An increase in migration costs lowers the net gains to

migration and reduces the likelihood of a move.
• All these implications deliver the same basic
message: Migration occurs when there is a good
chance that the worker will recoup his human capital
investment.

Dr. Edward Asiedu Slide 40

 Labour Mobility – Family Migration
• Thus far, our discussion of geographic migration
focuses on the behavior of a single worker as he or
she compares employment opportunities across
regions and chooses the one location that
maximizes the present value of lifetime earnings.

• However, most migration decisions are not made by

single workers, but by families.

Dr. Edward Asiedu Slide 41

 Labour Mobility – Family Migration

• The migration decision, therefore, should not be

based on whether a particular member of the house
hold is better off at the destination than at the origin,
but on whether the family as a whole is better off.

Dr. Edward Asiedu Slide 42

 Labour Mobility – Family Migration
• The impact of the family on the migration decision
can be easily described.

• Suppose that the household is composed of two

persons, a husband and a wife.

Dr. Edward Asiedu Slide 43

 Labour Mobility – Family Migration

• Let's denote by tPVH the change in the present value

of the husband's earnings stream if he were to move
geographically (say from Kumasi to California).

• And let tPVw be the change in the present value of

the wife’s earnings stream if she were to make the
same move.

Dr. Edward Asiedu Slide 44

 Labour Mobility – Family Migration
• Note that change in PVH can also be interpreted as the
husband's gains to migration if he were single and were
making the migration decision completely on his own.

• These gains are called the husband's "private" gains to

migration. If the husband were not tied down by his
family responsibilities, he would migrate if the private
gains in change in PVH were positive.

• Similarly, the quantity change in PVw gives the wife's

private gains to migration.
Dr. Edward Asiedu Slide 45
 Labour Mobility – Family Migration

Dr. Edward Asiedu Slide 46

 FINC 407
Labour Economics

Session 10– Labour Market Discrimination

Lecturer: Dr. Edward Asiedu, UGBS

Contact Information: easiedu1@gmail.com

College of Education
Department of Distance Education
2017/2018
 Session Overview
By the end of this session students should be able to:

• Understand the actions of some employers in the labour

market.
• Understand the reason why employers will employ a particular
group of workers.
• Understand and examine the impact of employee
discrimination on a firm’s profit.
• U n d e r s t a n d a n d e x a m i n e t h e i m p a c t o f e m p l o y e r ’s
discrimination on a firm’s profit.

Dr. Edward Asiedu Slide 2

 Session Outline
The key topic to be covered in the session Labour market
discrimination

More specifically:
• The Discrimination Coefficient.
• Employer discrimination.
• Employee discrimination.
• Statistical discrimination.

Dr. Edward Asiedu Slide 3

 Reading List
• Borjas, G. J. (2000). Labour economics (Vol. 2). New
York: McGraw-Hill.
• Ehrenberg, R. G., & Smith, R. S. (2016). Modern
labour economics: Theory and public policy.
Routledge.
• Kaufman, B.E. and J.L. Hotchkiss (2003). The
Economics of Labour Markets, 6th edition, Dryden
Press, Fort Worth

Dr Edward Asiedu Slide 4

 Topic One

LABOUR MARKET
DISCRIMINATION

Dr. Edward Asiedu Slide 5

 Labour Market Discrimination
• In previous chapters we analyzed how differences in
the characteristics of jobs or the skills of workers
generate wage dispersion in competitive markets.

• We will now demonstrate that differences in earnings

and employment opportunities may arise even among
equally skilled workers employed in the same job
simply because of the workers' race, gender, national
origin, sexual orientation, or other seemingly
irrelevant characteristics.
Dr. Edward Asiedu Slide 6
 Labour Market Discrimination –
Race and Gender in the Labour Market

• We o f t e n " r e a d " a p e r s o n ' s s o c i o e c o n o m i c

background to learn more about that person's
productivity and skills.

• For instance, we all know that teenagers are more

likely to engage in reckless driving.

Dr. Edward Asiedu Slide 7

 Labour Market Discrimination –
Race and Gender in the Labour Market

• This information is useful to a stranded motorist who

has been offered a ride from a teenage driver.

• Similarly, employers, workers, and customers will use

race, gender, and any other relevant traits to fill in
information gaps about participants in the market
place.

Dr. Edward Asiedu Slide 8

 Labour Market Discrimination – Race
and Gender in the Labour Market

• In the US, the data shows that men earn more than
women, and whites earn more than non-whites. In
particular, white men have the highest annual
earnings of any of the groups (GHC36,942).

• In contrast, white women earn only GHC21,208,

black men ear GHC24,510, and Hispanic women earn
GHC16,459.

