LABOUR ECONOMICS

MAS 457

LECTURER: JOHN OSEI OBIRI YEBOAH

 INTRODUCTION
TO
LABOUR ECONOMICS
INTRODUCTION TO LABOUR ECONOMICS

 Labour economics seeks to understand the complex

workings of the labour market by studying the
dynamics between employers, employees, under the
assumption that workers strive to maximize their
wellbeing and firms strive to maximize profits.

 Purpose of the Course

 to understand how workers and firms make decisions in the
labour market
 To understand how the government can alter the economic
opportunities to workers and firms through social policies
 THE LABOUR MARKET
 The labour market is where human creativity and sweat is
bought and sold.

 Actors of Labour Market

 Workers or employees: Workers try to get the best possible job
thus looking for the highest bidder for their services.

 Firms: Firm continuously search for better means to utilise labour

thus looking to pay the lowest price in the form of wages and
salaries.

 Government: Government set ground rules to regulate

transactions in the labour market and limit the types of economic
changes that occur between workers and firms.
 BASICS OF THE LABOR MARKET
 Participants are assigned motives:
 Workers look for the “best” job.

 Firms look for profits.

 Government uses regulation to achieve goals of public

policy.
 Minimum wages

 Occupational safety
THREE “ACTORS”
 Workers
 Themost important actor; without workers,
there is no “labor”.

 Desireto maximize utility (i.e., to optimize by

selecting the best option from available
choices).

 Suppliesmore time and effort for higher

payoffs, causing an upward sloping labor supply
curve.
THREE “ACTORS”
 Firms
 Decide who to hire and fire.

 Motivated to maximize profits.

 Relationship
between price of labor and the
number of workers a firm is willing to hire
generates the labor demand curve.
THREE “ACTORS”
 Government
 Imposes taxes, regulations.

 Provides
ground rules that guide exchanges
made in labor markets.
SUPPLY AND DEMAND IN
THE LABOR MARKET
Earnings ($)
Labor Supply
Curve

50,000

Equilibrium
40,000

Labor Demand
Curve
30,000

10,000 20,000 30,000 Employment

 WORKERS AND THE LABOUR SUPPLY CURVE
 Workers choose whether to work or not, how many hours
to work, how much effort to allocate to the job, which
skills and abilities to acquire, when to quit a job, which
occupations to enter, and whether to join a labour union.

 Workers will always act in ways that maximize their well-

being either individually or through the union. The labour
supply curve, therefore, is often upward sloping.

 The labour supply curve reflects the number of person-

hours supplied to the wage that is being provided. The
higher the wage that is being provided, the higher the
labour supplied.
 FIRMS AND THE LABOUR DEMAND CURVE
 Firms have motives to maximize profits. The firm will
maximize its profits by making the production decisions
- the hiring and firing decisions that best serve the
consumers' needs. This means that the demand of firms
are derived demand as it is dependent on the demand of
consumers.

 The assumption that firms want to maximize profits

implies that firms will prefer to employ numerous
employees when labour is cheap but will desist from
hiring when labour is costly. The relation between the
price of labour and how many workers firms are willing
to hire is summarized by the downward-sloping labour
demand curve.
 THE GOVERNMENT
 The government produces goods and services,
including roads and national defence.

 The government collects taxes, and that alters

economic behaviour.

 The government regulates economic activities for a

number of reasons, including workplace safety, who
can work and consumer protection.
NORMATIVE VS. POSITIVE ECONOMICS
 Normative economics
 Addresses “values”
 Focus on “what should be”
 Requires judgments about economic fairness

 Positive economics
 Addresses the facts and cause and effect
 Focus on “what is” and testing of economic theories
 Questions answered with the tools of economics
 NORMATIVE ECONOMICS
 The normative economics answer questions on
“what should be” . Answers to this type of
economics involves individual’s value judgments
which leads to different views irrespective of the
theories or facts.

 Eg. Drugs (narcotics) lead to a total revenue of $20 million

each month in Ghana. It also cost Ghana $12 million dollars to
effectively deal with the narcotics trade in Ghana. The
question is should the Government stop the trade and lose $32
million a month or decide not to act so that the total gain is
now $32 million.
 THE ROLE OF POSITIVE ECONOMICS IN LABOUR
ECONOMICS
 Positive economics is about descriptive, factual
statements about the world. It uses scientific
principles to arrive at objective, testable
conclusions.

 Itattempts to describe how the economy operates using

the scientific method.

 It usually addresses question on “what is”

 FUNDAMENTAL CONCEPTS OF POSITIVE
ECONOMICS
 Scarcity: Economists assume that resources are
scarce relative to society's wants and needs.
Scarcity is a basic economic problem that arises
because people have unlimited wants but resources
are limited.

 The scarce resources have alternative uses hence prudent

economic decisions for efficient allocation of resources.

 Due to scarcity, individuals make rational choices based on

their selfish interest. These choices are made despite the
constraints on information and time.
MARKET FAILURES
 MARKET FAILURE AND ITS INABILITY TO ACHIEVE PARETO
EFFICIENCY IN LABOUR MARKETS
 A market failure is a situation where free markets fail to allocate
resources efficiently.

 Pareto efficiency or Pareto optimality (Vilfredo Pareto)

 The allocation (or re-allocation) of goods, either input or output goods, such that more
of something (utility or output) can be produced without producing less of something
else – pareto improvement

 When no further pareto improvements can be made, the allocation of resources is said
to be pareto efficient. That is there is efficiency in consumption.

 This efficiency is reached when;

 Firms produce at the lowest cost per unit possible (productive efficiency)
 The economy's resources are allocated between firms and industries in the most efficient
way (allocative efficiency).

NB: This is better explained with the production possibility frontier (PPF)
THE PRODUCTION POSSIBILITY FRONTIER
(PPF)
 OPPORTUNITY COST
 Opportunity cost is the loss of other alternatives when
one alternative is chosen. Thus it is the cost of the
forgone alternative as a result of choosing a particular
option.

