Labor Market Concepts: Unemployment, Wages, and Discrimination

Unemployment Types and Dynamics

Unemployment is a multifaceted economic phenomenon, categorized into several distinct types based on its underlying causes.

Frictional Unemployment

Frictional unemployment arises because both workers and firms need time to locate each other and to digest the information about the value of a potential job match. It is a natural part of a dynamic labor market.

Structural Unemployment

Structural unemployment occurs if the skills or characteristics of persons looking for work do not "fit" the jobs available. This mismatch can be due to technological changes, shifts in industry, or geographical immobility.

Cyclical Unemployment

Cyclical unemployment arises because the economy has moved into a recession. During such periods, there is an excess supply of workers, and the market does not clear because the wage is often "sticky" and cannot adjust downward quickly enough.

Seasonal Unemployment

Seasonal unemployment affects workers in industries with predictable fluctuations, such as the garment and auto industries. Workers are laid off regularly, for instance, when new models are introduced, and firms shut down for retooling. This type of unemployment is usually very predictable.

The overall unemployment rate is typically smaller when jobs are more stable and larger when unemployment spells last longer.

Labor Market Equilibrium and Wages

Understanding market equilibrium is crucial for analyzing wage determination and employment levels.

Minimum Wage and Monopsony Power

A well-designed minimum wage can completely eliminate the market power of monopsonists and prevent the exploitation of workers, leading to more equitable wage outcomes.

Upward-Sloping Supply Curve for Competitive Firms

Can a competitive firm face an upward-sloping supply curve?

• Costly Job Changes: Potential employees find it costly to change jobs, so a firm must be willing to pay higher wages to attract workers from other employers. This dynamic leads to an upward-sloping supply curve for labor.
• Monitoring Challenges and Efficiency Wages: If an employer finds it harder to monitor its workers as employment (E) rises, they may implement efficiency wages to prevent workers from "shirking." This can also result in an upward-sloping supply curve for labor, as higher wages are needed to incentivize productivity.

Labor Market Discrimination Analysis

Discrimination in the labor market can lead to significant wage differentials.

Oaxaca Decomposition Technique

The Oaxaca decomposition is a statistical technique that breaks down the raw wage differential between groups into two main portions: one related to differences in skills and another attributable to labor market discrimination.

Impact of AFQT Scores on Wage Differentials

A significant finding is that racial differences in the Armed Forces Qualification Test (AFQT) score account for practically the entire wage differential between young Black and White workers. The adjusted Black-White wage ratio jumps to about 0.95 (from an actual wage ratio of 0.8) once differences in AFQT scores between the groups are controlled for.

In short, much of the wage differential between young Black and White workers disappears once the wage data are adjusted for racial differences in AFQT scores. However, there is convincing evidence that the AFQT score is not a straightforward measure of innate ability. Persons who have more schooling or attend better schools tend to have higher AFQT scores. The score partly measures skills acquired prior to a person entering the labor market. This suggests that the importance of direct labor market discrimination in the U.S. labor market may have diminished substantially in recent decades, with pre-market factors playing a larger role.

Compensating Wage Differentials

Compensating wage differentials are wage differences that arise to offset the non-pecuniary characteristics of jobs.

Challenges in Compensating Wage Differentials

Why do compensating differentials often appear to go the "wrong" way?

Estimates of compensating wage differentials (CWDs) associated with particular job characteristics are valid only if all other factors that influence a worker’s wages are held constant. This is often difficult to achieve in empirical studies.

• Correlation with Ability: More able workers often command higher wages and have access to higher levels of "good" job amenities. This positive correlation between ability, wages, and amenities can work against the CWD hypothesis, making it seem as though undesirable jobs pay more, or desirable jobs pay less, than expected.
• Isolating CWDs: Because a worker’s innate ability does not change from job to job, analyzing the correlation between changes in wages and changes in job amenities can effectively isolate the impact of CWDs. It turns out that the correlation between the change in a worker’s wages and the change in her package of job amenities is much more consistent with the CWDs model, providing stronger evidence for their existence when properly controlled for.