Dr. Edward Asiedu Slide 9

 Labour Market Discrimination – Race
and Gender in the Labour Market

• This differences in annual earnings arise partly because of

differences in educational attainment. Only about 17
percent of white men do not have a high school diploma,
as compared to about a quarter of black men and 45
percent of Hispanic men.

• Similarly, 27 percent of white men are college graduates,

as compared to 22 percent of white women, 13 percent of
black men, and 11 percent of Hispanic men.

Dr. Edward Asiedu Slide 10

 Labour Market Discrimination – Race
and Gender in the Labour Market
• Gender gaps in wages also do matter for Ghana and other
developing countries.

• Using data from the fourth round (1998/99) of the Ghana

Living Standards Sur vey (GLSS 4) covering 5, 998
households

• . . . . Heintz and Slonimczyk (2007), Beyond dualism:

Multisegmented labor markets in Ghana, Economics
Department Working paper series, University of
Massachusetts - Amherst

Dr. Edward Asiedu Slide 11

 Labour Market Discrimination – Race
and Gender in the Labour Market

Slide 12
Dr. Edward Asiedu
 Labour Market Discrimination –
Discrimination Coefficient

Dr. Edward Asiedu Slide 13

 Labour Market Discrimination –
Discrimination Coefficient

Dr. Edward Asiedu Slide 14

 Labour Market Discrimination –
Discrimination Coefficient
• The employer will then act as if hiring a black worker
costs GHC15 per hour, a 50 percent increase in the
cost of black labour.

• The discrimination coefficient d, therefore, gives the

percentage "markup" in the cost of hiring a black
worker attributable to the employer's prejudice.

• This also applied to gender, ethnic and other

prejudice.

Dr. Edward Asiedu Slide 15

 Labour Market Discrimination –
Discrimination Coefficient

Dr. Edward Asiedu

Slide 16
 Labour Market Discrimination –
Discrimination Coefficient

• If these black employers prefer to hire black workers,

they will act as if hiring a black worker cheaper than
it actually is. This is also applicable to ethnicity and
other types of in-group favoritism.

Slide 17
Dr. Edward Asiedu
 Labour Market Discrimination –
Employer Discrimination

Dr. Edward Asiedu Slide 18

 Labour Market Discrimination –
Employer Discrimination

Dr. Edward Asiedu Slide 19

 Labour Market Discrimination –
Employer Discrimination

Slide 20
Dr. Edward Asiedu
 Labour Market Discrimination –
Employer Discrimination

Slide 21

Dr. Edward Asiedu

 Labour Market Discrimination –
Employer Discrimination

Dr. Edward Asiedu Slide 22

 Labour Market Discrimination –
Employer Discrimination

Dr. Edward Asiedu Slide 23

 Labour Market Discrimination –
Employment in a Discriminatory Firm

Dr. Edward Asiedu Slide 24

 Labour Market Discrimination –
Employment in a Discriminatory Firm

• There are, therefore, two types of firms: those that

hire an all-white workforce, which for convenience
we will call "white firms," and those that hire an all-
black workforce, or "black firms."

• The race/gender of the firm's workforce depends on

the magnitude of the employer's race/gender
discrimination coefficient

Dr. Edward Asiedu Slide 25

 Labour Market Discrimination –
Employer Discrimination

Dr. Edward Asiedu Slide 26

 Labour Market Discrimination
–Discrimination and Profit

• The fundamental implication of the model:

Discrimination does not pay.

• To see why, consider first the profitability of white

firms. These firms are hiring E; workers.

Dr. Edward Asiedu Slide 27

 Labour Market Discrimination
–Discrimination and Profit

• This hiring decision is unprofitable in two distinct

ways. First, the prejudiced employer could have hired
the same number of black workers at a lower wage.

• In other words, because black and white workers are

perfect substitutes, white firms could have produced
the same output at a lower cost.

Dr. Edward Asiedu Slide 28

 Labour Market Discrimination
–Discrimination and Profit

• In addition, white firms are hiring the wrong number

of workers; a color-blind firm would hire many more
workers (E;).
• By not hiring the right number of workers, white
firms further reduce their profits. This argument also
implies that even black firms that discriminate are
giving up profit.
• This is true also for other forms of discrimination.

Dr. Edward Asiedu Slide 29

 Labour Market Discrimination
–Discrimination and Profit

Dr. Edward Asiedu Slide 30

 Labour Market Discrimination
–Discrimination and Profit

• Because free entry and exit of firms ensure that firms

in the market are not earning excess profits,
employers must pay for the right to discriminate out
of their own pocket.

• A color-blind firm, therefore, should eventually be

able to buy out all the other firms in the industry. As a
result, employer discrimination will "wither away" in
competitive markets.

Dr. Edward Asiedu Slide 31

 Labour Market Discrimination –
Employee Discrimination

• The source of discrimination in the labor market need

not be the employer, but might instead be from fellow
workers.