 Nobel Laureate Milton Friedman was fond of saying,

“There is no such thing as a free lunch.” The reason
there is no free lunch is that your choice to go on a
paid date or perhaps spend your evening whatsapping,
tweeting and texting at home was an evening not
spent with other friends at a football game.
 LAW OF INCREASING COST
 The law of increasing cost proposes that an economy
running at peak efficiency and fully utilizing its fixed-
cost resources will experience a higher opportunity cost
with an increase in the quantity produced of a good.

 The law of increasing costs takes place when society

uses more resources to produce any specific good.

 To maximize profits and reduce inefficiency, business

owners and managers try to use all factors of production
at full capacity. At a certain productivity level, the
company achieves maximum efficiency of output with a
fixed amount of overhead and expense.
 CAUSES OF MARKET FAILURE
 Externalities: An externality is a by-product of a
production process that affects a third
party externally.

 It can be negative or positive

 When a trade (or the goods being traded) imposes

substantial costs (negative) on individuals not
participating in the trade (e.g. pollution) or
alternately, individuals not participating in the trade
realize significant benefits from (positive) it, it is
referred to as externality.
Negative Externality Positive externality
 CAUSES OF MARKET FAILURE CONT’D
 Imperfect Information
 Free market trading between individuals will result in Pareto
improvements as long as there is perfect information for
individuals about the existence of the trade, and what they will
be getting from the trade.
 It is however the case that most economies have imperfect
information.

 Public Good
A pure public good is one whose consumption by one person
does not reduce its availability for others. When a person
consumes a good such as national defence, fire service, bridges,
and roads, or a radio broadcast, however, the amount of the
good available for consumption by others is not diminished.
CAUSES OF MARKET FAILURE CONT’D
 Price distortion
 In a free market without any externalities, there will not be any
distortions in price when the market is in equilibrium where the
price equals the marginal cost of the firm.

 There could be distortions in the market that will cause the

marginal cost of production not to be equal to the price being
charged consumers. Eg Government intervenes on the prices of
goods (of price ceiling, price floors, taxes or subsidies)

 Equity vs. Efficiency

 Policymakers are most of the time faced with a trade-off between
equity and efficiency. In attempt to make market outcomes more
equitable often results in the loss of economic efficiency.
SUMMARY
 Labor economics studies how labor
markets work.
 Models in labor economics typically
contain three actors: workers, firms, and
governments.
 A good theory should have realistic
assumptions and can be tested with real-
world data.
 The tools of economics are helpful in
answering positive questions.
LABOUR SUPPLY
 LEARNING OBJECTIVES

 Explain the model of labour supply

 Measure the labour force

 Explain the effect of change in wage on hours of work

 Explain the concept of reservation wage

 Explain labour supply over a lifetime

 MEASURING THE LABOUR FORCE
 Employed: a worker must have been at a job with pay for at least 1 hour or
working in a family business.

 Unemployed: an individual either on a temporary layoff from a job or

without a job but actively looking for work in the four-week period prior to
the reference week.

 Labour Force: A person participates in the labour force if he or she is either

employed or unemployed
 Let E = persons employed
 Let U = persons unemployed
 Let LF = size of the labour force
 Let P = population

 The size of the Labour Force is shown as

 LF=E+U
 The labour force participation rate (LFPR)
 LFPR=LF/P × 100
 The employment rate (ER) is given as
 ER=E/P × 100
 The Unemployment rate (UR) is given as
 THE DECISION TO WORK MODEL OF LABOUR
(NEOCLASSICAL MODEL OF LABOUR LEISURE CHOICE)

 Economists use the neoclassical model of labour – leisure

choice to analyse labour supply behaviour.

 The model also helps to predict how changes in economic conditions

or in government policies affect work incentives.

 Thefirst assumption is that there are two goods, labour and leisure
and that individuals seek to maximize their well-being by consuming
goods and leisure.

 people have to earn the money required to buy their desired goods (nice
cars, houses etc. Thus the amount of labour determines your consumption of
these goods.

 There is an economic trade off: If we work, we will be able to afford many

of these goods and services, but we must give up some of our valuable
 UTILITY AND INDIFFERENCE CURVES
 Utility measures the level of
satisfaction of consuming goods.

 The indifference curve (as shown in the

diagram) is a graph shows alternative
combinations of goods that provide a
given level of satisfaction (utility).

 Assumption: Utility is based on real

income (Y), and leisure time (L). U
= f (C, L)

 It is assumed that the same

satisfaction is achieved at each point
of the indifference curve.

 Point Z on the outside lies on a higher

indifference curve and provides a
higher utility level.
 PROPERTIES OF THE INDIFFERENCE
CURVES
 Indifference curves are downward sloping
 We assumed that individuals prefer more of both C and L. It is
downward slopping because individuals are willing to give up
some income (Y) to receive additional leisure (L) and vice versa.
 Higher indifference curves indicate higher levels of utility
 The consumption bundles lying on the indifference curve that
yields 40,000 utils are preferred to the bundles lying on the curve
that yields 25,000 utils.
 Indifference curves do not intersect
 Iftwo indifference curves intersect, it implies that the individual
can be on two different indifferent curves at the same time.
 Indifference curves are convex to the origin
 The convexity (bowed inward) of indifference curves reflects an
additional assumption about the shape of the utility function. It
is as a result of the increased opportunity cost.
 THE BUDGET CONSTRAINT
 It defines all the
combinations of goods and
services that a consumer can
purchase with his given
income (at the given current
prices) and her time.

 Utility is maximised at the

point of tangency between
an indifference curve and
the budget constraint i.e.
where the indifference curve
makes contact at a single
point on the budget line.
THE EFFECT OF A CHANGE IN THE WAGE RATE ON
HOURS OF WORK

 A change in the wage rate rotates the budget line around the endowment point E. A wage increase moves
the worker from point P to point R, and can either decrease (fig a) or increase (fig b) hours of work.

