Table Of ContentCHAFTER 1: Introduction io Labour Market Economics
Labour economics is the study of the cutcomes of decisions each of us can expect to make
over our lifetime. As a subject of inguiry, it 1s relevant to both our everyday lives and to the
broader issues of society. This makes labour economics interesting, practical. and socially
relevant, as well as controversial.
Decisions by Individuals, Firms,
and Governments
Labour market decisions that affect cur everyday well-being are made by the three main
actors. or participants, in the labour market: individuals, firms. and governments.
For individuals, the decisions include when 1o enter the labour force: how much education,
training, and job search to undertake; what occupanen and industry to enter; how many hours
te work; whether to move 1o a different region: when to accept a job; when to quit or look for
another job; what wage to demand:; whether to join a umion or employee association: and
when to retire. There may also be decistons as to how to allocate time beiween market work
and household responsibilities.
Many aspects of labour market behaviour are positive experiences, such as obiaining a job.
getting a wage increase or promotion, or receiving a senerons pension. Other experiences are
negative, such as being unemploved or permanently displaced from cne’s job, or experiencing
discrimination or poverty.
Employers have to make decisions also, such as how many workers 1o hire: what wages and
benefits to offer; what hours of work to require; when to lay off workers or, perhaps ultim-
ately, to close a plant; what to cutsource; and how to design an effective pension and retire-
ment policy. These decisions are increasingly being made under pressures from elobal
competition, free trade, industrial restructuring, deregulation, and privatization. As well, the
decisions of employers must be made in the context of a dramatically changing work force,
with respect to such factors as age, gender. and ethnic diversity.
The legislative environment within which employers operate is also constantly changing in
a number of areas: human righis and anti-discrimination legislation; employment standards
laws with respect to things such as minimum wages, maternity leave, and hours of work and
overtime; legislation regarding workers' compensation and occupational health and safety;
legislation regarding pensions and mandatory retirement; and labour relations laws that regu-
late the process of collective bargaining.
Governments, throngh their legislators and policymakers, establish the environment in
which employvees and employers interact. In part. this involves a balancing act between pro-
viding rights and protection to individuals while not jeopardizing the competitiveness of em-
plovers. It also involves decisions as tc what to provide publicly in such areas as training,
imformation, employment insurance, workers’ compensation, vocational rehabilitation. 1n-
come maintenance, pensions, and even public sector jobs.
Labour economics deals with these decisions by individuals, employers, and govern-
meni—decisions that affect our everyday lives and that lead to consequences we can all ex-
pect to experience. While this makes labour economics interesting and relevant—and
controversial—it also puts a premium on the existence of a solid framework from which to
analyze these decistons and their consequences. The purpose of this book 15 to provide and
apply such a framework.
Parts of the book may be more challenging and seem less interesting than the sections
more cbviously related to policy and other applications; however, they provide the basic tools
and theoretical framework that are crucial to understanding labour market behaviour. In many
cases, the immediate application of economic theory to labour market issues facilitates under-
standing of the basic tools of economics itself; that is, the application economic theory to in-
teresting and important issues in the labour market facilitates a deeper understanding of
economic theory itself.
In labour economics, however, the ultimate usefulness of economic theory is in building an
understanding of labour market behaviour. “The proof of the pudding 1s in the eating™; that is,
CHAPTER 1! Introducticn to Labour Market Economics
the usefulness of basic economic theory and empirical methods in the labour area must be
demonstrated by 1ts ability 10 help us understand labour market behaviour. This is one of the
objectives of this book.
Subject Matter of Labour Market Economics
Labour market economics involves analyzing the determinants of the various dimensions of
labour supply and demand, and their interaction in alternative market siructures to determine
wages, employment, and unemployment. Behind this simple description, however, lies a com-
plex array of behaviours, decision making, and dimensions that often relate labour economics
with other disciplines and areas of study.