• Suppose that whites dislike working alongside blacks

and that blacks are indifferent about the race of their
coworkers.

Dr. Edward Asiedu Slide 32

 Labour Market Discrimination –
Employee Discrimination

Dr. Edward Asiedu Slide 33

 Labour Market Discrimination –
Employee Discrimination

Dr. Edward Asiedu Slide 34

 Labour Market Discrimination –
Employee Discrimination

• Suppose a white worker who dislikes working

alongside blacks has two job offers.

• Both employers offer the same wage of, say, GHC15

per hour, but working conditions vary in the two
firms.

Dr. Edward Asiedu Slide 35

 Labour Market Discrimination –
Employee Discrimination
• In particular, one firm has a completely white
workforce and the other firm has an integrated
workforce, consisting of black and white workers.
• Because the worker dislikes blacks, the two firms are
not offering equivalent utility-adjusted wages. In the
worker's view, the integrated firm offers a lower wage.
Therefore, integrated firms will have to offer more
than GHC15 per hour if they wish to attract white
workers.

Dr. Edward Asiedu Slide 36

 Labour Market Discrimination –
Employee Discrimination
• Color-blind employers hire whichever labour is
cheaper. If blacks are cheaper, employers increase
their demand for black labor and decrease their
demand for white labor
• Note that employee discrimination does not affect the
profitability of firms.

Dr. Edward Asiedu Slide 37

 Labour Market Discrimination –
Employee Discrimination
• Because all firms pay the same price for an hour of
labour and because black and white workers are
perfect substitutes, there is no advantage to being
either a black or a white firm.
• There are no market forces, therefore, that will tend to
diminish the importance of employee discrimination
over time.

Dr. Edward Asiedu Slide 38

 Labour Market Discrimination –
Statistical Discrimination
• Suppose that a color-blind profit-maximizing
employer has a job opening. The employer wants to
add a worker to a finely tuned team that will develop
a revolutionary word processing program in the next
few years.

• The employer is looking for a worker who, in

addition to the usual requisites of intelligence and
ambition, can be counted on to be a team member
over the long haul.

Dr. Edward Asiedu Slide 39

 Labour Market Discrimination –
Statistical Discrimination
• Two persons apply for the job. The resumes of the
two job applicants are identical; both just graduated
from the same college, majored in the same field,
enrolled in the same courses, and had similar class
rankings.

• Moreover, both applicants passed the interview with

flying colors. The employer found them to be bright,
motivated, knowledgeable, and articulate.

Dr. Edward Asiedu Slide 40

 Labour Market Discrimination –
Statistical Discrimination
• It just happens, however, that one of the applicants is a
man and the other is a woman.

• To make an informed decision (rather than just toss a

coin), the employer will evaluate the employment
histories of similarly skilled men and women that this
firm or other firms-hired in the past.

• Suppose that this review of the statistical record reveals

that many women leave the firm when they reach their
mid-to late-twenties (perhaps to engage in child rearing).

Dr. Edward Asiedu Slide 41

 Labour Market Discrimination –
Statistical Discrimination
• The employer has no way of knowing if the female job
applicant under consideration intends to leave the labor
force eventually.

• Nevertheless, the employer infers from the statistical data

that the woman has a higher probability of quitting her
job prior to the completion of the program.

• Because a quit would disrupt the team's work and

substantially increase the costs of development, the profit-
maximizing employer offers the job to the man.

Dr. Edward Asiedu Slide 42

 FINC 407
Labour Economics

Session 11– Labour Union

Lecturer: Dr. Edward Asiedu, UGBS

Contact Information: easiedu1@gmail.com

College of Education
Department of Distance Education
2017/2018
 Session Overview
By the end of this session students should be able to:

• Reasons why trade unions are on a decline over the years.

• Reasons that will make a union flourish.
• When a worker will either support or oppose a union.
• Determinants of union membership.

Dr. Edward Asiedu Slide 2

 Session Outline
The key topic to be covered in the session is Labour
Union.

More specifically:
• Labour Union
• Unemployment

Dr. Edward Asiedu Slide 3

 Reading List
• Borjas, G. J. (2000). Labour economics (Vol. 2). New
York: McGraw-Hill.
• Ehrenberg, R. G., & Smith, R. S. (2016). Modern
labour economics: Theory and public policy.
Routledge.
• Kaufman, B.E. and J.L. Hotchkiss (2003). The
Economics of Labour Markets, 6th edition, Dryden
Press, Fort Worth

Dr Edward Asiedu Slide 4

 Topic One

LABOUR UNION

Dr. Edward Asiedu Slide 5

 Labour Union
• Up to this point, our study of the labor market has
ignored the institution of labor unions. The omission
of labor unions from the analysis may seem quite
surprising.