 The wage increase also makes leisure more expensive. When the worker earns $20 an hour, she gives up
$20 every time she decides to take an hour off. 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 should then 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.

 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 very expensive and that she simply cannot
 DECOMPOSING THE IMPACT OF A WAGE CHANGE
INTO INCOME AND SUBSTITUTION EFFECTS
 An increase in the wage rate generates both income and
substitution effects.

 In the case of income effect, as the wage rate of an individual

increases, her real income rises and she is able to consume more
of all normal goods.

 If leisure is a normal good, the individual will increase her

consumption of leisure leading to a decrease in the hours of work.

 The income effect isolates the change in the consumption bundle

induced by the additional income generated by the wage increase
(movement from point P to R in the fig below)
 CONT.

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

substitution effect.

 The substitution effect is the opportunity cost of forgoing

leisure time as wage rate increases.

 It illustrates what happens to the worker's consumption

bundle as the wage increases, holding utility constant.

 The substitution effect implies that an increase in the

wage rate, holding real income constant, increases hours
of work.
CONT.
 THE RESERVATION WAGE
 The definition of the reservation wage
implies that 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.
Therefore, the decision to work is
influenced by how the employers are
able to meet a person’s reservation
wage.

 It gives the minimum increase in income

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

 At a low wage (Wlow), the person is

better off not working. At a high wage
(Whigh), she is better off working.

 The reservation wage is given by the

slope of the indifference curve at the
endowment point.
 THE LABOUR SUPPLY CURVE
 The predicted relation between
hours of work and the wage
rate is called the labour supply
curve.

 The labour supply curve traces

out the relationship between
the wage rate and hours of
work.

 The diagram on the left shows

the number of alternative wage
levels whilst the right one
shows the relationship between
the wage rate and optimal
 Labour Supply over the Life Cycle

 Evidence suggests that there is a predictable path in a workers’ age-earnings profile (i.e.
the worker's wages over her life cycle): wages tend to be low when the worker is young;
they rise as the worker ages, peaking at about age 50; and the wage rate tends to remain
stable or decline slightly after age 50, all things being equal.

 For a young worker who expects his income to increase at the late thirties will opt for
more pleasure in his early years and then more hours when leisure becomes more
expensive.
NB: In all the wage model implies that over the life cycle of a worker, the hours of work
move with the wage rate.
 Labour Supply with Household Production
• The basic static model of a trade-off between consumption and
leisure neglects numerous elements such as household activities

• The classical household production model predicts that individuals

allocate their time between work, housework and leisure based on
the shadow price of their time spent in the labour market. The
assumptions include:

– Output that is produced by the household is consumed directly and not

sold in the market.

– The production of household output requires an input of human time of

one or more household members and an input/good purchased in the
market.
CONT.
 T0 = h M + h D + L
 Where:
 hM = paid working time

 hD = household working time

 The individual’s consumption pattern will be

to choose the quantities CM, CD, hD, hM, and L
that maximize his or her utility under the
budget constraint
SUMMARY
 Summary
 The reservation wage is the wage that makes a person indifferent between
working and not working. A person enters the labour market when the
market wage rate exceeds the reservation wage.

 Utility-maximizing workers allocate their time so that the last money

(cedi) spent on leisure activities yields the same utility as the last money
(cedi) spent on goods.

 An increase in wage generates both an income and a substitution effect

among persons who work.

 The income effect reduces hours of work; the substitution effect increases
hours of work.

 The labour supply curve, therefore, is upward sloping if substitution

effects dominate and downward sloping if income effects dominate.
 The end
LABOUR DEMAND
 LEARNING OBJECTIVES

 After this lesson you should be able to:

 Understand the demand of labour by firms

 Explain the factors that affect labour demand

 Understand the production function and law of diminishing

marginal returns and how they affect labour demand

 Understand how the labour demand works in many markets

 INTRODUCTION
 Firms hire workers because consumers want to purchase a
variety of goods and services.
 Demand for workers is derived from the wants and desires of
consumers.

 Interest of Economist
The interest of economist is to examine how labour demand is
affected by;
 Technological shocks
 Unionization
 Business
cycle fluctuations
 Minimum wages
 Intro cont.
 Interest of the Human Resource Department lies in the hiring
decisions for organisational productivity.

 Central questions: how many workers are hired and what are they
paid?
 Implications:
 Socially
 Politically

 Hired labour is pay wages and salaries. These are cost to the firm
which directly affects the productivity of the firm.

 The study of labour demand can be looked at from the

production function of a firm
 THE PRODUCTION FUNCTION OF
ORGANISATIONS
 The production function specifies the technology that the firm uses
to produce its goods and services.

 Technology is the body of know-how, skills, methods and

procedures that are applied to create goods and services.

 Assuming that the firm uses only two factors of production

(inputs): the number of employee-hours hired (E) and capital (K),
the output (q) of the firm will be:
 q= f (E,K).

 Let q= output
 Let E = total hours
 Let K = capital
ASSUMPTIONS IN THE PRODUCTION FUNCTION
 The number of labour hours is made up of two
components: the workers and the average
hours worked per worker.

 By focusing on E and not its components, it is

assumed that the firm gets the same output when
it hires 20 workers for an eight-hour day as when it
hires 40 workers for a four-hour shift.

 The second assumption is that the production

function considers all workers as ‘labour’
without any distinctions.
 Marginal Product and Average Product
• The most important concept associated with the production
function is the marginal product.

• The marginal product is a change in output as a result of an

additional input

• Marginal product of labour (MPE) is defined as the change in

output resulting from hiring an extra worker, holding the quantities
of other inputs (including capital) constant.