Labour supply. for example, invelves a variety of dimensions. It includes population
growth, which involves decisions pertaining to fertility and family formation, as well as 1o
immigration and emigration, all of which are amenable to economic analysis. Labour supply
alsc involves the dimension of labour force participation: that is, determining what portion of
the population will participate in labour market activities as opposed to other activities, such
as household work, education, retirement, or pure leisure. For those who participate in the
labour market there are consideration, such as of hours of work, including trends and cyclical
patterns, and such phenomena as overtime, moonlighting, part-time work, work sharing, flex-
ible work-time arrangements, compressed workweeks, and working from home. The latter has
taken increased importance in the pandemic of 2020. These things ue labour economics to
such areas as demography and personnel and human resource planning, as well as behavioral
aspects related 1o psychology.
In addition to these guantiry dimensions of labour supply, there are also guafiry dimensions
that are amenable 10 economic analysis. Quality dimensions include education, training, and
health. These dimensions, along with labour mobility, are often analyzed as human capital
investment decisions, emphasizing that they involve incurring costs today in exchange for
benefiis in the future. Qualhity dimensions of labour supply also include work effort and inten-
sity—dimensions that are analyzed in the context of efficiency wage theory and optimal com-
pensation systems. This connects labour economics to issues of personnel and human resource
management as well as to the key policy 1ssue of productivity, often involving education and
training considerations.
Labour supply analysis also involves determining the work incentive effects of income
maintenance and tax-transfer schemes. Such schemes include demogrants (e.g.. the (3d Age
Security Pension or universal basic income), negative income taxes, wage subsidies, in-
come taxes, unemployment insurance. welfare, disability paymeats, workers’ compensa-
tion, and private and public pension plans. This ties labour economics to the interesting and
controversial areas of poverty and income distribution, as well as to tax and social welfare
policy.
The labonr demand side of the picture focuses on how firms vary their demand for labour
m response to changes in the wage rate and other elements of labour cost, including fringe
benefiis and legisiatively imposed costs. The impact of quasi-fixed costs that may be involved
in hiring, training, and even ierminating workers are also important. Since the demand for
labour is a derived demand—derived from the demand for the firm’s outpui—this side of the
picture 18 influenced by such 1ssuees as free trade, global competition and ouisourcing, indus-
trial restructuring, privatization, public sector retrenchment. mereers and acquisitions, and
technological change. It is increasingly imporiant to analyze the demand side in the context of
changes that are occurring in the international glebal environment.
The various dimensions of labour supply and demand are interesiing and informative not
only in their own right but also because their interaction determines other key labour market
outcomes: wages. crmpleyment, unemployment, and labour shortages. These outcomes are
mfluenced by the ineraction of labour supply and demand in alternative market structures,
mcluding the degree of competition in the product market as well as the labour market. They
are also influenced by unions and collective bargaining. as well as by legislanive interventions,
CHAFTER 1. Introduction 1o Labour Market Economics
including minimum wages and equal pay and eqgual opportunity laws. This highlights the
interrelaiionship of labour economics with industrial relations and labour law.
The various wage structures that emerge include wage differentials by occupation (e.g..
engineer versus waiter), by industry (e.g., public versus private sector), by region (e.g., New-
foundland and Labrador versus Ontario), and by personal characteristics {e.g., men versus
women). Economic analysis outlines the determinants of these wage structures, how and why
they change over time, and how they are influenced by such factors as demand changes, non-
wage aspects of employment, and noncompetitive factors including unions, legislation, occu-
pational licensing, and labour market impecrfections. For some wage structures, like
male—female wage differentials. the economic analysis of discrimination offers msight into
why wage differentials arise and persist, and how they will be affected by legislation and other
policy initiatives.