• After all, supporters of the union movement often

argue that labor unions, as the sole institution
representing workers’ interests in the labor market,
are mainly responsible for the improvement in
working conditions.
Dr. Edward Asiedu Slide 6
 Labour Unions

• This chapter argues that unions, like workers

attempting to maximize utility and firms attempting
to maximize profits, choose among various options
in order to maximize the well-being of their
members.

• It has long been recognized that unions can arise

and prosper only under certain conditions.

Dr. Edward Asiedu Slide 7

 Labour Unions
• Because the free entry and exit of firms into the marketplace
reduce profits to a normal return on investment (that is, zero
excess profits), unions can flourish only when firms earn
above-normal profits, or what economists call "rents.“

• In effect, unions provide an institutional mechanism through

which employers share the rents with workers.

• This chapter investigates how unions influence the terms of the

employment relationship between workers and firms.

Dr. Edward Asiedu Slide 8

 Labour Unions
• The right to form or join a trade union is a fundamental
workers' right and is at the core of trade unionism. It is
central to the exercise of workers' rights and freedoms
(Baahet al, 2009).

• Article 21(e) of the 1992 Constitution of Ghana,

guarantees freedom of association, which shall include
freedom to form or join trade unions or other associations,
national and international, for the protection of their
interest.

Dr. Edward Asiedu Slide 9

 Labour Unions
• Article 24(3) of the constitution provides that every
worker has a right to form or join a trade union of his
choice for the promotion and protection of his
economic and social interests.
• Despite the legal guarantees, trade union membership
around the world is declining

Dr. Edward Asiedu Slide 10

 Labour Unions

Dr. Edward Asiedu Slide 11

 Topic Two

TRADE UNION MEMBERSHIP

IN GHANA

Dr. Edward Asiedu Slide 12

 Trade Union Membership in Ghana
• Despite the legal guarantees, trade union membership
around the world is declining.

• The GLSS V data reveals that only 37.5 percent of

the working age population who had a job during the
reference period indicated that they have trade unions
at their workplaces.

Slide 13
Dr. Edward Asiedu
 Trade Union Membership in Ghana

• More males (39.5%) than females (34.4%) are

working in organizations where trade unions exist
(see Table 1 below).The data confirm the declining
trend of unionization in Ghana.

Slide 14
Dr. Edward Asiedu
 Trade Union Membership in Ghana

• The GLSS IV (1998/99) data showed that

approximately 50 percent of formal sector workers
were working in unionized enterprises compared to
about 38 percent in 2005/06.

Dr. Edward Asiedu Slide 15

 Trade Union Membership in Ghana
• The Competitive firms choose whichever system
yields the highest profits.
• Firms that have very high monitoring costs will not
be able to offer piece-rate systems.
• Firms facing very high monitoring costs, therefore,
opt for time rates, and firms facing low monitoring
costs choose piece rates.

Dr. Edward Asiedu Slide 16

 Trade Union Membership in Ghana
• Unionization rate is relatively high the utilities (75%)
and mining and quarrying industries (64.8%).
• The existence of trade unions at the workplace is
lowest in the trade and commerce (11.1%) and
construction (6.6%) sectors (see Table 20).

Dr. Edward Asiedu Slide 17

 Topic Three

DETERMINATES OF TRADE
UNION MEMBERSHIP

Dr. Edward Asiedu Slide 18

 Determinants of Trade Union
Membership
Determinants of trade union membership
• Workers choose whether to join a union. A worker
joins if the union offers him a wage-employment
package that provides more utility than the wage-
employment package offered by a non-union
employer.

• To see the worker's trade-off in this decision,

consider the familiar model of labour-leisure
choice illustrated in Figure 1 1-3.
Dr. Edward Asiedu
Slide 19
 Determinants of Trade Union
Membership
• Suppose that the person is initially working at a non-
union firm offering the competitive wage w*. At this
wage rate, the worker's budget line is given by AT.

• A worker maximizes utility by choosing the consumption-

leisure bundle where the indifference curve U is tangent
to the budget line (or point P).

• The firm is targeted by union organizers, and these

organizers promise that a vote for the union will lead to a
new and improved employment contract.

Slide 20
Dr. Edward Asiedu
 Determinants of Trade Union
Membership
• In particular, the union promises a wage increase to
Wu dollars. The worker's budget line, therefore, shifts
to BT.
• The worker knows that there is no free lunch. The
wage increase comes at a cost, and the cost may be a
cutback in employment.

Dr. Edward Asiedu Slide 21

 Determinants of Trade Union
Membership

Dr. Edward Asiedu Slide 22

 Determinants of Trade Union
Membership

Slide 23
Dr. Edward Asiedu
 Trade Union Membership in Ghana

Slide 24

Dr. Edward Asiedu

 Topic Four

THE DEMEND FOR, AND

SUPPLY OF UNION JOBS

Dr. Edward Asiedu Slide 25

 Demand for, and Supply of Union Jobs
• In general, workers are more likely to support
unionization when the union organizer can promise a
higher wage and a smaller employment loss.

