Lecture 3 1-24-2012 - Econ 151 lecture January 24, 2012...

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Econ 151 lecture January 24, 2012 Labor Demand Models Outline : The competitive labor demand model. 2. Two policy applications: payroll tax holiday; mandates that increase health insurance costs. 1. Labor demand in a simple competitive model a. Firm’s demand curve . Firm is price and wage taker . It can hire as much labor as it wants and the going wage and sell as much product as it wants at the going price. In this model, labor markets clear instantaneously. MP of L = f (technology, K, L), diminishing returns, substitutability In the short run, with K fixed, firm’s decision involves setting L, conditional on w, so as to max profits. It does this at VMP (of L) = w. -- Get downward sloping demand curve for the firm: the law of demand, like the law of gravity (Gary Becker). --Note that profits are not competed to zero; when MPL< APL the return to capital is positive. b. Industry demand curve 1
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--Obtained by adding individual firm D curves, taking into account the industry’s product market price elasticity. --Then with upward sloping industry labor supply curve, get unique and stable equilibrium that is market-clearing. --No room for role of bargaining power or unemployment; any mandates like a minimum wage, protections against layoffs will be inefficient. c. Long run: allow capital to vary. --Result is a greater responsiveness of labor demand to a change in wage—more elasticity-- because of additional operational margin of substituting capital for labor. So have scale and substitution effects. d. Add two kinds of labor: skilled and unskilled . --Results depend upon degree of substitutability and the complementarities among skilled labor, unskilled labor and capital inputs. --If skilled labor and capital are complements, while skilled labor and unskilled labor are substitutes, skill-biased technical change is a potential source of growing wage differentials. 2
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--If skilled labor and unskilled labor are complements, then immigration of unskilled labor can increase the wages of skilled native workers without reducing their employment. 2. Application: case of payroll taxes paid by employer (as in textbook) a. Institutional and policy context --The payroll tax, which for most workers is much larger than the income tax, is earmarked for retirement (Social Security), disability insurance, Medicare and unemployment insurance. The revenues go into a trust fund for future use. --Employers and employees each contribute about 7.65 percent of employee pay, up to a cap of about $107,000, into a series of trust funds. The employee share is paid through withholding. Pay above the cap is not subject to the payroll tax. The cap is indexed to inflation. --The cap used to be higher in the wage distribution than it
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Lecture 3 1-24-2012 - Econ 151 lecture January 24, 2012...

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