Wage differentials between union and non-union workers can be explained by basic eco-
nomic analysis that incorporates bargaining theory. In order to fully understand how unions
affect wages. 1t is also necessary to understand why unions arise in the first place and how
they affect the non-wage aspecis of employment. Labour economics is also applied to under-
standing why certain institutional arranpgements exist in the labour market. incleding unions,
seniority-based wage increases, and various personnel practices.
There is increasing recognition that wages can have strong impacts on incentives, such
as to acquire education and training. to move, to stay with a job or quit or retire early. and
to work harder and more productively. The effects of these changes are analvzed in various
areas of labour market economics: human capital theory, optimal compensation systems,
efficiency wages, and private pension plan analysis. This, again, highlights the interrela-
tionship of labour economics with industrial relations and personnel and human resource
management.
Unemployment 1s analyzed at both the microeconomic and the macroeconomic levels. At
the micro level. the emphasis is on theories of job search. imphicil contracts and efficiency
wages, and the impact of unemployment insurance. At the macro level, the relationships be-
tween wage changes, price inflation, productivity, and unemployment are emphasized.
Preliminary Explorations of Labour
Market Outcomes
The fundamental subject mater considered by labour economics is how individuals earn a
living, and especially how they do so by selling their labour services in the labour market.
Labour economists are interested in both the average level of earnings from the market and the
distribution; that is, how unequal are labour marketl outcomes {and why)?
Table 1.1 shows selected descriptive statistics concerning these outcomes. The tabulations
are based on a large sample of approximately 34,000 Canadians, referring to their incomes
and labour activity in 2017, The sample is drawn from the Canadian lncome Survey, an an-
nual cross-sectional survey of household and individual income by source that is also linked
tc the Labour Force Survey. In this table, we restrict attention to individuals in their main
working years, between the ages of 20 and 65. It shows the average levels of various types of
income, and the percentage of people with each particular source of income. The averages are
alsc broken down separately for men and women.
Looking first at the full sample, we see that earnings (from the labour market or self-
employment} averaged $41.348 per person. Labour earnings are, by far, the largest source of
mcome tor Canadians: they constitute 90 percent of non-transfer income and 83 percent
of total income. Income is earned by 83 percent of Canadians aged 20 to 65 at some point
during the year, though they may not work for the entire year. Goverament transfers, such as
employment insurance or social assistance, are another important source of income received
by 60.1 percent of the sample. Transfer income 15 also closely related to labour market out-
comes, because it is low labour income that usually qualifies someone to receive the transter.
Finally, note that income taxes reduce earned income by about |7 percent {on average}.
CHAPTER 1! Introduction to Labour Market Economics 5
TABLE 11 Sources of lncome for Individual Canadians, 2017
Full Sample Men Women
Mean % Positive Mean % Positive Mean % Positive
Earnings 41,348 82.6 50,824 86.2 31,910 79.0
Investment income 2542 271 2906 27.7 2,179 26.5
FPension income 1,262 4.0 1,484 4.3 1,040 3.7
Otherincome 957 14.2 971 13.7 933 14.7
Government transfers 3,728 60.1 2,495 52.8 4955 68.5
Subtotal 49,831 98.1 58,681 98.6 41,017 97.6
Income taxes 8,391 70.0 11,168 75.2 5,625 64.8
After-tax total 41,440 98.2 47,512 98.7 35,392 97.8
Annual hours worked 1,411 81.1 1,683 85h.3 1,230 76.8
Average hourly wage 29.77 73.3 3257 76.7 2B6.67 bs8.8
Worked, but not self-employed 64.7 66.1 63.3
MOTES:
.Income figures are average values for all individuals aged 20 1o 65, in 2017 doflars. The "% positive™ column reports the percentage of individuals with positive
[or negative) incame for that source. The income averages are calculated over the whole sample, including individuals with 2ero income.
2. The "average hourly wage™ is the implicit average hourly wage calculated by dividing annwal wage and salary income By toral annual hours worked. Note that
the produrct of hours and wages will not equal earnings, and the average wage is calculated only over those who worked. SOURCE: Adapted from Statistics
Canada's Canadian lncome Survey public use microdata, 2017 All computations on these microdata were prepared by the authors. The responsibility for the use
and interpretation of these data is entirely that of the authors.