• Marginal product of capital (MPK) is the change in output from

hiring one added unit of capital, holding the quantities of other
inputs (including labour) constant.

• It is assumed that the MPE and the MPK are both positive such that
an increase in one unit leads to an increase in output (q).
 From table 3.1, as more workers are hired,
the output initially increases at an increasing
rate and later at a decreasing rate.

 Law of Diminishing Returns: Law of

diminishing marginal product states that as
more and more units of an input (labour) are
added to a set amount of an additional input
(capital), a stage of total production is
achieved ahead of which the marginal
product of labour declines.
 TOTAL, MARGINAL AND THE AVERAGE PRODUCT CURVES

 The total product curve shows the relation between

output and the total number of employees employed by
a firm (keeping capital fixed).
 The marginal product curve shows how productive an
added worker is.
 The average product curve shows the output per
worker
PROFIT MAXIMIZATION
 Objective of the firm is to maximize profits.
 The profit function is:
 Profits = TR – TC
 Where TC= (wE + rk)

 This clearly puts labour in the category of cost.

 An addition of an extra worker will increase productivity

which will in turn increase revenue reflecting in high profits,
ceteris paribus but the addition of the extra worker would
mean an increase in cost which will reduce the level of
profits.

 As such, before labour is employed in every organisation, it

is prudent to check whether this demand would be
profitable to the organization.
 organizations will hire workers when they are certain
that the profits gain from the additional workers is high
the cost incurring.

 Economists rely on two measures in examining this issue:

 themarginal revenue product (MRP) of labour, and

 The marginal factor cost (MFC) of labour.

 MRP of Labour is the additional revenue made from an

additional use of labour is.

 MFC of labour is the additional cost (in wages and

salaries) associated with the use of an additional unit of
labour
 A profit-maximizing firm will:

1. increase the use of labour if MRP > MFC,

and
2. Reduce the use of labour if MRP < MFC.

 A profit-maximizing firm hires workers up to

the point where the wage rate equals the
value of marginal product of labour.
THE DEMAND CURVE
 The demand curve for labour is a downward
sloping from left to right.

 This indicates that firms will be willing to

demand more labour when wages are low
than when wages are high.
 LABOUR DEMAND ELASTICITY
 Labour demand elasticity is a measure of the responsiveness of
labour demand to a change in factor prices.

 The Marshall’s Rules of Derived Demand is used as the

determinants of elasticity.

 Substitute Inputs Availability: demand will be more elastic when there

are larger number of substitutes.

 Elasticity of Supply of Substitute Inputs: demand will be more elastic

if supply of substitute inputs is also more elastic.

 Demand for Output’s Elasticity: If demand for output is inelastic, the

demand for labor would also be inelastic. The converse is true.

 TYPES: OWN-WAGE ELASTICITY OF LABOUR DEMAND
 The own-wage elasticity of labour demand is a measure of how
sensitive the demand for a particular category of labour to a
change in the wage rate in that specific labour market.
 The mathematical representation is

 the own-wage elasticity of labour demand will always be negative

as a result of the negative slope of labour demand curves.
 Demand is
 elastic if nii>1 (1% increase in wage, more than 1% fall in
employment)
Inelastic if nii<1 (1% increase in wage, less than 1% fall in
employment)
Unit elastic if n =1 (1% increase in wage, 1% fall in employment)
CROSS-WAGE (CROSS-PRICE) ELASTICITY OF DEMAND
 The cross-wage elasticity of labour demand (also
known more generally as the cross-price elasticity of
demand) is a measure of the effect of the change in
the price of one factor of production on the demand
for another factor of production.
n =
ij

 A positive cross-price elasticity of demand between

two inputs indicates that the two inputs are gross
substitutes
 A negative cross-price elasticity means the two are
gross complements
 UNION BEHAVIOUR AND ELASTICITY OF
LABOUR DEMAND
 A union’s warfare is normally for the increase in collective
wages through the use of collective bargaining

 The higher the wages above the equilibrium level, the

higher the level of unemployed labour.

 When an industry under consideration faces an inelastic

demand for labour, union would then be most effective if
it opts for higher wages.
 Ifunions are able to lower the firm’s elasticity of demand for
labour it would then be of much interest to the unions
 That is why unions naturally oppose technological advances that
increase the potential of substituting between labour and
FACTORS THAT SHIFT THE LABOUR DEMAND CURVE

 The labour demand curve shifts due to certain factors that change the

number of labour that organisations want to employ at particular level of

the real wage

 Union

 The unions provide higher wages and better job benefit. Additionally this brings about a

cost. The costs are: Less jobs, an exclusion of workers from the market

 Minimum wage

 Minimum wage is a good option for those near the minimum wage area but this does

increase unemployment rate and job search.

LABOUR MARKET
EQUILIBRIUM
LEARNING OBJECTIVES
 After reading this unit you should be able to:

 Explain equilibrium

 Explain shortages and Surplus labour

 Identify the impact of payroll taxes on equilibrium

 INTRODUCTION
 Equilibrium is reached when the labour demanded by
firms is equal to the labour supplied by workers

 This section focuses on the unique policy applications

and how they shift the market equilibrium which
ultimately influences the various prospects which are
made available to employers and employees at each
stage of disequilibrium.
LABOUR MARKET EQUILIBRIUM
 Labour market equilibrium equates the
different needs of employees and
employers and ascertains the wage rates
and employment levels witnessed in the
labour market.
 OUT OF EQUILIBRIUM
 At various times within the labour market,
it is very common to find it out of
equilibrium. In this states various situations
can occur in the labour market including:

 Labour surplus
 Labour shortages
LABOUR SURPLUS
LABOUR SHORTAGE
 COMPETITIVE EQUILIBRIUM IN TWO LABOUR
MARKETS LINKED BY MIGRATION
 In this scenario we consider employment to be
differentiated by regions that is southern (Western,
Central, Eastern, Volta and Greater Accra regions)
and Northern (Ashanti, Brong Ahafo, Northern, Upper
west, and Upper east).