• Moreover, because there are additional costs to

joining a union (such as union dues), the worker will
be more likely to support unions when these costs are
small.

• These factors generate the "demand" for union jobs.

Dr. Edward Asiedu Slide 26

 Demand for, and Supply of Union Jobs
• The demand for union jobs is not the sole determinant
of the extent of unionization in the labor market.

• The ability of union organizers to deliver union jobs

depends on the costs of organizing the workforce, on
the legal environment that permits certain types of
union activities and prohibits others, on the resistance
of management to the introduction of collective
bargaining, and on whether the firm is making excess
rents that can be captured by the union membership.
Dr. Edward Asiedu Slide 27
 Demand for, and Supply of Union Jobs
• These forces, in effect, determine the "supply" of
union jobs.

Dr. Edward Asiedu Slide 28

 Demand for, and Supply of Union Jobs
Why has union membership decline around the
world

• Tactics by management ring union leaders,

influencing union elections and union management.
• Influence from national politics.
• Structural changes in the economy increase in part-
time jobs, self-employment etc.

Dr. Edward Asiedu Slide 29

 FINC 407
Labour Economics

Session 12– Incentive Pay and Unemployment

Lecturer: Dr. Edward Asiedu, UGBS

Contact Information: easiedu1@gmail.com

College of Education
Department of Distance Education
2017/2018
 Session Overview
• By the end of this session students should be able to:
• Understand and differentiate between piece rate and
time rate system of compensation.
• Understand why a firm will either use a piece rate or
time rate system of compensation.
• Understand the disadvantages of piece rate system of
compensation.
• Understand the different types of unemployment.

Dr. Edward Asiedu Slide 2

 Session Outline
The key topics to be covered in the session are :

• Incentive pay
• Unemployment

Dr. Edward Asiedu Slide 3

 Reading List
• Borjas, G. J. (2000). Labour economics (Vol. 2). New
York: McGraw-Hill.
• Ehrenberg, R. G., & Smith, R. S. (2016). Modern
labour economics: Theory and public policy.
Routledge.
• Kaufman, B.E. and J.L. Hotchkiss (2003). The
Economics of Labour Markets, 6th edition, Dryden
Press, Fort Worth

Dr Edward Asiedu Slide 4

 Topic One

INCENTIVE PAY

Dr. Edward Asiedu Slide 5

 Incentive Pay
• There are, in fact, a wide range of compensation
systems used in labor markets, with piece rates and
time rates being the two popular compensation
systems.

• This chapter analyzes why various methods of

compensation arise in labour markets and how the
nature of the compensation package affects the
worker's productivity and the firm's profits.

Dr. Edward Asiedu Slide 6

 Incentive Pay
• Piece-rate sy stem comp en sates the wo rk er
according to some measure of the worker's output.

• For example, garment workers might be paid on the

basis of how many pairs of shirts they produce;
salespersons are often paid a commission based on
the volume of sales.

Can you think about examples of jobs that uses a

piece-rate system?
Dr. Edward Asiedu Slide 7
 Incentive Pay
• In contrast, the compensation of time-rate workers
depends only on the number of hours the worker allocates
to the job and has nothing to do with the number of units
the worker produces, at least in the short run.

• Over the long run, of course, the firm will make decisions
on retention and promotion based on the worker's
performance record.

• For simplicity, we assume that the weekly earnings of

time-rate workers depend only on hours worked, and do
not depend on the worker's performance.
Dr. Edward Asiedu Slide 8
 Topic Two

SHOULD A FIRM OFFER

PIECE RATE OR TIME RATE?

Dr. Edward Asiedu Slide 9

 Should a Firm offer Piece Rates or
Time rates?
• Consider a firm deciding whether to offer piece rates
or time rates.
• If the firm offers a piece rate, the worker's wage
should equal exactly her value of marginal product.

Dr. Edward Asiedu Slide 10

 Should a Firm offer Piece Rates or
Time rates?
• If the firm offers the piece-rate worker a wage
lower than her value of marginal product, the
worker will find another firm that is willing to pay
a higher wage and move there.

• However, in many cases although the worker may

know precisely how much she has produced, firm
may be much less certain about the worker's
productivity.

Dr. Edward Asiedu Slide 11

 Should a Firm offer Piece Rates or
Time rates?
• In other words, if the firm wishes to pay the worker
by the piece, the firm will have to monitor the worker
constantly.
• These resources could have been used by the firm in
other ways, such as buying additional capital for the
production line. As a result, the firm that monitors
workers incurs "monitoring costs."

