Labour economics

Some theories focus on human capital, or entrepreneurship, (which refers to the skills that workers possess and not necessarily the actual work that they produce).

It looks at how these interactions influence macro variables such as employment levels, participation rates, aggregate income and gross domestic product.

The unemployment level is defined as the labour force minus the number of people currently employed.

Changes in the labour force are due to flow variables such as natural population growth, net immigration, new entrants, and retirements.

[6] Natural Unemployment Unnatural Unemployment Aggregate expenditure (AE) can be increased by increasing consumption spending (C), investment spending (I), government spending (G), or increasing exports (X), since AE = C + I + G + X. Neoclassical economists view the labour market as similar to other markets in that the forces of supply and demand jointly determine the price (in this case the wage rate) and quantity (in this case the number of people employed).

In microeconomic theory, people are assumed to be rational and seeking to maximize their utility function.

If consumption is measured by the value of income obtained, this diagram can be used to show a variety of interesting effects.

The wage increase shown in the previous diagram can be decomposed into two separate effects.

The intuition behind this latter case is that the individual decides that the higher earnings on the previous amount of labour can be "spent" by purchasing more leisure.

If the substitution effect is greater than the income effect, an individual's supply of labour services will increase as the wage rate rises, which is represented by a positive slope in the labour supply curve (as at point E in the adjacent diagram, which exhibits a positive wage elasticity).

This positive relationship is increasing until point F, beyond which the income effect dominates the substitution effect and the individual starts to reduce the number of labour hours he supplies (point G) as wage increases; in other words, the wage elasticity is now negative.

Other variables that affect the labour supply decision, and can be readily incorporated into the model, include taxation, welfare, work environment, and income as a signal of ability or social contribution.

It is typical in economic models for greater availability of capital for a firm to increase the MRP of the worker, all else equal.

[12] According to neoclassical theory, over the relevant range of outputs, the marginal physical product of labour is declining (law of diminishing returns).

This constantly restructures exactly what a labour market is, and leads way to cause problems for theories of inflation.

Some labour markets have a single employer and thus do not satisfy the perfect competition assumption of the neoclassical model above.

[13] Since it is difficult for the employer to identify the hard-working and the shirking employees, there is no incentive to work hard and productivity falls overall, leading to the hiring of more workers and a lower unemployment rate.

One solution that is used to avoid a moral hazard is stock options that grant employees the chance to benefit directly from a firm's success.

However, this solution has attracted criticism as executives with large stock-option packages have been suspected of acting to over-inflate share values to the detriment of the long-run welfare of the firm.

Another solution, foreshadowed by the rise of temporary workers in Japan and the firing of many of these workers in response to the financial crisis of 2008, is more flexible job- contracts and -terms that encourage employees to work less than full-time by partially compensating for the loss of hours, relying on workers to adapt their working time in response to job requirements and economic conditions instead of the employer trying to determine how much work is needed to complete a given task and overestimating.

[citation needed] Another aspect of uncertainty results from the firm's imperfect knowledge about worker ability.

[13] One way to combat adverse selection, firms will try to use signalling, pioneered by Michael Spence, whereby employers could use various characteristics of applicants differentiate between high-ability or low-ability workers.

However, signalling does not always work, and it may appear to an external observer that education has raised the marginal product of labour, without this necessarily being true.

One of the major research achievements of the 1990–2010 period was the development of a framework with dynamic search, matching, and bargaining.

"[15][16] The focus is on "how firms establish, maintain, and end employment relationships and on how firms provide incentives to employees," including models and empirical work on incentive systems and as constrained by economic efficiency and risk/incentive tradeoffs relating to personnel compensation.

In the context of labour economics, inequality is usually referring to the unequal distribution of earning between households.

The higher the Gini coefficient is calculated to be the larger inequality exists in a region.

The Oaxaca decomposition is a common method to calculate the amount of discrimination that exists when wages differ between groups of people.

There are many other taste models other than these that Gary Becker has made to explain discrimination that causes differences in hiring in wages in the labour market.