 It is assumed that workers in a the north earn higher

wages compared to their colleagues in the south.

 It is also assumed that the workers have the same

skills and are perfect substitutes.
The end
COMPENSATING WAGE
DIFFERENTIALS
LEARNING OBJECTIVES
 After reading this unit you should be
able to:
 Understand various theories on wage
differences
 Understand the use of wage differentials
on employer-employee matching
INTRODUCTION
 Compensating wage differential is a theory that
seeks to explain why there are differences in the
wage level of various jobs. Adam Smith was the
first to express this theory in his book Wealth of
Nations in 1776. It can be simply expressed as
the payment made to employees because of
their job being dirty, dangerous, and difficult.
CONT’D
 Compensating wage differentials operates
on these basic assumptions:
First, we assume that employees
maximize utility, not income.
Second, we assume they have perfect
information about the wages and risk
involved with each job.
Third, we assume that workers are
mobile and can change jobs without
cost.
HEDONIC WAGE THEORY
 Hedonic price theory connotes that differences
in wage rates may not strictly be based on
human capital differences but the working
conditions, the structure of the work and
working environment. According to this theory, a
wage differential or higher pay are given to
those whose work are deemed as less desirable
as compared with other jobs on offer.
ISOPROFIT CURVES
 “Iso” is a Greek word which stands for “equal”.
This simply explains isoprofit curves as “equal-
profit curves”. An isoprofit curve is a graph of all
combinations of wage rates and levels of risk
that result in a given level of economic profits.
Isoprofit curves help us understand the
relationship between wages and risks that firms
face.
ASSUMPTIONS: ISOPROFIT CURVES
 First, we assume that safety costs money.
 Second, we assume that firms will earn zero
economic profits (along their zero economic
profit isoprofit curve) in a long-run equilibrium.
 Third, we assume that other job characteristics
are the same – the only things that varies across
jobs are wages and safety.
CONT’D
USING COMPENSATING DIFFERENTIALS
(EMPLOYER-EMPLOYEE MATCHING)
 Employees will always choose a high
paying job for every level of risk should
all the other job characteristics held
constant.
 It must be noted that people who are
more risk averse will accept high
paying job while.
CONT’D
HUMAN CAPITAL INVESTMENT
LEARNING OBJECTIVES
After reading this unit you should be able
to:
 Understand Human Capital Investment as
an economic theory
 Understand the factors that affect
Human Capital Investment
 Understand education as a human
capital tool
INTRODUCTION
 Human capital can be thought of as a measure of an
individual's productive capacity. Under the human
capital model, we assume that the level of a person's
human capital is proportionate to his earnings. An
individual can increase his or her human capital by
investments in:
 education,
 training.
 Mathur (1999) defines Human Capital as the
accumulated stock of skills and talents, which
manifest itself in the educated and skilled workforce
in a region.
THE CONCEPT OF ‘HUMAN CAPITAL
 There are three main aspects of human capital, namely
 early ability (skills you had before training: whether
acquired or innate);
 qualifications and knowledge acquired through formal
education; and skills, competencies and
 expertise acquired through training on the job.
 Human capital investments involve an initial cost which
the individual or firm hopes to gain a return on in the
future
THE BASIC THEORY OF HUMAN
CAPITAL
 General Issues
 The basic notion behind human capital
investment is that workers have a set of
marketable skills that need to be improved upon.
Improving upon these “skills” can be likened to
investing in any other commodity in a firm.
 The extreme version of this assumption is that,
wage differentials is due to the differences in
human capital. This explains why a lecturer
would be paid more than the teaching assistant.
 It can be assumed that the skills of a person
directly reflects his/her level of education which
translate into their level of earnings.
CONT’D
 Here it is useful to mention three:

 Compensating differentials:
 Labour market imperfections:
 Taste-based discrimination:.
FACTORS AFFECTING HUMAN CAPITAL
INVESTMENTS
 interest rates,
 the age of the individual,
 the costs of education, and
 the wage differential between highly educated and
less educated and non-educated workers
EDUCATION AS A TOOL FOR HUMAN CAPITAL
DEVELOPMENT
 Estimates of the rate of return to education are
determined by comparing the expected lifetime
earnings streams that an individual could receive
under alternative levels of educational attainment.
 The following are two possible biases that are made:
 ability bias,
 selectivity bias
COSTS OF EDUCATION
 Three main cost associated with a University
education:
 directcosts such as tuition, books, and supplies,
 forgone earnings (the opportunity cost of time), and
 psychic costs.
BENEFITS OF EDUCATION
 The benefits associated with acquiring a
University degree include:
 higher expected earnings,
 more pleasant jobs,
 lower expected unemployment rates, and
 psychic benefits (This include better working
environment, job security less energy consuming
work)
RETURNS TO INDIVIDUAL
 In the standard economic model, the accumulation of human
capital is seen as an investment decision, where the individual
gives up some proportion of income during the period of
education and training in return for increased future earnings.
Individuals will only undergo additional schooling or training if
the costs are compensated by sufficiently higher future earnings.
In a competitive labour market where wages reflect the marginal
product of workers, to be able to command higher earnings, the
better-educated or more-trained workers must be sufficiently
more productive in employment than their less-skilled
counterparts.
 Note, however, that in the presence of imperfect competition or
of barriers to entry into different occupations, wage differentials
between the qualified and the unqualified may not necessarily be
related to productivity differentials
RETURNS TO EMPLOYER
 Employers fully or partially fund the training of workers in
the hope of gaining a return on this investment in terms of
being a more productive, more competitive and
consequently being a more profitable firm in the future. In
practice, however, it is very difficult to measure this return.
We saw in the previous section that training results in
workers receiving higher real wages. These real wage
increases have to be paid out of productivity gains and
therefore should provide a lower bound on the likely size of
productivity increases.
COBWEB MODEL OF
EDUCATIONAL ATTAINMENT
CONT’D
USES OF HUMAN CAPITAL
 The Becker view
 The Gardener view
 The Schultz/Nelson-Phelps view
 The Bowles-Gintis view
 The Spence view
LABOUR MOBILITY
LEARNING OBJECTIVES
 After reading this unit you should be able
to:

 Identify Common Labour Mobility

 Identify some Characteristics and effect of
immigration and brain Drain.
 Identify the effect of labour turnover
INTRODUCTION
 Mobility in labour can be described as the change in
the location of a worker across jobs (Occupational
Mobility) or physical space (geographic mobility).
This unit reviews the relevant issues on the two sets
of labour mobility.