Regarding labour market activities, &1 percent of Canadians in the sample worked at
least one hour over the year, the average being 1,411 hours worked. The average wage was
$29.77 per hour. Finally, excluding people who worked in self-employment (i.e.. worked for
themselves), it remains the case that almost two-thirds (64.7 percent) of individuals had the
labour market as a source of earned income.
The nexi four columns compare these outcomes for men and women. Most striking is the
gap between men’s and women's earnings; the ratio of men’s 1o women’s earnings is 1.59.
Some of this can be explained by differences in hours worked. Mea were slightly more likely to
work (85.3 percent versus 76.8 percent), and they work longer hours, an average of 1,593 hours
per year versus 1,230. The male—female ratio of hours worked is thus only .30, which falls
short of explaining the earnings difference. We can also see that the hours explanation is not
the whole story, because the ratio of men’s to women's wages is $32.57/%$260.67 = 1.22. Later
in this book, we spend considerable time trying 1o explain the earnings and wage differentials
between men and women, in particular assessing the extent to which this differential is driven
by discriminaticn as opposed to “legitimate™ (or explainable) differences in productivity.
Finally, note that some of the earnings difterential is offset by the higher taxes paid, and lower
government transfers received, by men.
While the averages shown in Table 1.1 are informanve, they hide considerable variation, or
dispersion, of outcomes across individuals. In Figure 1.1 (on the nexi page) we plot a histo-
gram of the distribution of labour earnings. In this figure, we restrict our sample 1o these who
have positive earnings and whose earnings come exclusively from wages and salaries (i.e.. we
exclude the seif-employed). Each bar on the histogram shows the fraction of individuals with
a particular level of earnings. To aid in interpretation. we also show three reference lines: the
10th, 50th, and 90th percentiles.
While earnings may range from a low of $1,200 per year to a high of $220,000 per year,
maost people had earnings between $9,750 and $100,000.'The 10¢h percentile (or first decile)
is $9,730. This means that 10 percent of individuals had earnings below $9,750 per year.
! For clarty of the graphics. we have immed the sample of the Towest and highest camers, dropping U wp and boltom | peccenl
fromn the smple. However. the percentiles are calcubiated owver the enitine saonple.
CHAPTER 1: Introduction 1o Labour Market Economics
8
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9 25,000 50,000 75,000 100,000 150,C00 200,000
Wage earnings
FIGURE 1.1 The Distribution of Individual Labour Earnings, 2017
This is a histogram showing the distribution of labour earnings for a targe sample of Canadians in
2017 Each bar shows the proportion of the sample with earnings in the range indicated on the hori-
zontal axis. For reference purposes, we also show vertical lines corresponding to the 1Gth percent-
ile, median, and 90th percentile.
MOTES:
1. Ir this figure, we show the distribution of average annual wage earnings. For clarfty, we show only the middie
88 percent of the distribution; that is, that part of it with [abour earnings above the first percentile ($1,200) and
below the 99th percentite {($220,000).
2 Reference lines cormesponding to the 10th percentite ($9,750), median ($43,000), and 90th percentife
{$100,000) are also shown.
SOURCE: Adapted from Statistics Canada: see Table 11.
The median (or 50th percentile} is $43,000. This means that half of the sample had earnings
below, and half above, $43,000. Finally, the 90th percentile is $100,000, indicating that
90 percent of people had incomes below this level, or, conversely. that 10 percent
had earnings higher than this. One common measure of income dispersion is the ratio of
incomes at the 90th to the 10th percentiles. In this case, a “high income™ earner (at the 90th
percentile) earned about 10 times more ($100,000/$9,750} than a “low income™ person
(at the 10th decile).
