CH 5: Frictions in the Labor Market
• Quasi-fixed labor costs
– Types of QF costs
– Effects of QF costs on hours/workers
– Training as a QF cost & consequences of training
investments for structure of pay.
Monopsony
• The firm’s labor supply curve is upward sloping
• Sources of monopsony:
– Mobility costs
– Job search and information costs
– Small # of competing employers
Monopsony
• The firm’s labor supply curve is upward sloping
MEL
LS
MRP
•Profit maximizing wage? Level of employment?
• MRP vs. W in a monopsony? Perfect competition?
•Effect of a change in MRP? Perfect competiton vs. monopsony?
Quasi Fixed Labor Costs, Walter Oi (1962).
The cyclical behavior of labor markets reveals a number of puzzling
features for which there are no truly satisfying explanations.
Included among these are
1. occupational differences in the stability of employment and
earnings
2. the uneven incidence of unemployment
3. the persistence of differential labor turnover rates
4. discriminatory hiring and firing policies
I believe that the major impediment to rational explanations for
these phenomena lies in the classical treatment of labor as a
purely variable factor.
Quasi-fixed labor costs
• Examples
– Hiring costs
– Maintenance of payroll records, issuing
checks
– Training costs
• Explicit monetary costs
• Implicit opportunity costs of trainer’s time and
capital used
• Implicit opportunity cost of trainee’s time
Quasi-fixed labor costs
Avg. hours of formal instruction by training
personnel
hours spent by management in orientation,
informal training, extra supervision
hours spent by co-workers in informal
training
hours spent by new worker watching
others do work
Total
Source: Ehrenberg and Smith
19
59
34
41
153
Employee Benefits
Quasi-fixed labor costs
• Hiring and training costs are quasi-fixed
• Some benefits are quasi-fixed, others are not.
– pensions
• Are contributions a fixed dollar amount per
employee, % of pay, or % of pay up to a maximum
value?
– legally required benefits
• many are % of pay up to a maximum.
– health insurance
• typically, a worker is either covered or not and the employer
contribution is independent of incremental hours worked.
Optimal Mix of Workers and Hours
 MEM = marginal expense of an additional worker
= W*H + Q
where W =wage rate, H=hours per week, Q=QFC per worker
 MEH = marginal expense of an additional hour of work for all its
existing workforce.
= W*N
where W=wage rate and N=number of workers
 MPM = MP of an additional worker for H hours.
 MPH = MP of an additional hour of work for N workers.
Optimal Mix of Workers and Hours
MEM /MPM = MEH /MPH
What should firm do if
– QFC rises?
– Wage rate rises?
Optimal Mix of Workers and Hours
•
APPLICATIONS
– raising the salary cap for payroll taxes
– increasing the payroll tax rate on capped payroll
taxes.
– effect of training costs on likelihood of part-time work.
– the over-time premium.
– mandatory health insurance coverage for full-time
workers
– worker preferences for part-time as opposed to fulltime work
– why do firms sometimes institute mandatory over-time
rules
• would firms ever pay an over-time premium
even in the absence of federal legislation?
Training Investments
The firm's decision to invest in training a worker in a twoperiod model:
Period 0:
• pay Z to train the worker
• pay W0 in wages to the worker
• worker produces MP0
Period 1:
• pay W1 in wages to the worker
• worker produces MP1
If worker is not trained, MP is fixed at MP* in both periods
and the worker can receive a wage of W*=MP* at a
competing firm.
Training Investments
Optimal employment
will be at E*
Training Investments
• How are W0 & W1 determined?
• Must offer a competitive PV of
compensation
• W0 + W1/(1+r) > W* + W*/(1+r)
Training Investments
Examples: Suppose that W*=100 and r=6%.
Alternative W0 W1 Present value (r=6%)
• A
128 70 194
• B
100 100 194
• C
81 120 194
• D
62 140 194
• E
43 160 194
Why would the firm be reluctant to offer A or B?
Why is worker reluctant to accept C, D, or E?
Training Investments
• Firms that invest in training will want to
– Defer pay
– Find ways to restrict mobility of workers
Training Investments
GENERAL VERSUS SPECIFIC TRAINING.
• General training increases productivity at all
firms.
• Specific training increases productivity only at a
specific firm (presumably the firm providing the
training).
• If training is general, a firm will have difficulty
recouping its investment in training.
Training Investments
• With general training, firm must pay W1>MP1
in second period unless there is a way to
prevent worker from quitting.
• Since W1>MP1, firm cannot recoup training
investments by underpaying in second period
• With specific training, firm can pay
MP1*<W1<MP1 and recoup some of its training
investments. Firms can recoup investment in
specific training with restricting mobility.
Training Investments
• How should training investments affect firm
layoff behavior if product demand falls?
• How does the above affect the cyclical nature of
productivity?
• If there are large training costs, firms should be
concerned about screening out quitters.
– Statistical discrimination
– Fringe benefit packages
– Discount rates
Investments in Training
• Employer investments in general
training
– Armed forces
– Sports contracts
– Employer pays for employee education
while “on the job”