 This unit reviews the determinants of labour mobility

and the means by which the markets improve the
allocation of workers to various firms. Mobility in
various ways is critical to the development of the
country. Recently Ghana had a surge in the number
of Chinese immigrants and the emigration of
Ghanaian Teachers to countries such as China,
Malaysia and the UAE.
CONT’D
 Labour mobility on a whole brings to large
extent important economic benefits. Many
have argued that workers across regions
(usually geographic and occupational
mobility) allow the efficient use of labour
across jobs and areas. Individual workers also
benefits as it improves the economic
situations, skills and aspirations.
MIGRATION

 Migration is defined as the movement of individuals from a location

to the other or between countries. Human migration has been
defined as the movement of individuals from a location to the
other or between countries with the aim of assuming permanent or
semi-permanent residence status.
 Usually migration can be involuntary (forced migration) or
voluntary (moving at will). The magnitude of migration can be
between continents (intercontinental), between countries on the
same continent (intra-continental), between countries of a specific
region (interregional). But the most common form of migration is
the rural-urban migration (usually for better conditions of life)
MOTIVATION FOR MIGRATION
 Labour migration occurs everywhere in the
world. Some of the major reasons are as follows:

 The search for favourable Jobs or job opportunities

(NB: this is considered the major reason for migration
in the world).
 Moving away from wars or conflicts
 Moving away from political persecution(Political
Asylum)
 Movement for the purpose of family reunification
 Moving for educational opportunities
 Moving away from adverse climate change or to
favourable climates
LABOUR MIGRATION
 Labour migration is the movement of labour force
from one location to the other. Migration of labour
is usually as a result of shift in technology,
relocation of plants or operational area of a
business and the emergence of new industries.

 Looking at the world today, and the supply and

demand for labour, it is expected that labour
migration around the world is expected to rise.
The expected movement are likely to come with
benefits and losses across countries but it is sad to
note that the gains and losses are not evenly
spread among countries.
THE EFFECTS OF IMMIGRATION
ON THE WAGE OF NATIVES
 The immigrant share of low skilled employees has played a
major role in reducing the wages of low skilled natives. In
examining the effect of migration on wages of native, a
simple aggregate production framework is adopted. In the
framework, the relative quantities of immigration directly
influence the wages.
 Assuming the demand curve for natives and immigrants in
the skilled group is perfectly elastic. The same is also held
for low skilled workers. It is also assumed that the total
immigrants constitute a percentage of high skilled
immigrants and low skilled immigrants. Therefore as the
percentage of low skilled immigrants increases, then the
wages of low skilled natives reduces. On the other way too,
when the percentage of high skilled labourers increases,
then the wages of high skilled workers begin to drop.
THE DETERMINANTS OF
WORKER MOBILITY
 Personal characteristics of movers

 Age
 Education
 Family factors
 Other factors
SKILLS, THE EARNINGS DISTRIBUTION
AND INTERNATIONAL MIGRATION

 This section will look at the extent of international

migration. The cost of immigration which is usually high
are borne by immigrants. The gains obtained from
migration are important in analysing the flows from
international labour migration. Usually, earnings obtained
from migration are compared with the home country of
the immigrants.
 Some countries around the world have compressed (equal)
earnings irrespective of the skills. That is the difference
between the earnings of skilled employees and unskilled
employees is not that wide.
CONT’D

 This means that the returns obtained from human capital

investments is low. That means that in such a country, it is
more likely for skilled employees from these countries to
move to countries where the returns on human capital
investment are high.

 On the other hand in countries where the wage differential

between the skilled and unskilled labourers is high, the
unskilled labourers have the motivation to migrate to other
countries where there is a perceived higher wage.
CONT’D
 In the case of less developed countries like
Ghana where there are unequal wage
distributions, it is normal for unskilled
labour to always want to travel to
developed countries for better earnings.
BRIAN DRAIN

 The movement of highly skilled and trained professionals

from the various under-developed nations to the developed
countries is not a new phenomenon but the degree of the
situation in Africa presents a threat to the continent and its
development.

 The International Organisation for Migration (IOM) has

proclaimed that Africa alone loses one-third (1/3) of skilled
personnel and it continues to rise at an alarming rate. The
severe consequences of the situation threaten the overall
development of the continent.
CONT’D
 Global Competitiveness Report (2013)
ranked Rwanda 19th on the international
scene but 1st in Africa followed by Gambia,
Botswana, South Africa, Nigeria, Liberia
and Ghana at 2nd, 3rd, 4th, 5th, 6th and
7th respectively. This means that currently
Ghana is the 7th least affected country
when it comes to brain drain.
THREATENING NATURE OF
BRAIN DRAIN IN AFRICA
 Previously between 1980’s and late 90’s Ghana
lost 60% of the total medical Doctors and it was
reported that a total number of 600 to 700
Ghanaians practiced in the USA alone. At that
time the number represented 50% of the total
number of doctors in Ghana.
 Around the same period, Zambia’s public sector
was only able to retain 50 out of 600 doctors that
were trained by the country’s medical schools.
FACTORS THAT PUSH LABOUR
FROM AFRICA