Slide 12
Dr. Edward Asiedu
 Should a Firm offer Piece Rates or
Time rates?
• These costs will typically vary from firm to firm,
depending on how easy or how hard it is to monitor
workers in a particular environment, and could be
substantial for some firms.

• Alternatively, the firm can choose a time-rate system

and pay the worker a fixed salary of, say, GHC500
per month. At least in the short-run, a firm that
chooses a time-rate system does not have to monitor
the worker's performance

Dr. Edward Asiedu Slide 13

 Should a Firm offer Piece Rates or
Time rates?
• The Competitive firms choose whichever system
yields the highest profits.
• Firms that have very high monitoring costs will not
be able to offer piece-rate systems.
• Firms facing very high monitoring costs, therefore,
opt for time rates, and firms facing low monitoring
costs choose piece rates.

Dr. Edward Asiedu Slide 14

 Should a Firm offer Piece Rates or
Time rates?
• Therefore, it is not surprising that piece rates are
often paid to workers whose output can be observed
easily (the number of pants produced, the number of
boxes of strawberries picked, the cedi volume of sales
made in the last period), whereas time rates are
offered to workers whose output is difficult to
measure.

Dr. Edward Asiedu Slide 15

 Topic Three

DISADVANTAGES OF USING A
PIECE RATE COMPENSATION
SYSTEM
Dr. Edward Asiedu Slide 16
 Disadvantages of Using a Piece-rate
Compensation System
• Our discussion suggests that there are advantages to
piece-rate incentive pay.

• A piece rate attracts the most-able workers, elicits high

levels of effort from the workforce, ties pay directly to
performance, minimizes the role of discrimination and
nepotism, and increases the firm's productivity.

• In view of these benefits, why are piece rates not used

more often in the labor market?
• Can you think of any reason (s)?
Slide 17
Dr. Edward Asiedu
 Disadvantages of Using a Piece-rate
Compensation System
• Perhaps the most obvious reason is that the work
incentives introduced by piece rates are of little use
when the firm’s production depends on team effort as
opposed to individual effort.

• Offering piece rates to one of the workers along a

garment production line would have little impact on
her productivity since the speed at which the line
moves also depends on the productivity of all the
other workers on the line.

Dr. Edward Asiedu Slide 18

 Disadvantages of Using a Piece-rate
Compensation System
• Altho u g h i t m i g h t b e p o s s i b l e t o s t r u c t u r e
compensation so as to offer a piece rate to the entire
team based on the team’s output, there is always the
possibility that some members of the team will
"free ride" on the effort of other members.

• Piece-rate systems, therefore, work best when the

worker’s own pay can be tied directly to her own
productivity.

Dr. Edward Asiedu Slide 19

 Disadvantages of Using a Piece-rate
Compensation System
• A piece-rate compensation system also
overemphasizes the quantity of output produced and
not quality. In the typical piece-rate system, the
worker will want to trade o quality for quantity.
• This problem could be reduced if the worker's
earnings depend on the number of units produced that
meet a well-defined quality standard.

Slide 20
Dr. Edward Asiedu
 Disadvantages of Using a Piece-rate
Compensation System
• Incorporating both quality and quantity as variables in
the pay-setting formula, however, would probably
increase the monitoring costs faced by firms, and
hence would reduce the likelihood that firms will
offer piece-rate systems in the first place.

Slide 21

Dr. Edward Asiedu

 Topic Four

UNEMPLOYMENT

Dr. Edward Asiedu Slide 22

 Unemployment - Types
Frictional and structural unemployment
• The labor market is in constant ux.
• Some workers quit their jobs, other workers are laid
off.
• Some firms cut employment, other firms expand
employment.
• New workers enter the market after completing their
education, and many other workers re-enter after
spending some time in the nonmarket sector.

Dr. Edward Asiedu Slide 23

 Unemployment - Types
• The existence of frictional unemployment does not
suggest that there is a fundamental structural problem
in the economy, such as an imbalance between the
number of workers looking for work and the number
of jobs available.

• As a result, frictional unemployment is not viewed

with alarm by policymakers. By its very nature,
frictional unemployment leads to short
unemployment spells.
Dr. Edward Asiedu Slide 24
 Unemployment - Types
• Frictional unemployment is also "productive" because the
search activities of workers and firms improve the
allocation of resources.

• There are also easy policy solutions for reducing

frictional unemployment, such as providing workers with
information about job openings and providing firms with
information about unemployed workers.

• At any point in time, many workers may also be

experiencing seasonal unemployment.

Dr. Edward Asiedu Slide 25

 Unemployment - Types
• Farm workers may be laid off during dry/rainy
seasons.

• Firms could shut down so that they can be retooled.

• Spells of seasonal unemployment are usually very

predictable.