How much of this difference is due to differences in wage rates, which depend on individ-
ual preductivity, education, and luck, and how much depends on differences in hours worked,
which may depend on a variety of factors, ranging from preferences to constraints emanating
from household tasks to the tnability to find work (unemployment}? To take a quick look at
this, we can break total earnings, WH, into its constituent parts: wages, W (or more precisely,
average hourly earnings), and hours, H. The separate distributions for hours and wages are
shown in Figures 1.2 and 1.3.
Looking first at hours, there 1s considerable variation, with hours ranging from as low as
91 per year to as high as 3,120 per year. Recall also that almost 20 percent of individuals do
not work at all (i.e., have zero hours}, and they are not represented in this figure. Someone
may have high earnings because they work a lot (3,000 hours corresponds to 58 hours per
week, 52 weeks per year!), or has low earnings because they work very little, if at all. Despite
the dispersion in hours worked. most people work around 2,000 hours per year. which
CHAFPTER 1- Introduction to Labour Market Economics
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Hours worked last year
FIGURE 1.2 The Distribution of Individual Annual Hours Worked, 2017
This is a histogram showing the distribution of houres worked for a large sample of Canadians in
2017, Each bar shows the proportion of the sample with hours worked in the range indicated on the
horizontal axis. There are 20 bars, so each bar corresponds to {approximately} a range of 150 hours.
For reference purposes, we atso show varticat lines corresponding to the 10th percentile, median,
and S0th percentile.
MOTES:
+ This figure shows distribution of annual hours worked in 20072, For clatity, we only show the middle 93 percent of
the distribution; that is, that part of it with hours above the first percentile (8} and below the B8th percentile
{2120}
2 Reference lines corresponding to the 1th percentile (640), median [1,950), and S0th percentile {2,184 are also
showr.
SOURCE: Adapted from Statistics Canada: see Table 1.1,
corresponds to the typical 40 hours per week for 50 weeks per year. One of the primary
objectives of labonr economics is to explain the variation in hours across individuals, and, in
particular, why some people work fewer than 100 hours per year (if at all} while others work
more than 2,500 hours per year. Are low hours voluntarily chosen, or are they the result of
unemployment or other constraints?
The wage distribution is depicted in Figure 1.3 {on the next page). Average hourly earnings
are a noisy measure of a “true™ hourly wage rate since not everyone has a constant wage. For
example. many people are paid an annuoal salary that is independent of hounrs worked. That
said, “average hourly earnings” yields a reasonable estimate of a person’s wage rate for these
purposes. Given the noisy nature of the data, for clarity in the graph we trim wages below
$5.00 per hour and above $100.00 per hour (there are very few such ohservation and they
distort the scale of the graph). Most people had wages between $11.56 and $54.95 per hour,
corresponding to the 10th and 90th percentiles.
Notice that the ratio of wages at the 90th to the 10th percentiles is 4.73, which is much less
than the case for earnings; that 1s, wages are considerably more equally distributed than earn-
ings. The higher inequality of earnings results from the combined inequality of hours and
wages. Still, if everyone is created equal, why 15 there such dispersion in wages? Labour
gconomists attempt to answer this question, exploring the factors discussed in the previous
section and relying heavily on the neoclassical supply and demand model.
CHAFTER 1. Introduction to Labour Market Economics
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Average hourly eamings
FIGURE 1.3 The Distribution of Individual Average Hourly Earnings
(Wages), 2017
This is a histogram showing the distribution of average hourly earnings {wages) for a large sample
of Canadians in 2017, Each bar shows the proportion of the sample with wages in the range ingi-
cated on the horizontal axis. For reference purposes, we also show vertical lines corresponding to
the 10th percentile, median, and 90th percentile.
MOTES:
. In this particular figure we show the distribition of average hourly earnings (wagqes). For clarity, we only show
the part of the distritiution between $5.00 per hour and $100.00 per hour.