 Eroding wages due to inflation as well as low income levels compared to

counterparts in other parts of the world
 Poor living conditions and lack of basic facilities such as housing, transport
and health services
 Low levels of prospects for development coupled with unsatisfactory
working conditions and underutilization of the skilled labour
 Inadequacy of support staff, research facilities, tools and equipment and
research funds.
 Political and social unrest
 The educational quality is declining
 Unfair promotions and appointments
 Restricted freedom
FACTORS THAT PULL LABOUR
TO AFRICA
 Higher income and wages
 Better standards and conditions of living
 There are better working conditions such as
career opportunities and professional
development.
 Better support staff, research facilities, tools and
equipment and research funds.
 Political and social stability
 Modern educational system; prestige of ‘foreign
training’
 Meritocracy, transparency
 Intellectual freedom
NEGATIVE IMPACT OF BRAIN
DRAIN
 Reduces the already low quantity of skilled manpower
available in African countries and needed for their
development
 Reduces numbers of dynamic and innovative people,
whether entrepreneurs or academics
 Increases dependence on foreign technical assistance
 Slows the transfer of technology and widens the gap
between African and industrialized countries
 Negatively affects the continent’s scientific output
 Money lost in income tax revenues and in potential
contributions to gross domestic product
POSITIVE IMPACT OF BRAIN
DRAIN
 Contribution of new skills when migrants return
 A remittance from skilled migrants boosts household
welfare
 Remittances support the balance of payments
OTHER PATTERNS OF JOB
MOBILITY
 Wage effects
 Effects of employer size
 Gender differences
 Cyclical effects
 Employer location
ADVANTAGES OF MOBILITY

 Mobility has been generally seen as a good

adventure as it promotes quality of employee
well-being as well as efficient job match.
 Job mobility or the threat of mobility is
essential for the creation of compensating
wage differentials
 It enables the job matches that best suit
changing work environment.
DISADVANTAGES OF MOBILITY
 Lower mobility cost serves as a disincentive
to invest in specific training on the part of
the employer and employee.

 Mobility cost can also bring about

monopsony which is seen as a market
failure.
 LABOUR
DISCRIMINATION
LEARNING OBJECTIVES
 After this section, you should:
 under the dimensions of discrimination in the
labour market of ghana.
 recognize the distinction between premarket and
market discrimination, and how each of them
affects labour-market outcomes.
 understand the various theories of market
discrimination
INTRODUCTION
 The previous chapters have sufficiently enumerated
how wage variations in a competitive labour market is
as a result of disparities in the characteristics of jobs
or the skills required on the job. In simple human
resource management terms, wage differentials
among people should be as a result of the differences
in job descriptions and specifications.

 However and most surprisingly, due to some failures in

the labour market, equally skilled workers employed
on the same job are often treated unequally by virtue
of the workers’ gender, race, place of origin, political
opinion, colour, religion or personal characteristics.
CONT’D
 The chapter vividly demonstrates how economists measure
discrimination in the labour market, specifically focusing on
the commonest forms of discrimination: racial and gender
discrimination. It further explains the gender and race-
earnings differences backing it with evidence from data.
 Finally, the chapter provides insights into the impact of
government policies in ensuring equal economic well-being
of minorities and women across the globe, particularly
examining what the Labour Act of Ghana says about this
issue.
 Labour market discrimination is defined as a situation in
which persons who offer labour market services and who are
equally productive in a physical or material sense are
treated unequally in a way that is related to some
observable personal characteristics (Altoji and Blank, 1999).
CONT’D
 As defined by economists, labour-market discrimination is a
situation in which equally materially productive persons
are treated unequally on the basis of an observable
characteristic (Laing, 2011).
 According to Nobel-prize winning economist Kenneth Arrow,
labour market discrimination occurs as a result of placing
high value on the personal characteristics of the worker that
is unconnected to the worker productivity.
 When members of a minority are treated less favorably than
members of a majority group with the same productive
characteristics, it results in discrimination. The minority
refers to the group that is subject to discrimination, the
majority refers to the group that discriminates (Laing,
2011).
DIMENSIONS OF LABOUR
DISCRIMINATION
 Wage discrimination
 Gender discrimination
 Employment discrimination
WHY DISCRIMINATION ARISE IN
LABOUR MARKETS
 The 'Taste' Model (Gary Becker)
 Employer ignorance
 Occupational crowding effects
DISCRIMINATION AND THE LAW
 The chapter 5 of the 1992 constitution of
Ghana
 Labour Act 651, (2003),
 Section 14, 63 and 87
 Part XVII, section 127
TYPES OF DISCRIMINATION
 There are two main types of discrimination:
mainly
 Premarket discrimination
 Market discrimination
 Earnings discrimination

 Occupational discrimination

 The effects of premarket and market

discrimination are intertwined, especially
since the anticipation of future
discrimination affects current actions (Liang,
2011).
THEORIES OF MARKET
DISCRIMINATION
 Neo-Classical Models of Discrimination
 Becker's 'Employer Taste' Model
 Winners and losers in Becker's 'Employer Taste' Model
 Statistical Discrimination
 Other theories of labour discrimination
 Employee discrimination
 Customer discrimination
UNEMPLOYMENT
LEARNING OBJECTIVES
 After reading this unit you should be able to:

 Define unemployment.
 Understand the various types of unemployment.
 Explain unemployment effects on the economy.
 Distinguish between unemployment and
underemployment.
 Understand the labour market and its trends.
 INTRODUCTION
 When an individual do not have a job and is actively
searching for work this state is called
unemployment. In a society where most people
earn a living by working for others, not being able
to find a job is a serious problem. Unemployment,
the failure or in ability to obtain employment can
also be associated with social and economic costs
for society as a whole.
TYPES OF UNEMPLOYMENT

 STRUCTURAL UNEMPLOYMENT: IT comes about when a labour

market is not capable to offer jobs for everyone who wants one
because there is a difference between the skills of the unemployed
workers and the skills needed for the jobs available.