Dr. Edward Asiedu Slide 26

 Unemployment - Types

• As a result, seasonal unemployment, like frictional

unemployment, is not what the unemployment
problem is about.
• After all, most of the unemployed workers will return
to their former employer once the employment season
starts.

Dr. Edward Asiedu Slide 27

 Unemployment - Types
• The type of unemployment that creates a great deal of
concern, and that dominates the policy discussions, is
structural unemployment.
• Structural unemployment can arise for two distinct
reasons.
• Suppose the number of workers looking for work
equals the number of jobs available so that there is no
imbalance between the numbers being supplied and
demanded.

Dr. Edward Asiedu Slide 28

 Unemployment - Types
• At any time, some sectors of the economy are
growing and other sectors are declining. If skills were
perfectly transferable across sectors, the laid-off
workers could quickly move to the growing sectors.

• Skills, however, might be specific to the worker's job

or industry, and laid-o workers lack the qualifications
that expanding firms are looking for.

Dr. Edward Asiedu Slide 29

 Unemployment - Types

• As a result, the unemployment spells of the displaced

workers might last for a long time because they must
retool their skills.

Dr. Edward Asiedu Slide 30

 Unemployment - Types

• Structural unemployment thus arises because of a

mismatch between the skills that workers are
supplying and the skills that firms are demanding.

• The policy prescriptions for this type of structural

unemployment are very different from those that
would reduce frictional unemployment. The problem
is skills; the unemployed are stuck with human
capital that is no longer useful.

Dr. Edward Asiedu Slide 31

 Unemployment - Types
• To reduce this type of unemployment, therefore, the
government would have to provide training programs
that would "inject" the displaced workers with the
types of skills that are now in demand.

• Even if skills were perfectly portable across sectors,

structural unemployment also arises if there is an
imbalance between the number of workers looking
for jobs and the number of jobs available.

Dr. Edward Asiedu Slide 32

 Unemployment - Types
• The policy prescriptions for this type of
unemployment have little to do with helping workers
find jobs or with retooling workers' skills. To reduce
this type of unemployment, the government would
have to stimulate aggregate demand (economic
growth) and re-establish market equilibrium.

Dr. Edward Asiedu Slide 33

 FINC 407
Labour Economics

Session 13– Examining Labour Market Interventions

Lecturer: Dr. Edward Asiedu, UGBS

Contact Information: easiedu1@gmail.com

College of Education
Department of Distance Education
2017/2018
 Session Overview
By the end of this session students should be able to:

• Understand and explain an econometric analysis.

• Write an econometric model and identify the dependent
and independent variables.
• Understand and explain the conditions under which
difference-in-difference and regression discontinuity
design can be used in impact assessment.

Dr. Edward Asiedu Slide 2

 Session Outline
The key topics to be covered in the session are :

• Econometric analysis.
• Labour market intervention.

Dr. Edward Asiedu Slide 3

 Topic One

EXAMINING LABOUR MARKET

INTERVENTIONS:
ECONOMETRIC ANALYSIS
Dr. Edward Asiedu Slide 4
 Examining Labour Market
Interventions
• Identification and other issues
• What is econometrics?
• It is used to determine economic relationships, to test
economic theories, to evaluate policy programs , to
predict the development of macroeconomic variables (e.g.
interest rate, GDP)......

• Example: Effect of training programs on wages.

• Example: Effect of payment systems on workers effort
and firm income.
Dr. Edward Asiedu Slide 5
 Examining Labour Market
Interventions
• Econometrics make use of experimental data (e.g.
from laboratory or natural experiments) and non-
experimental data.

• Statistics work with non-experimental (observational)

data.

Dr. Edward Asiedu Slide 6

 Examining Labour Market
Interventions
Steps of an empirical analysis:
• Formulation of research question.
• Formulation of the formal economic model, if it exists
(e.g. utility maximization) or creation of a model by
intuition (e.g. wage of a worker is dependent of education,
age, experience...)

Dr. Edward Asiedu Slide 7

 Examining Labour Market
Interventions

Dr. Edward Asiedu Slide 8

 Examining Labour Market
Interventions
• Simple bivariate regression model
• We want to relate two variable y and x.

Aim:
Explain y by x, investigate how y changes if x change.

Dr. Edward Asiedu Slide 9

 Examining Labour Market
Interventions
• Simple bivariate regression model

Three questions:
• How do we take account of other factors influencing y?
• How does the relationship between x and y look like?
• How do we guarantee for the ceteris-peribus-relationship
between x and y?