2 Reference lines corresponding to the 0th percentite ($11.56), median ($25.41), and 90th percentile ($54.95) are
alzo shown.
SOURCE: Adapted from Statistics Canada: see Table 11.
The Supply and Demand Model:
Workhorse of Labour Economics
The wide-ranging set of topics discussed in the first few pages hints at the breadth of subject
matter in labour economics, while the previcus empirical explorations show how this broad
range of labour market cutcomes can be distilled into two variables: employment and wages.
Explaining employment and wage cutcomes will go a considerable way toward explaining
many diverse labour market outcomes. 1t just sc happens that econcmists have a powerful set
of tools with which to explain quanttties and prices—in this case, employment and wages.
The foundation of that set of 1ools is the standard supply and demand model, which forms the
core of this textbook.
There are two key ingredients in the ncoclassical supply and demand model:
1. Behavionral assumptions about how buyers and sellers respond te prices and other factors.
2. Assumptions about how buyers and sellers interact, and how the market determines the
level and terms of exchange.
Throughout this text we will develop, build upen. and critically evaluate both ingredients.
For now, we provide a quick overview of the supply and demand framework, with special
emphasis on the natre and interpretation of the competitive equilibrium.
CH APTER 1! Introduction to Labour Market Economics
Wages NS
W [~ o m o mmmsm sy
w* ___________________
ND
N N* N# Employment
FIGURE 1.4 Wages and Employment in a Competitive Labour Market
The labour supply curve, N, depicts the desired amount of labour that individuals would like to sell
at each wage rate, holding all other factors constant. Similarly, the demand curve, NP, shows how
much labour firms would like to hire at each wage rate ftholding all other factors constant). The equi-
librium combination of employment and wages (W*, N™ is given by the intersection of supply and
demand. Only at W* is it the case that the quantity supplied equals the quantity demanded.
The familiar supply and demand model as applied to the labour market is depicted 1n
Figure 1.4. The objective of this model is to yvield a prediction concerning the level of employ-
ment and wages likely to prevail in a market. With a well-developed behavicural model, we can
also conduct “thonght experiments.” whereby we change assumptions concerning the supply or
demand side of the market, and explore the logical consequences for employment and wages.
The supply curve, N3, represents the behaviour of the sellers” side of the market. We usually
imagine that the labour supply decision is made by individuoals, and that it depends on many
variables. However, in this exercise we hold all factors constant except the wage, and then plot
the amount of labour that would be offered for sale at each wage rate. Similarly. the demand
function NP shows the amount of labour that firms would be willing to hire at each wage rate.
Obviously, labour demand will also depend on many variables besides the wage, but these
variables are held constant. The guestion is, then, if individuals and firms simultaneously act in
their own best interests, selling and buying labour according to their supply and demand curves,
what wage and employment combination will prevail in the market? The assumption of com-
petitive behaviour permits strong predictions concerning the labour market ouicomes.
Wages and Employment in a Competitive
Labour Market
In the simplest model, buyers and sellers of labour interact competitively in the labour mar-
ket—that is, they take the market wage as given and supply or demand the relevant quantity of
labour according to their supply or demand functions.
No single agent has the power to affect the market wage by its actions. How then is the
market wage determined? We might imagine a mythic auctioneer using trial and error to es-
tablish a market clearing price; however, such an anctioneer does not actually exist. Before
discussing how the market wage is determined, economists try t¢c characterize the equilib-
rivm; that is, the properties the market wage should satisfy. Of the continuum of possible
wages that conld prevail in the market, economists focus on the wage that clears the market—
the wage that sets supply equal to demand. This equilibrinm is depicted in Figure 1.4.