 FRICTIONAL UNEMPLOYMENT: It can be defined as the time where a

worker is moving from one job to the other or is in a position of
looking for a job.

 CYCLINCAL UNEMPLOYMENT: This type of unemployment is also

known as Keynesian unemployment or the deviant demand. It is
related to the demand for goods and services (BUSINESS CYCLE).
NATURAL RATE OF UNEMPLOYMENT
UNDEREMPLOYMENT
 Underemployment refers to the situation where
the employees capabilities is being underutilised
in his employment. Examples include holding a
part-time job despite desiring full-time work,
and over qualification, where the employee has
education, experience, or skills beyond the
requirements of the job. In this type of
employment, the absence of the individual do
not or less likely affect the company in which
the person finds himself in.
 IT CAN BE AS A RESULT FROM
 OVER QUALIFICATION
 INVOLUNTARY PART-TIME
 OVERSTAFFING
LABOUR UNIONS
INTRODUCTION
 This chapter argues that unions, like employees attempting
to maximize utility and firms, in their quest to make
maximum profits, choose among various alternatives so
that the welfare of their members can be maximized.
 Labour unions are formed to represent labour interest and
to ensure that the conditions of service of workers are
improved. It has long been seen that unions can arise and
thrive only under certain circumstances.
 This chapter delves into how unions influence the terms of
the employment relationship between workers and firms.
We will find that the employment contract is influenced in
virtually every facet by unions. And these include hours of
work, wages, labour turnover, job satisfaction, fringe
benefits, worker productivity and the firm's profitability.
UNIONS IN THE PUBLIC SECTOR
 Much of the research on the economic impact of
public-sector unions is motivated by the fact that
labour demand curves for many essential public-sector
workers-such as police officers, fire-fighters, and
teachers-tend to be inelastic.
 Public-sector employees are usually a powerful
political force, some politicians might be willing to
grant high wage increases to public-sector unions in
exchange for votes.
 Public-sector unions might not generate very high
wage increases because governments do face
constraints. A wage increase for public-sector workers
has to be funded by taxpayers, and higher taxes which
will encourage the outmigration of workers.
MONOPOLY UNIONS
UNION AND LABOUR MARKET EFFICIENCY
CALCULATING EFFICIENCY
THE FIRM’S ISOPROFIT CURVE
 An isoprofit curve gives the various wage-
employment combinations that yield the
same level of profits. A profit-maximizing
firm is indifferent among the various wage-
employment combinations that lie on a single
isoprofit curve.
THE DECISION TO JOIN A UNION
STRIKES
 Is a planned action by workers to shirk their duties when
presenting their glitches to management.
 Workplaceinfo.com defines it as a collective withdrawal of
labour by employees. Under such action, employees refuse to
perform all work, not just selected duties. Strikes are usually,
but not always, organised by a union. The purpose of a strike is
to pressure an employer (or other third party) into complying
with particular demands or refraining from doing something.


 Under the Labour Act 651 2003 strike action may be 'protected
action' if undertaken during a bargaining period for an
enterprise agreement and other formal procedures have been
complied with. Protected action may also cover other types of
industrial action as well as strikes. 'Protected action' means that
industrial tribunals will not intervene to resolve the dispute as
long as it is conducted within the rules of legitimate protected
action
THE HICKS PARADOX: STRIKES
ARE NOT PARETO OPTIMAL
THE OPTIMAL DURATION OF A
STRIKE
UNION WAGE EFFECTS
 Four possible reactions:
1. Spillover effects: Suggests that wages are higher
for union workers but employment level fall among
union workers.
2. Threat effect: . Threat effect is that non-union
employees who are profit maximizing firms are
forced to increase wage to prevent unionisation.
3. Wait unemployment: waiting for union jobs to open
up. Not everyone who loses a job in the union
sector will spill over into the non union sector
moderating downward pressure on nonunion wages
4. Shifts in labour demand: unions put effort to
increase product demand
THREATS AND SPILLOVER
EFFECTS
 Unions have influence not only on wages of union workers
but also on the wage of non-union workers.
 Unions also might have spillover effects on the non-union
sector. As workers lose their jobs in union firms (perhaps
because firms move up along the demand curve in
response to the union-mandated wage increase), the
supply of workers in the non-union sector increases and
the competitive wage falls.
 This influence on no-union sectors is through threat
effects. Threat effect is that non-union employees who
are profit maximizing firms are forced to increase wage
to prevent unionisation. The increased wages are also in
the hope that non-unionized firms will not lose labour to
unionised firms. Threat effect therefore implies that
unions have a positive impact on non-union wages.
NON-WAGE EFFECTS OF
UNIONS
 Unions influence many other aspects of the employment
relationship, including the worker's productivity, labour
turnover, and job satisfaction.

 One channel of union influence is through the “exit-voice

hypothesis”. Unions act as the established mechanism for
informing employers of workers grievances concerning
the employment relationship. In the absence of such
mechanisms (union), individual may face victimisation or
dismissal when they complain. The only way non-union
workers can register their grievance is through “exit”:
where they vote with their feet by leaving the firm. Thus
while unions provide workers with formal channel for
voicing out their grievances, non-union workers can only
grieve through exiting the organization.
UNIONS, PRODUCTIVITY AND
PROFITS
 Unions provide stability of employment to their
workers. This stability or security of employment
favourably impacts on the firms’ productivity.
 As unionized firms increase productivity, this results
in increased profits for the firms. This is because
firms move up the demand curve as union wage
increase. This results in a fall in employment and
an increase in the marginal productivity of labour.
 Also, the union wage increase may “shock” the firm
into more diligent hiring (selection) practices. A
better screened workforce will typically be more
productive. A productive firm is typically a
profitable firm.
  END OF SEMESTER –

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