Dr. Edward Asiedu Slide 10

 Examining Labour Market
Interventions

Dr. Edward Asiedu Slide 11

 Topic Two

IMPACT ASSESSMENT OF
LABOUR MARKET
INTERVENTIONS
Dr. Edward Asiedu Slide 12
 Examining Labour Market
Interventions

Dr. Edward Asiedu Slide 13

 Examining Labour Market
Interventions

Slide 14
Dr. Edward Asiedu
 Examining Labour Market
Interventions
• Example for Interpretation:
Estimated: Wage= -0.90 + 0.54educ

• for educ = 10years:

• Wage = 0.90 + 0.54 * 10 = Ghc4.5 per hour
• Four more years of education leads to additional Ghc 2.26 per
hour (4 * 0.54)

• Because of the linearity, 1 year more has always the same

effect, independent of which education level has already been
attained

Dr. Edward Asiedu Slide 15

 Examining Labour Market
Interventions
• With no education, the hourly wage is -0.9 Ghc . This
seems really counterintuitive but think about how
many people have zero years of education. In the
sample there might be no one! still, we usually do not
interpret the intercept and will in most cases not be
interested in it.

Dr. Edward Asiedu Slide 16

 Examining Labour Market
Interventions
• LaLonde (1986)
• Evaluating the econometric evaluation of training programs
with experimental data.

• LaLonde investigates, if experimental or non experimental

design in more suitable to estimate the effect of training
program on income.

• National Supported Work Demonstration (NSW) program in

the USA
• Program was aimed to aid disadvantaged workers to get some
labour market experience
• Moreover: group meeting and consultation.

Dr. Edward Asiedu Slide 17

 Examining Labour Market
Interventions
• Eligible for the program: AFDC-women (women,
who get financial aid for their children), ex-drug-
addicted, ex-criminals and high school drop outs.
• They did get some payment, but less than in a regular
job.
• Experimental: We randomly assign people to
treatment (received training) and control (no-training).
• Non-experimental: Non-random assignment.

Slide 18
 Examining Labour Market
Interventions
• For experimental studies treatment and control groups
should be similar at baseline (before providing
training).
• Thus, randomization is said to work if treatment and
control groups are balanced on observables at
baseline.

Slide 19
Dr. Edward Asiedu
 Examining Labour Market
Interventions

Slide 20
Dr. Edward Asiedu
 Topic Three

IMPACT EVALUATION
METHODS : DIFFERENCE-
INDEFFERENCE AND
REGRESSION DISCOUNTINUITY
Dr. Edward Asiedu Slide 21
 Examining Labour Market
Interventions – Diff-in-Diff
Idear of Difference -in-Difference models

• Individual of specific groups are observed over a period.

• Treatment group and control group.

• Group A is treated with treatment D at specific point in

time.
• Group B is not treated (no training).

Slide 22
Dr. Edward Asiedu
 Examining Labour Market
Interventions – Diff-in-Diff
• Key identifying idea
• Development of control group over time as an image
of how treatment group would have developed over
time if there had not been a treatment.
• Development of control group depicts the
“counterfactual”, unobserved , “What if…” case for
the treatment group.
• Particular useful for analyzing clear cut policy
reforms or changes in economic conditions.

Dr. Edward Asiedu Slide 23

 Examining Labour Market
Interventions – Diff-in-Diff
• Graphical intuition

Slide 24
Dr. Edward Asiedu
 Examining Labour Market
Interventions – Diff-in-Diff
For the Diff-in-Diff method to be valid, it is necessary,
that
• Treatment and control group follow the same time
trend in absence of treatment.
• The composition of treatment and control group may
not be influence by the treatment, i.e we have for
example to take care of selective migration into
treatment regions.

Slide 25
Dr. Edward Asiedu
 Examining Labour Market
Interventions - RDD
• Regression Discontinuity Design (RDD)

• RDD exploits natural experiments and we can compare

people ( countries, cities, firms,...) who are just affected
by a certain rule with those, who are not affected.

• Example 1. Scholarship rule: A student will only receive a

scholarship if he/she obtains more than 70% in all courses.

• This method is appropriate for examining the impact of

the scholarship on academic performance.

Dr. Edward Asiedu Slide 26

 Examining Labour Market
Interventions - RDD
• Example 2. In a social assistance program, workers
under the age of 40 years receive lower benefits than
workers above 40 years.

• We use can use discontinuity in policy to estimate the

effects of the social assistance on labour force
participation.

Dr. Edward Asiedu Slide 27

 Examining Labour Market
Interventions - RDD

Dr. Edward Asiedu Slide 28

 Examining Labour Market
Interventions - RDD
How to identify causal effects in RDD models?

• There is a jump in treatment status at a certain

threshold “c”.
• Individuals slightly below and slightly above the
threshold c differ from each other in the treatment D
• Jump in Y at threshold “c” is due to the jump in
treatment D.

Dr. Edward Asiedu Slide 29

 Thank You.
I wish you the very best!

Dr. Edward Asiedu Slide 30