0 CHAFTER 1: Introduction o Labour Market Economics
Why is this intersection so appealing to economists? Fiest, at W, supply equals demand at
N*: that is, at (W*, N¥) is the optimal labour supplied by workers (it lies on N} and the opti-
mal labour demanded by firms (it lies on NP}. The easiest way to see why this is, a1 least, a
reascnable candidate combination of W* and N* to prevail in the market is by considering
any other combination. We maintain the assumption that the agents in the labour market are
optimizing: that is. they will choose to supply or demand N according to their supply and de-
mand functions. Let us also assume that exchange is voluntary: that is, individuals cannot be
forced to buy or sell unless they choose o do so.
Consider a wage W' above W*. At this wage, NP’ will be exchanged since firms cannot
be forced to hire any more labour. At this wage, supply exceeds demand. There is, in prin-
ciple. no reason why this wage will not prevail in the market, but it would be difficult 1o
characterize this as a markei equilibrium. At this wage there would be workers willing
to work for slightly less and firms willing to hire at a slighily lower wage. Thus, there would
be competitive pressures for the wage to fall. In the absence of rigidities, we might expect
wages o fall toward W¥. A similar areument (in reverse) would apply to a situation where
the market wage was below W™*. Thus, if we believe that there are equilibriating mechan-
18sms in the market, the combination of W* and N¥ is a reasonable candidate to prevail in
the labour market.
[t 1s worth exploring in more detail some of the features and implications of the competi-
tive equilibrium, since this market-clearing model underlies most of neoclassical econom-
ics. One implication is that in markets with homogeneous workers (individuals who are the
same 1n terms of productive characteristics} and homogeneons jobs (jobs that are equally de-
sirable from the workers™ point of view), wages will be equalized across workers. Firms would
not pay more than the going market wage, because they can employ as much labour as desired
at the going wage rate. Workers would not accept less than the market wage because there are
equally satisfactory jobs available at the going wage raie. We can, thos, vse the supply and
demand model 1o explore the determinants of wages across markets. an important first step in
trying to explain wage differennials across different groups of individuals. But our first predic-
Lion 15 thai otherwise identical workers should be paid the same.
This implication of the basic competitive equilibrium is illustrated in Figure 1.5 for the
case of two industries or regions employing the same type of homogeneous labour. Panel {a)
shows the situation in which the labour market is not 1n equilibrium {even though demand
equals supply in each individual labour market) becanse employees in sector A are receiving
a lower wage than employees in secior B. In the presence of full information, and in the ab-
sence of mobility cosis (costs of changing from one sector to another}, workers would move
from sector A to sector B, thus increasing labour supply in B and reducing it in sector A. As a
consequence, wages would fall in sector B and rise in sector A. This process would continue
uniil wages are equalized across the two sectors, as tllustrated 1n panel (b}.
Mobility costs could account for some persistence of earnings differences across sectors, at
least in the short run, especially if the sectors are geographically separated. However, these
differences are unlikely to persist in the longer run. As older workers retire and young workers
enter the labour marcket, new entrants will tend to choose the higher-paying sector over the
lower-paying sector, thus bringing aboul wage equality across the homogeneous work force.
Another implication of the basic competitive equilibrizm is the absence of involuntary
uncmployment. This is also illustrated in panel (b) of Figure 1.3, [n labour markei equilib-
rium, there are no individuals who would like 10 work at the going markel wage, W, unable
to find work at that wage. There are some individuals whe are “voluntarily unemploved™ in
the sense that they would be willing to work at a higher wage (e.g.. at wage W ;3. but at the
wage W, the value of their time spent in leisure or household production exceeds the value of
their time spent in market work. (This aspect is evident from the nsing labour supply curves
in these two labour markets.) This labour supply decision may explain our finding in Figure 1.2
that many individuals choose low hours of work.
The absence of involuntary unemployment implies that there are also no unexploited
“eamns from trade” that would mutpaily benefit emplovers and unemployed workers. For ex-
ample, if there existed an unemploved worker who would be willing to work at a wage below
the existing market wage, both the worker and the hiring firm would benefit from a job match.
